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EX-32.1 - EXHIBIT 32.1 - MEDCO HEALTH SOLUTIONS INCc99694exv32w1.htm
EX-32.2 - EXHIBIT 32.2 - MEDCO HEALTH SOLUTIONS INCc99694exv32w2.htm
EX-31.2 - EXHIBIT 31.2 - MEDCO HEALTH SOLUTIONS INCc99694exv31w2.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 27, 2010
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 1-31312
MEDCO HEALTH SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction of incorporation)
  22-3461740
(I.R.S. Employer Identification No.)
     
100 Parsons Pond Drive, Franklin Lakes, NJ   07417-2603
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code: 201-269-3400
 
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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer þ   Accelerated filer o   Non-Accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of the close of business on April 19, 2010, the registrant had 456,852,895 shares of common stock, $0.01 par value, issued and outstanding.
 
 

 

 


 

MEDCO HEALTH SOLUTIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
         
PART I – FINANCIAL INFORMATION
 
       
       
 
       
    1  
 
       
    2  
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    14  
 
       
    33  
 
       
    34  
 
       
PART II – OTHER INFORMATION
 
       
    34  
 
       
    35  
 
       
    35  
 
       
    35  
 
       
    35  
 
       
    35  
 
       
    37  
 
       
    38  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

 


Table of Contents

PART I — FINANCIAL INFORMATION
Item 1.   Financial Statements
MEDCO HEALTH SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In millions, except for share data)
                 
    March 27,     December 26,  
    2010     2009  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 1,562.1     $ 2,528.2  
Short-term investments
    18.2       20.1  
Manufacturer accounts receivable, net
    1,874.5       1,765.5  
Client accounts receivable, net
    1,849.6       2,063.3  
Income taxes receivable
    24.8       198.3  
Inventories, net
    1,250.4       1,285.3  
Prepaid expenses and other current assets
    73.0       67.1  
Deferred tax assets
    240.1       230.8  
 
           
Total current assets
    6,892.7       8,158.6  
Property and equipment, net
    910.6       912.5  
Goodwill
    6,352.0       6,333.0  
Intangible assets, net
    2,369.0       2,428.8  
Other noncurrent assets
    91.0       82.6  
 
           
Total assets
  $ 16,615.3     $ 17,915.5  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Claims and other accounts payable
  $ 2,839.4     $ 3,506.4  
Client rebates and guarantees payable
    2,273.2       2,106.9  
Accrued expenses and other current liabilities
    789.3       718.6  
Short-term debt
    21.1       15.8  
 
           
Total current liabilities
    5,923.0       6,347.7  
Long-term debt, net
    4,000.7       4,000.1  
Deferred tax liabilities
    918.4       958.8  
Other noncurrent liabilities
    243.9       221.7  
 
           
Total liabilities
    11,086.0       11,528.3  
 
           
 
               
Commitments and contingencies (See Note 10)
               
 
               
Stockholders’ equity:
               
Preferred stock, par value $0.01— authorized: 10,000,000 shares; issued and outstanding: 0
           
Common stock, par value $0.01— authorized: 2,000,000,000 shares; issued: 663,118,602 shares at March 27, 2010 and 660,846,867 shares at December 26, 2009
    6.6       6.6  
Accumulated other comprehensive loss
    (52.7 )     (44.2 )
Additional paid-in capital
    8,216.7       8,156.7  
Retained earnings
    5,530.1       5,209.6  
 
           
 
    13,700.7       13,328.7  
 
               
Treasury stock, at cost: 205,823,049 shares at March 27, 2010 and 186,353,868 shares at December 26, 2009
    (8,171.4 )     (6,941.5 )
 
           
Total stockholders’ equity
    5,529.3       6,387.2  
 
           
Total liabilities and stockholders’ equity
  $ 16,615.3     $ 17,915.5  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MEDCO HEALTH SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In millions, except for per share data)
                 
    Quarters Ended  
    March 27,     March 28,  
    2010     2009  
 
               
Product net revenues (Includes retail co-payments of $2,471 for 2010, and $2,259 for 2009)
  $ 16,083.7     $ 14,616.3  
Service revenues
    227.2       217.6  
 
           
Total net revenues
    16,310.9       14,833.9  
 
           
 
               
Cost of operations:
               
Cost of product net revenues (Includes retail co-payments of $2,471 for 2010, and $2,259 for 2009)
    15,253.6       13,832.0  
Cost of service revenues
    64.6       57.8  
 
           
Total cost of revenues
    15,318.2       13,889.8  
Selling, general and administrative expenses
    350.6       340.3  
Amortization of intangibles
    70.5       75.9  
Interest expense
    40.7       45.1  
Interest (income) and other (income) expense, net
    (1.4 )     (3.5 )
 
           
Total costs and expenses
    15,778.6       14,347.6  
 
           
 
               
Income before provision for income taxes
    532.3       486.3  
Provision for income taxes
    211.8       195.3  
 
           
 
               
Net income
  $ 320.5     $ 291.0  
 
           
 
               
Basic weighted average shares outstanding
    467.7       492.2  
 
               
Basic earnings per share
  $ 0.69     $ 0.59  
 
           
 
               
Diluted weighted average shares outstanding
    478.2       501.2  
 
               
Diluted earnings per share
  $ 0.67     $ 0.58  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MEDCO HEALTH SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(UNAUDITED)
(Shares in thousands; $ in millions, except for per share data)
                                                                 
    Shares of     Shares             Accumulated                          
    Common     of     $0.01 Par Value     Other                          
    Stock     Treasury     Common     Comprehensive     Additional                    
    Issued     Stock     Stock     Income (Loss)     Paid-in Capital     Retained Earnings     Treasury Stock     Total  
Balances at December 26, 2009
    660,847       186,354     $ 6.6     $ (44.2 )   $ 8,156.7     $ 5,209.6     $ (6,941.5 )   $ 6,387.2  
 
                                               
Comprehensive income (loss):
                                                               
Net income
                                  320.5             320.5  
 
                                               
Other comprehensive income (loss):
                                                               
Foreign currency translation loss
                      (8.8 )                       (8.8 )
Amortization of unrealized loss on cash flow hedge, net of tax of $(0.3)
                      0.5                         0.5  
Defined benefit plans, net of tax:
                                                               
Amortization of prior service credit included in net periodic benefit cost, net of tax of $0.4
                      (0.6 )                       (0.6 )
Net gains included in net periodic benefit cost, net of tax of $(0.2)
                      0.4                         0.4  
 
                                               
Other comprehensive income (loss)
                      (8.5 )                       (8.5 )
 
                                               
Total comprehensive income (loss)
                      (8.5 )           320.5             312.0  
Stock option activity, including tax benefit
    1,110                         61.3                   61.3  
Issuance of common stock under employee stock purchase plan
    86                         5.4                   5.4  
Restricted stock unit activity, including tax benefit
    1,076                         (6.7 )                 (6.7 )
Treasury stock acquired
          19,469                               (1,229.9 )     (1,229.9 )
 
                                               
Balances at March 27, 2010
    663,119       205,823     $ 6.6     $ (52.7 )   $ 8,216.7     $ 5,530.1     $ (8,171.4 )   $ 5,529.3  
 
                                               
The accompanying notes are an integral part of this condensed consolidated financial statement.

 

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MEDCO HEALTH SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In millions)
                 
    Quarters Ended  
    March 27,     March 28,  
    2010     2009  
Cash flows from operating activities:
               
Net income
  $ 320.5     $ 291.0  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    44.4       43.2  
Amortization of intangibles
    70.5       75.9  
Deferred income taxes
    (74.3 )     (40.5 )
Stock-based compensation on employee stock plans
    37.3       35.5  
Tax benefit on employee stock plans
    52.7       30.5  
Excess tax benefits from stock-based compensation arrangements
    (27.5 )     (11.6 )
Other
    32.1       33.5  
Net changes in assets and liabilities (net of acquisition effects for 2010):
               
Manufacturer accounts receivable, net
    (109.0 )     (107.4 )
Client accounts receivable, net
    183.2       0.9  
Inventories, net
    34.3       180.6  
Prepaid expenses and other current assets
    (5.8 )     254.3  
Income taxes receivable
    173.5       (1.3 )
Other noncurrent assets
    (7.9 )     2.6  
Claims and other accounts payable
    (666.2 )     (88.3 )
Client rebates and guarantees payable
    166.3       413.1  
Accrued expenses and other current and noncurrent liabilities
    76.2       58.3  
 
           
Net cash provided by operating activities
    300.3       1,170.3  
 
           
Cash flows from investing activities:
               
Capital expenditures
    (42.6 )     (35.4 )
Purchases of securities and other assets
    (19.5 )     (105.6 )
Acquisitions of businesses, net of cash acquired
    (19.4 )      
Proceeds from sale of securities and other investments
    16.7       44.1  
 
           
Net cash used by investing activities
    (64.8 )     (96.9 )
 
           
Cash flows from financing activities:
               
Proceeds from short-term debt
    5.3        
Purchases of treasury stock
    (1,229.9 )     (215.6 )
Excess tax benefits from stock-based compensation arrangements
    27.5       11.6  
Net payments from employee stock plans
    (4.5 )     (8.3 )
 
           
Net cash used by financing activities
    (1,201.6 )     (212.3 )
 
           
Net (decrease) increase in cash and cash equivalents
    (966.1 )     861.1  
Cash and cash equivalents at beginning of period
    2,528.2       938.4  
 
           
Cash and cash equivalents at end of period
  $ 1,562.1     $ 1,799.5  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MEDCO HEALTH SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial statements of Medco Health Solutions, Inc. and its subsidiaries (“Medco” or the “Company”) have been prepared pursuant to the Securities and Exchange Commission’s rules and regulations for reporting on Form 10-Q. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States for complete consolidated financial statements are not included herein. In the opinion of the Company’s management, all adjustments, which include adjustments of a normal recurring nature necessary for a fair statement of the financial position, results of operations and cash flows at the dates and for the periods presented, have been included. The results of operations for any interim period are not necessarily indicative of the results of operations for the full year. The unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2009. The Company’s first fiscal quarters for 2010 and 2009 each consisted of 13 weeks and ended on March 27, 2010 and March 28, 2009, respectively.
On January 29, 2010, the Company acquired DNA Direct, Inc., a leader in providing guidance and decision support to payors, physicians and patients, on a range of complex issues related to genomic medicine. The acquisition did not have a material impact on the unaudited interim condensed consolidated financial statements included in this Quarterly Report.
2. RECENTLY ADOPTED FINANCIAL ACCOUNTING STANDARDS
Subsequent Events. In May 2009, the Financial Accounting Standards Board (“FASB”) issued a standard which established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date; that is, whether that date represents the date the financial statements were issued or were available to be issued. This guidance was subsequently amended in February 2010 for SEC filers and no longer requires disclosure of the date through which an entity has evaluated subsequent events. The Company’s adoption of the standard had no impact on the unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Improving Disclosures about Fair Value Measurements. In January 2010, the FASB issued a standard which requires additional disclosure about the amounts of, and reasons for, significant transfers in and out of Level 1 and Level 2 fair value measurements. This standard also clarifies existing disclosure requirements related to the level of disaggregation of fair value measurements for each class of assets and liabilities and disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring Level 2 and Level 3 measurements. The new disclosures are effective for interim and annual reporting periods beginning after December 15, 2009. In addition, effective for interim and annual periods beginning after December 15, 2010, this standard will require disaggregated information about activity in Level 3 fair value measurements on a gross basis, rather than as one net amount. The Company’s adoption of the standard in 2010 did not have a material impact on its unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
3. FAIR VALUE DISCLOSURES
The Company accounts for and reports the fair value of certain assets and liabilities in accordance with FASB standards.
Fair Value Measurements
Fair Value Hierarchy. The inputs used to measure fair value fall into the following hierarchy:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3: Unobservable inputs reflecting the reporting entity’s own assumptions.

 

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The Company utilizes the best available information in measuring fair value. The following tables set forth, by level within the fair value hierarchy, the Company’s financial assets recorded at fair value on a recurring basis ($ in millions):
                         
Medco Fair Value Measurements at Reporting Date  
    March 27,              
Description   2010     Level 1     Level 2  
Money market mutual funds
  $ 1,049.0 (1)   $ 1,049.0     $  
Fair value of interest rate swap agreements
    14.1 (2)           14.1  
     
(1)   Reported in cash and cash equivalents on the unaudited interim condensed consolidated balance sheet.
 
(2)   Reported in other noncurrent assets on the unaudited interim condensed consolidated balance sheet.
                         
Medco Fair Value Measurements at Reporting Date  
    December 26,              
Description   2009     Level 1     Level 2  
Money market mutual funds
  $ 1,959.0 (1)   $ 1,959.0     $  
Fair value of interest rate swap agreements
    14.0 (2)           14.0  
     
(1)   Reported in cash and cash equivalents on the unaudited interim condensed consolidated balance sheet.
 
(2)   Reported in other noncurrent assets on the unaudited interim condensed consolidated balance sheet.
The Company’s money market mutual funds are invested in funds that seek to preserve principal, are highly liquid, and therefore are recorded on the consolidated balance sheets at the principal amounts deposited, which equals the asset values quoted by the money market fund custodians. The fair value of the Company’s obligation under its interest rate swap agreements, which hedge interest costs on the senior notes, is based upon observable market-based inputs that reflect the present values of the difference between estimated future fixed rate payments and future variable rate receipts, and therefore are classified within Level 2. Historically, there have not been significant fluctuations in the fair value of the Company’s financial assets.
Fair Value of Financial Instruments
The carrying amount of the term loan and revolving credit obligations under the Company’s senior unsecured bank credit facilities, short-term and long-term investments approximated fair values as of March 27, 2010 and December 26, 2009. The Company estimates fair market value for these assets and liabilities based on their market values or estimates of the present value of their future cash flows.
The carrying values and the fair values of the Company’s senior notes are shown in the following table ($ in millions):
                                 
    March 27, 2010     December 26, 2009  
    Carrying     Fair     Carrying     Fair  
    Amount     Value     Amount     Value  
7.25% senior notes due 2013
  $ 498.3 (1)   $ 564.4     $ 498.2 (1)   $ 560.8  
6.125% senior notes due 2013
    298.9 (1)     329.2       298.8 (1)     322.4  
7.125% senior notes due 2018
    1,189.4 (1)     1,373.6       1,189.1 (1)     1,341.2  
     
(1)   Reported in long-term debt, net, on the unaudited interim condensed consolidated balance sheets, net of unamortized discount.
The fair values of the senior notes are based on observable relevant market information. Fluctuations between the carrying values and the fair values of the senior notes for the periods presented are associated with changes in market interest rates.

 

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4. STOCK-BASED COMPENSATION
Stock Option Plans. The Company grants options to employees and directors to purchase shares of Medco common stock at the fair market value on the date of grant. The options generally vest over three years (director options vest in one year) and expire within 10 years from the date of the grant. The fair value of options granted is estimated on the date of grant using the Black-Scholes option-pricing model. The Company typically grants annual stock awards in February.
Summarized information related to stock options held by the Company’s employees and directors is as follows:
                                 
                    Weighted        
                    Average     Aggregate  
    Number of     Weighted     Remaining     Intrinsic  
    Shares     Average     Contractual     Value  
    (in thousands)     Exercise Price     Term     (in millions)  
Outstanding at December 26, 2009
    26,317.8     $ 34.14                  
Granted
    5,653.4       63.24                  
Exercised
    (1,083.4 )     30.61                  
Forfeited
    (70.6 )     42.86                  
 
                             
Outstanding at March 27, 2010
    30,817.2     $ 39.58       7.17     $ 783.9  
 
                       
Exercisable at March 27, 2010
    18,642.0     $ 30.92       5.99     $ 635.7  
 
                       
As of March 27, 2010 there was $150.3 million of total unrecognized compensation cost related to outstanding stock options. That cost is expected to be recognized over a weighted average period of 2.3 years.
Restricted Stock Units. The Company grants restricted stock units to employees and directors. Restricted stock units generally vest after three years (director restricted stock units vest in one year). The fair value of restricted stock units granted is determined by the product of the number of shares granted and the grant-date market price of the Company’s common stock.
Upon vesting, certain employees and directors may defer conversion of the restricted stock units to common stock. Restricted stock units granted to directors are required to be deferred until their service on the Board of Directors ends. Summarized information related to restricted stock units held by the Company’s employees and directors is as follows:
                 
            Aggregate  
    Number of     Intrinsic  
    Shares     Value  
Restricted Stock Units   (in thousands)     (in millions)  
Outstanding at December 26, 2009
    5,781.4          
Granted
    1,393.5          
Converted
    (1,756.8 )        
Forfeited
    (24.4 )        
 
             
Outstanding at March 27, 2010
    5,393.7     $ 350.7  
 
           
Vested and deferred at March 27, 2010
    729.4     $ 47.4  
 
           
The weighted average grant-date fair value of restricted stock units granted during the quarter ended March 27, 2010 was $63.24. As of March 27, 2010, there was $151.8 million of total unrecognized compensation cost related to nonvested restricted stock units. This cost is expected to be recognized over a weighted average period of 2.3 years.
5.   EARNINGS PER SHARE (“EPS”)
The following is a reconciliation of the number of weighted average shares used in the basic and diluted EPS calculations (amounts in millions):
                 
    Quarters Ended  
    March 27,     March 28,  
    2010     2009  
Basic weighted average shares outstanding
    467.7       492.2  
Dilutive common stock equivalents:
               
Outstanding stock options, restricted stock units and restricted stock
    10.5       9.0  
 
           
Diluted weighted average shares outstanding
    478.2       501.2  
 
           

 

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The FASB’s earnings per share standard requires that stock options and restricted stock units granted by the Company be treated as potential common shares outstanding in computing diluted earnings per share. Under the treasury stock method on a grant by grant basis, the amount the employee or director must pay for exercising the award, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefit that would be recorded in additional paid-in capital when the award becomes deductible, are assumed to be used to repurchase shares at the average market price during the period. For the quarters ended March 27, 2010 and March 28, 2009, there were outstanding options to purchase 5.9 million and 11.6 million shares of Medco stock, respectively, which were not dilutive to the EPS calculations when applying the treasury stock method. These outstanding options may be dilutive to future EPS calculations. The decreases in the weighted average shares outstanding and diluted weighted average shares outstanding for the quarter ended March 27, 2010 compared to the same period in 2009 result from the repurchase of approximately 205.7 million shares of stock in connection with the Company’s share repurchase programs since inception in 2005 through the first quarter of 2010, compared to an equivalent amount of 164.3 million shares repurchased inception-to-date through the end of the first quarter of 2009. The Company repurchased approximately 19.5 million shares of stock in the first quarter of 2010 compared to approximately 5.3 million shares in the first quarter of 2009. In accordance with the standard, weighted average treasury shares are not considered part of the basic or diluted shares outstanding.
6. ACCOUNTS RECEIVABLE
The Company separately reports accounts receivable due from manufacturers and accounts receivable due from clients. Client accounts receivable are presented net of allowance for doubtful accounts and include a reduction for rebates and guarantees payable to clients when these payables are settled on a net basis in the form of an invoice credit. As of March 27, 2010 and December 26, 2009, identified net Specialty Pharmacy accounts receivable, primarily due from payors and patients, amounted to $485.7 million and $483.1 million, respectively.
The Company’s allowance for doubtful accounts as of March 27, 2010 and December 26, 2009 of $143.3 million and $133.3 million, respectively, includes $94.1 million and $86.1 million, respectively, related to the Specialty Pharmacy segment. The relatively higher allowance for the Specialty Pharmacy segment reflects a different credit risk profile than the pharmacy benefit management (“PBM”) business, and is characterized by reimbursement through medical coverage, including government agencies, and higher patient co-payments. See Note 9, “Segment and Geographic Data,” to the unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for more information on the Specialty Pharmacy segment. The Company’s allowance for doubtful accounts as of March 27, 2010 and December 26, 2009 also includes $38.6 million and $37.4 million, respectively, related to PolyMedica Corporation (“PolyMedica”) for diabetes supplies, which are primarily reimbursed by government agencies and insurance companies. In addition, the Company’s allowance for doubtful accounts reflects amounts associated with member premiums for the Company’s Medicare Part D product offerings.
7. GOODWILL AND INTANGIBLE ASSETS, NET
The changes in the Company’s carrying amount of goodwill for the quarter ended March 27, 2010 are as follows ($ in millions):
                         
            Specialty        
    PBM     Pharmacy     Total  
Balances as of December 26, 2009
  $ 4,417.1     $ 1,915.9     $ 6,333.0  
Goodwill acquired
    26.5             26.5  
Translation adjustment and other
    (7.4 )     (0.1 )     (7.5 )
 
                 
 
                       
Balances as of March 27, 2010
  $ 4,436.2     $ 1,915.8     $ 6,352.0  
 
                 

 

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The following is a summary of the Company’s intangible assets ($ in millions):
                                                 
    March 27, 2010     December 26, 2009  
    Gross                     Gross              
    Carrying     Accumulated             Carrying     Accumulated        
    Value     Amortization     Net     Value     Amortization     Net  
Client relationships
  $ 3,447.6     $ 2,025.2     $ 1,422.4     $ 3,446.1     $ 1,977.2     $ 1,468.9  
Trade name
    569.9       52.2       517.7       569.3       47.6       521.7  
Manufacturer relationships
    357.5       82.0       275.5       357.5       77.5       280.0  
Patient relationships
    282.9       138.8       144.1       280.1       127.8       152.3  
Other intangible assets
    39.0       29.7       9.3       33.7       27.8       5.9  
 
                                   
Total
  $ 4,696.9     $ 2,327.9     $ 2,369.0     $ 4,686.7     $ 2,257.9     $ 2,428.8  
 
                                   
For intangible assets existing as of March 27, 2010, aggregate intangible asset amortization expense in each of the five succeeding fiscal years is estimated as follows ($ in millions):
         
Fiscal Years Ending December        
2010 (remaining)
  $ 210.7  
2011
    262.3  
2012
    253.4  
2013
    248.6  
2014
    245.8  
 
     
Total
  $ 1,220.8  
 
     
The weighted average useful life of intangible assets subject to amortization is 23 years in total. The weighted average useful life is approximately 23 years for the PBM client relationships and approximately 21 years for the Specialty Pharmacy segment-acquired intangible assets. The Company expenses the costs to renew or extend contracts associated with intangible assets in the period the costs are incurred. For PBM client relationships, the weighted average contract period prior to the next renewal date as of March 27, 2010 is approximately 1.9 years. The Company has experienced client retention rates of approximately 98% for the past two years.
8. PENSION AND OTHER POSTRETIREMENT BENEFITS
Net Pension and Postretirement Benefit Cost. The Company has various plans covering the majority of its employees. The net cost for the Company’s pension plans consisted of the following components ($ in millions):
                 
    Quarters Ended  
    March 27,     March 28,  
    2010     2009  
Service cost
  $ 6.6     $ 6.5  
Interest cost
    3.3       2.8  
Expected return on plan assets
    (3.0 )     (2.4 )
Amortization of prior service cost
    0.1       0.1  
Net amortization of actuarial losses
    0.5       1.1  
 
           
Net pension cost
  $ 7.5     $ 8.1  
 
           
The Company maintains an unfunded postretirement healthcare benefit plan covering the majority of its employees. The net credit for these postretirement benefits consisted of the following components ($ in millions):
                 
    Quarters Ended  
    March 27,     March 28,  
    2010     2009  
Service cost
  $ 0.3     $ 0.3  
Interest cost
    0.2       0.2  
Amortization of prior service credit
    (1.0 )     (1.0 )
Net amortization of actuarial losses
    0.1       0.1  
 
           
Net postretirement benefit credit
  $ (0.4 )   $ (0.4 )
 
           
The Company amended the postretirement healthcare benefit plan in 2003, which reduced and capped benefit obligations, the effect of which is reflected in the amortization of the prior service credit component of the net postretirement benefit credit.

 

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9. SEGMENT AND GEOGRAPHIC DATA
Reportable Segments. The Company has two reportable segments, PBM and Specialty Pharmacy. The PBM segment involves sales of traditional prescription drugs and supplies to the Company’s clients and members, either through the Company’s networks of contractually affiliated retail pharmacies or the Company’s mail-order pharmacies. The PBM segment also includes the operating results of PolyMedica, a provider of diabetes testing supplies and related products, as well as majority-owned Europa Apotheek Venlo B.V., which primarily provides mail-order pharmacy services in Germany. The Specialty Pharmacy segment includes the sale of higher-margin specialty pharmacy products and services for the treatment of chronic and complex (potentially life-threatening) diseases including specialty infusion services.
The Company defines the Specialty Pharmacy segment based on a product set and associated services, broadly characterized to include drugs that are usually high-cost, developed by biotechnology companies and often injectable or infusible, and may require elevated levels of patient support. When dispensed, these products frequently require ancillary administration equipment, special packaging, and a higher degree of patient-oriented customer service, including in-home nursing services and administration. Specialty pharmacy products and services are often covered through client PBM contracts. Specialty pharmacy products and services are also covered through medical benefit programs with the primary payors being insurance companies and government programs. Additionally, payors include patients, for co-payments and deductibles.
Selected Segment Income and Asset Information. Total net revenues and operating income are measures used by the chief operating decision maker to assess the performance of each of the Company’s operating segments. The following tables present selected financial information about the Company’s reportable segments, including a reconciliation of operating income to income before provision for income taxes ($ in millions):
                                                 
    Quarter Ended March 27, 2010     Quarter Ended March 28, 2009  
            Specialty                     Specialty        
    PBM     Pharmacy     Total     PBM     Pharmacy     Total  
 
                                               
Product net revenues
  $ 13,430.4     $ 2,653.3     $ 16,083.7     $ 12,352.4     $ 2,263.9     $ 14,616.3  
Service revenues
    204.2       23.0       227.2       195.2       22.4       217.6  
 
                                   
 
                                               
Total net revenues
    13,634.6       2,676.3       16,310.9       12,547.6       2,286.3       14,833.9  
Total cost of revenues
    12,831.0       2,487.2       15,318.2       11,781.0       2,108.8       13,889.8  
Selling, general and administrative expenses
    278.7       71.9       350.6       265.5       74.8       340.3  
Amortization of intangibles
    59.8       10.7       70.5       64.5       11.4       75.9  
 
                                   
 
                                               
Operating income
  $ 465.1     $ 106.5     $ 571.6     $ 436.6     $ 91.3     $ 527.9  
 
                                           
Reconciling items to income before provision for income taxes:
                                               
Interest expense
                    40.7                       45.1  
Interest (income) and other (income) expense, net
                    (1.4 )                     (3.5 )
 
                                           
Income before provision for income taxes
                  $ 532.3                     $ 486.3  
 
                                           
 
                                               
Capital expenditures
  $ 37.2       5.4       42.6     $ 30.6     $ 4.8     $ 35.4  
                                                 
    As of March 27, 2010     As of December 26, 2009  
            Specialty                     Specialty        
    PBM     Pharmacy     Total     PBM     Pharmacy     Total  
 
                                               
Identifiable Assets:
                                               
Total identifiable assets
  $ 12,863.3     $ 3,752.0     $ 16,615.3     $ 14,226.8     $ 3,688.7     $ 17,915.5  
Geographic Information. The Company’s net revenues from its European operations represented less than 1% of the Company’s consolidated net revenues for the quarters ended March 27, 2010 and March 28, 2009. All other revenues are primarily earned in the United States.

 

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10. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
In the ordinary course of business, the Company is involved in litigation, claims, government inquiries, investigations, charges and proceedings, including, but not limited to, those relating to regulatory, commercial, employment, employee benefits and securities matters. The significant matters are described below.
There is uncertainty regarding the possible course and outcome of the proceedings discussed below. Although it is not feasible to predict or determine the final outcome of any proceedings with certainty, the Company believes there is no litigation pending against the Company that could have, individually or in the aggregate, a material adverse effect on the Company’s business, financial condition, liquidity and operating results. However, there can be no assurances that an adverse outcome in any of the proceedings described below will not result in material fines, penalties and damages, changes to the Company’s business practices, loss of (or litigation with) clients or a material adverse effect on the Company’s business, financial condition, liquidity and operating results. It is also possible that future results of operations for any particular quarterly or annual period could be materially adversely affected by the ultimate resolution of one or more of these matters, or changes in the Company’s assumptions or its strategies related to these proceedings. The Company continues to believe that its business practices comply in all material respects with applicable laws and regulations and is vigorously defending itself in the actions described below. The Company believes that most of the claims made in these proceedings would not likely be covered by insurance.
In accordance with the FASB’s standard on accounting for contingencies, the Company records accruals for contingencies when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated. These assessments can involve a series of complex judgments about future events and may rely heavily on estimates and assumptions that have been deemed reasonable by management.
Government Proceedings and Requests for Information. The Company is aware of the existence of three qui tam matters—two are sealed and in the third, the government has declined to intervene and the complaint has been unsealed. The sealed first action is filed in the Eastern District of Pennsylvania and it appears to allege that the Company billed government payors using invalid or out-of-date national drug codes (“NDCs”). The sealed second action is filed in the District of New Jersey and appears to allege that the Company charged government payors a different rate than it reimbursed pharmacies; engaged in duplicate billing; refilled prescriptions too soon; and billed government payors for prescriptions written by unlicensed physicians and physicians with invalid Drug Enforcement Agency authorizations. The Department of Justice has not yet made any decision as to whether it will intervene in either of these matters. The matters are under seal and U.S. District Court orders prohibit the Company from answering inquiries about the complaints. The Company was notified of the existence of these two qui tam matters during settlement negotiations on an unrelated matter with the Department of Justice in 2006. The Company does not know the identities of the relators in either of these matters.
The third qui tam matter relates to PolyMedica, a subsidiary of the Company acquired in the fourth quarter of 2007. The Company has learned that the Government declined to intervene in the qui tam matter. This matter will now progress as a civil litigation, United States of America ex. rel. Lucas W. Matheny and Deborah Loveland vs. Medco Health Solutions, Inc., et al., in the U.S. District Court for the Southern District of Florida, although the government could decide to intervene at any point during the course of the litigation. The complaint largely includes allegations regarding the application of invoice payments.
ERISA and Similar Litigation. In December 1997, a lawsuit captioned Gruer v. Merck-Medco Managed Care, L.L.C. was filed in the U.S. District Court for the Southern District of New York against Merck & Co., Inc. (“Merck”) and the Company. The suit alleges that the Company should be treated as a “fiduciary” under the provisions of ERISA (the Employee Retirement Income Security Act of 1974) and that the Company had breached fiduciary obligations under ERISA in a variety of ways. After the Gruer case was filed, a number of other cases were filed in the same Court asserting similar claims. In December 2002, Merck and the Company agreed to settle the Gruer series of lawsuits on a class action basis for $42.5 million, and agreed to certain business practice changes, to avoid the significant cost and distraction of protracted litigation. In September 2003, the Company paid $38.3 million to an escrow account, representing the Company’s portion, or 90%, of the proposed settlement. The release of claims under the settlement applies to plans for which the Company administered a pharmacy benefit at any time between December 17, 1994 and the date of final approval. It does not involve the release of any potential antitrust claims. In May 2004, the U.S. District Court granted final approval to the settlement and a final judgment was entered in June 2004.

 

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Various appeals were taken and in October 2007, the U.S. Court of Appeals for the Second Circuit overruled all but one objection to the settlement that had been the subject of the appeals. The appeals court vacated the lower court’s approval of the settlement in one respect, and remanded the case to the District Court for further proceedings relating to the manner in which the settlement funds should be allocated between self-funded and insured plans. Since that time, the settlement has been revised to allocate a greater percentage of the settlement funds to self-funded plans, and in June 2009, the District Court approved the modified plan of allocation. The plaintiff in one of the similar Gruer series of cases discussed above, Blumenthal v. Merck-Medco Managed Care, L.L.C., et al., has elected to opt out of the settlement and several conferences have recently been held in front of the judge to determine the status of this case.
Similar ERISA-based complaints against the Company and Merck were filed in eight additional actions by ERISA plan participants, purportedly on behalf of their plans, and, in some of the actions, similarly situated self-funded plans. The ERISA plans themselves, which were not parties to these lawsuits, had elected to participate in the Gruer settlement discussed above and, accordingly, seven of these actions had been dismissed pursuant to the final judgment discussed above. The plaintiff in another action, Betty Jo Jones v. Merck-Medco Managed Care, L.L.C., et al., filed a Second Amended Complaint, in which she sought to represent a class of all participants and beneficiaries of ERISA plans that required such participants to pay a percentage co-payment on prescription drugs. The U.S. District Court subsequently found that the plaintiff in this action did not have the authority to opt out on behalf of her plan and denied and overruled her objection to the settlement, thereby resulting in this case being terminated. In addition to these cases, a proposed class action complaint against Merck and the Company has been filed in the U.S. District Court for the Northern District of California by trustees of another benefit plan, the United Food and Commercial Workers Local Union No. 1529 and Employers Health and Welfare Plan Trust. This plan has elected to opt out of the Gruer settlement. The United Food and Commercial Workers Local Union No. 1529 and Employers Health and Welfare Plan Trust v. Medco Health Solutions, Inc. and Merck & Co., Inc. action has been transferred and consolidated in the U.S. District Court for the Southern District of New York by order of the Judicial Panel on Multidistrict Litigation.
In September 2002, a lawsuit captioned Miles v. Merck-Medco Managed Care, L.L.C., based on allegations similar to those in the ERISA cases discussed above, was filed against Merck and the Company in the Superior Court of California. The theory of liability in this action is based on a California law prohibiting unfair business practices. The Miles case was removed to the U.S. District Court for the Southern District of California and was later transferred to the U.S. District Court for the Southern District of New York and consolidated with the ERISA cases pending against Merck and the Company in that Court.
The Company does not believe that it is a fiduciary under ERISA (except in those instances in which it has expressly contracted to act as a fiduciary for limited purposes), and believes that its business practices comply with all applicable laws and regulations.
Antitrust and Related Litigation. In August 2003, a lawsuit captioned Brady Enterprises, Inc., et al. v. Medco Health Solutions, Inc., et al. was filed in the U.S. District Court for the Eastern District of Pennsylvania against Merck and the Company. The plaintiffs, who seek to represent a national class of retail pharmacies that had contracted with the Company, allege that the Company has conspired with, acted as the common agent for, and used the combined bargaining power of plan sponsors to restrain competition in the market for the dispensing and sale of prescription drugs. The plaintiffs allege that, through the alleged conspiracy, the Company has engaged in various forms of anticompetitive conduct, including, among other things, setting artificially low reimbursement rates to such pharmacies. The plaintiffs assert claims for violation of the Sherman Act and seek treble damages and injunctive relief. The plaintiffs’ motion for class certification is currently pending before the Multidistrict Litigation Court.

 

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In October 2003, a lawsuit captioned North Jackson Pharmacy, Inc., et al. v. Medco Health Solutions, Inc., et al. was filed in the U.S. District Court for the Northern District of Alabama against Merck and the Company. In their Second Amended Complaint, the plaintiffs allege that Merck and the Company engaged in price fixing and other unlawful concerted actions with others, including other PBMs, to restrain trade in the dispensing and sale of prescription drugs to customers of retail pharmacies who participate in programs or plans that pay for all or part of the drugs dispensed, and conspired with, acted as the common agent for, and used the combined bargaining power of plan sponsors to restrain competition in the market for the dispensing and sale of prescription drugs. The plaintiffs allege that, through such concerted action, Merck and the Company engaged in various forms of anticompetitive conduct, including, among other things, setting reimbursement rates to such pharmacies at unreasonably low levels. The plaintiffs assert claims for violation of the Sherman Act and seek treble damages and injunctive relief. The plaintiffs’ motion for class certification has been granted, but this matter has been consolidated with other actions where class certification remains an open issue.
In December 2005, a lawsuit captioned Mike’s Medical Center Pharmacy, et al. v. Medco Health Solutions, Inc., et al. was filed against the Company and Merck in the U.S. District Court for the Northern District of California. The plaintiffs seek to represent a class of all pharmacies and pharmacists that had contracted with the Company and California pharmacies that had indirectly purchased prescription drugs from Merck and make factual allegations similar to those in the Alameda Drug Company action discussed below. The plaintiffs assert claims for violation of the Sherman Act, California antitrust law and California law prohibiting unfair business practices. The plaintiffs demand, among other things, treble damages, restitution, disgorgement of unlawfully obtained profits and injunctive relief.
In April 2006, the Brady plaintiffs filed a petition to transfer and consolidate various antitrust actions against PBMs, including North Jackson, Brady, and Mike’s Medical Center before a single federal judge. The motion was granted in August 2006. These actions are now consolidated for pretrial purposes in the U.S. District Court for the Eastern District of Pennsylvania. The consolidated action is known as In re Pharmacy Benefit Managers Antitrust Litigation. The plaintiffs’ motion for class certification in certain actions is currently pending before the Multidistrict Litigation Court.
In January 2004, a lawsuit captioned Alameda Drug Company, Inc., et al. v. Medco Health Solutions, Inc., et al. was filed against the Company and Merck in the Superior Court of California. The plaintiffs, which seek to represent a class of all California pharmacies that had contracted with the Company and that had indirectly purchased prescription drugs from Merck, allege, among other things, that since the expiration of a 1995 consent injunction entered by the U.S. District Court for the Northern District of California, if not earlier, the Company failed to maintain an Open Formulary (as defined in the consent injunction), and that the Company and Merck had failed to prevent nonpublic information received from competitors of Merck and the Company from being disclosed to each other. The plaintiffs further allege that, as a result of these alleged practices, the Company has been able to increase its market share and artificially reduce the level of reimbursement to the retail pharmacy class members, and that the prices of prescription drugs from Merck and other pharmaceutical manufacturers that do business with the Company had been fixed and raised above competitive levels. The plaintiffs assert claims for violation of California antitrust law and California law prohibiting unfair business practices. The plaintiffs demand, among other things, compensatory damages, restitution, disgorgement of unlawfully obtained profits and injunctive relief. In the complaint, the plaintiffs further allege, among other things, that the Company acts as a purchasing agent for its plan sponsor customers, resulting in a system that serves to suppress competition.
PolyMedica Shareholder Litigation. In August 2007, a putative stockholder class action lawsuit related to the merger was filed by purported stockholders of PolyMedica in the Superior Court of Massachusetts for Middlesex County against, amongst others, the Company and its affiliate, MACQ Corp. The lawsuit captioned Groen v. PolyMedica Corp. et al., alleged, among other things, that the price agreed to in the merger agreement was inadequate and unfair to the PolyMedica stockholders and that the defendants breached their duties to the stockholders and/or aided breaches of duty by other defendants in negotiating and approving the merger agreement. Shortly thereafter, two virtually identical lawsuits (only one of which named the Company as a defendant) were filed in the same Court. In September 2007, the parties to these actions reached an agreement in principle to settle the actions for an immaterial amount and in May 2008, the Court granted final approval of the settlement and dismissed the actions with prejudice on the merits. Plaintiffs’ counsel’s application for attorneys’ fees was rejected by the Court, resulting in the award of costs only. Plaintiffs’ counsel had filed a motion for reconsideration of the fees with the Court. The Court has denied this motion and the plaintiff did not appeal this denial.

 

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Other Matters
In the ordinary course of business, the Company is involved in disputes with clients, retail pharmacies and vendors, which may involve litigation, claims, arbitrations and other proceedings. Although it is not feasible to predict or determine the final outcome of any proceedings with certainty, the Company does not believe that any of these disputes could have, individually or in the aggregate, a material adverse effect on the Company’s business, financial condition, liquidity or operating results. In addition, the Company entered into an indemnification and insurance matters agreement with Merck in connection with the Company’s spin-off in 2003, which may require the Company in some instances to indemnify Merck.
Purchase Commitments
As of March 27, 2010, the Company has purchase commitments primarily for contractual commitments to purchase inventory from certain biopharmaceutical manufacturers and a brand-name pharmaceutical manufacturer, the majority of which is associated with the Company’s Specialty Pharmacy business. These consist of a firm commitment of $248.9 million, and firm commitments for 2010 of $86.8 million with additional commitments through 2012 subject to price increases or variable quantities based on patient usage or days on hand. The Company also has purchase commitments for diabetes supplies of $58.8 million, technology-related agreements of $71.7 million and advertising commitments of $9.1 million.
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause results to differ materially from those set forth in the statements. No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. Forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about the business and future financial results of the pharmacy benefit management (“PBM”) and specialty pharmacy industries, and other legal, regulatory and economic developments. We use words such as “anticipates,” “believes,” “plans,” “expects,” “projects,” “future,” “intends,” “may,” “will,” “should,” “could,” “estimates,” “predicts,” “potential,” “continue” and similar expressions to identify these forward-looking statements. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those set forth below.
    Competition in the PBM, specialty pharmacy and the broader healthcare industry is intense and could impair our ability to attract and retain clients;
    Failure to retain key clients and their members, either as a result of economic conditions, increased competition or other factors, could result in significantly decreased revenues, harm to our reputation and decreased profitability;
    Government efforts to reduce healthcare costs and alter healthcare financing practices could lead to a decreased demand for our services or to reduced profitability;
    Failure in continued execution of our retiree strategy, including the potential loss of Medicare Part D-eligible members, could adversely impact our business and financial results;
    If we fail to comply with complex and evolving laws and regulations domestically and internationally, we could suffer penalties, be required to pay substantial damages and/or make significant changes to our operations;
    If we do not continue to earn and retain purchase discounts, rebates and service fees from manufacturers at current levels, our gross margins may decline;
    From time to time we engage in transactions to acquire other companies or businesses and if we are unable to effectively integrate acquired businesses into ours, our operating results may be adversely affected. Even if we are successful, the integration of these businesses has required, and will likely continue to require, significant resources and management attention;

 

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    New legislative or regulatory initiatives that restrict or prohibit the PBM industry’s ability to use patient identifiable information could limit our ability to use information critical to the operation of our business;
    Our Specialty Pharmacy business is highly dependent on our relationships with a limited number of suppliers and the loss of any of these relationships, or limitations on our ability to provide services to these suppliers, could significantly impact our ability to sustain and/or improve our financial performance;
    Our ability to grow our Specialty Pharmacy business could be limited if we do not expand our existing base of drugs or if we lose patients;
    Our Specialty Pharmacy business, certain revenues from diabetes testing supplies and our Medicare Part D offerings expose us to increased credit risk. Additionally, current economic conditions may expose us to increased credit risk;
    Changes in reimbursement rates, including competitive bidding for durable medical equipment suppliers, could negatively affect our revenues and profits;
    Prescription volumes may decline, and our net revenues and profitability may be negatively impacted, if the safety risk profiles of drugs increase or if drugs are withdrawn from the market, including as a result of manufacturing issues, or if prescription drugs transition to over-the-counter products;
    PBMs could be subject to claims under ERISA if they are found to be a fiduciary of a health benefit plan governed by ERISA;
    Pending litigation could adversely impact our business practices and have a material adverse effect on our business, financial condition, liquidity and operating results;
    Changes in industry pricing benchmarks could adversely affect our financial performance;
    We are subject to a corporate integrity agreement and noncompliance may impede our ability to conduct business with the federal government;
    The terms and covenants relating to our existing indebtedness could adversely impact our financial performance and liquidity;
    We may be subject to liability claims for damages and other expenses not covered by insurance;
    The success of our business depends on maintaining a well-secured pharmacy operation and technology infrastructure. Additionally, significant disruptions to our infrastructure or any of our facilities due to failure to execute security measures or failure to execute business continuity plans in the event of an epidemic or pandemic or some other catastrophic event could adversely impact our business;
    We may be required to record a material non-cash charge to income if our recorded intangible assets or goodwill are impaired, or if we shorten intangible asset useful lives; and
    Anti-takeover provisions of the Delaware General Corporation Law (“DGCL”), our certificate of incorporation and our bylaws could delay or deter a change in control and make it more difficult to remove incumbent officers and directors.

 

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The foregoing list of factors is not exhaustive. You should carefully consider the foregoing factors and the other risks and uncertainties that affect our business described in our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q (including Part II, Item 1A, “Risk Factors,” of this Quarterly Report on Form 10-Q) and other documents filed from time to time with the Securities and Exchange Commission (“SEC”).
Overview
We are a leading healthcare company that is pioneering the world’s most advanced pharmacy® and our clinical research and innovations are part of Medco making medicine smarter™ for approximately 65 million members. Medco provides clinically-driven pharmacy services designed to improve the quality of care and lower total healthcare costs for private and public employers, health plans, labor unions and government agencies of all sizes, and for individuals served by Medicare Part D Prescription Drug Plans. Our unique Medco Therapeutic Resource Centers®, which conduct therapy management programs using Medco Specialist Pharmacists who have expertise in the medications used to treat certain chronic conditions, and Accredo Health Group, Medco’s Specialty Pharmacy, represent innovative models for the care of patients with chronic and complex conditions.
Our business model requires collaboration with retail pharmacies, physicians, the Centers for Medicare & Medicaid Services (“CMS”) for Medicare, pharmaceutical manufacturers and, particularly in Specialty Pharmacy, collaboration with state Medicaid agencies, and other third-party payors such as health insurers. Our programs and services help control the cost and enhance the quality of prescription drug benefits. We accomplish this by providing PBM services through our national networks of retail pharmacies and our own mail-order pharmacies, as well as through Accredo Health Group, which we believe is the nation’s largest specialty pharmacy based on revenues. Medco’s Therapeutic Resource Center focused on diabetes was augmented with the 2007 acquisition of PolyMedica Corporation (“PolyMedica”), through which we believe we became the largest diabetes pharmacy care practice based on covered patients. In 2008, we also extended our capabilities abroad when we acquired a majority interest in Europa Apotheek Venlo B.V. (“Europa Apotheek”), a privately held company based in the Netherlands that primarily provides mail-order pharmacy services in Germany. See Note 3, “Acquisitions of Businesses,” to our audited consolidated financial statements included in Part II, Item 8 of our Annual Report on Form 10-K for more information. In 2009, Medco advanced its European healthcare initiatives through a joint venture with United Drug plc, a pan-European healthcare leader, to provide home-based pharmacy care services in the United Kingdom for patients covered by the country’s National Health Service. Medco has also partnered with Sweden’s largest pharmacy chain, Apoteket, to develop a national centralized drug utilization review system. Medco will have an ongoing role in supporting this national program in Sweden. Additionally, we reinforced our commitment to advancing the science of personalized medicine through our January 2010 acquisition of DNA Direct, Inc. (“DNA Direct”), a leader in providing guidance and decision support to payors, physicians and patients, on a range of complex issues related to genomic medicine.
The complicated environment in which we operate presents us with opportunities, challenges and risks. Our clients and members are paramount to our success; the retention of existing clients and members and winning of new clients and members poses the greatest opportunity to us and the loss thereof represents an ongoing risk. The preservation of our relationships with pharmaceutical manufacturers, biopharmaceutical manufacturers and retail pharmacies is very important to the execution of our business strategies. Our future success will be largely dependent on our ability to drive mail-order volume and increase generic dispensing rates in light of the significant brand-name drug patent expirations expected to occur over the next several years, as well as our ability to continue to provide innovative and competitive clinical and other services to clients and members, including through our active participation in the Medicare Part D Prescription Drug Plan (“Medicare Part D”) benefit, the rapidly growing specialty pharmacy industry and our Therapeutic Resource Centers. Additionally, our future success will depend on our continued ability to generate positive cash flows from operations with a keen focus on asset management and maximizing return on invested capital (“ROIC”).
Our financial performance benefits from the diversity of our client base and our clinically-driven business model, which we believe provides better outcomes at lower costs for our clients. We actively monitor the status of our accounts receivable and have mechanisms in place to minimize the potential for incurring material accounts receivable credit risk. To date, we have not experienced any significant deterioration in our client or manufacturer rebates accounts receivable.

 

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We are very focused on managing our ROIC to ensure we drive significant returns to our shareholders. We believe there is a close correlation between strong ROIC and long-term shareholder value and as such, in 2009 we began including ROIC as a component in our annual performance grid, which is the basis for providing bonuses to our employees.
When we use “Medco,” “we,” “us” and “our,” we mean Medco Health Solutions, Inc., a Delaware corporation, and its consolidated subsidiaries. When we use the term “mail order,” we mean inventory dispensed through Medco’s mail-order pharmacy operations.
Key Indicators Reviewed by Management
Management reviews the following indicators in analyzing our consolidated financial performance: net revenues, with a particular focus on mail-order revenue; adjusted prescription volume; generic dispensing rate; gross margin percentage; retail pharmacy reimbursement rates; cash flow from operations; return on invested capital; diluted earnings per share; Specialty Pharmacy segment revenue and operating income; Earnings Before Interest Income/Expense, Taxes, Depreciation, and Amortization (“EBITDA”); and EBITDA per adjusted prescription. See “EBITDA” further below for a definition and calculation of EBITDA and EBITDA per adjusted prescription. We believe these measures highlight key business trends and are important in evaluating our overall performance.
Financial Performance Summary for the Quarter Ended March 27, 2010
Our diluted earnings per share increased 15.5% to $0.67 and net income increased 10.1% to $320.5 million for the first quarter of 2010 compared to $0.58 per share and $291.0 million, respectively, for the first quarter of 2009. These increases primarily reflect higher generic dispensing rates and mail-order generic volumes, favorable retail pharmacy reimbursement rates and retail volumes, and growth in the Specialty Pharmacy business, as well as a decrease in the diluted weighted average shares outstanding. These are partially offset by the effect of client renewal pricing, as well as increased selling, general and administrative (“SG&A”) expenses. For the three months ended March 27, 2010, we generated cash flow from operations of $300.3 million and had cash and cash equivalents of $1,562.1 million on our unaudited interim condensed consolidated balance sheet at March 27, 2010.
The diluted weighted average shares outstanding were 478.2 million for the first quarter of 2010, compared to 501.2 million for the first quarter of 2009, representing a decrease of 4.6%, resulting primarily from our share repurchase programs.
Our total net revenues increased 10.0% to $16,310.9 million for the first quarter of 2010. Product net revenues increased 10.0% to $16,083.7 million, which reflects higher mail-order and retail prescription volume driven by new business, as well as higher prices charged by brand-name pharmaceutical manufacturers, partially offset by a greater representation of lower-priced generic drugs and higher client price discounts. Additionally, our service revenues increased 4.4% to $227.2 million for the first quarter of 2010, driven by higher client and other service revenues primarily reflecting higher revenues associated with Medicare Part D-related product offerings and increased revenues from formulary management fees.
The total adjusted prescription volume, which adjusts mail-order prescription volume for the difference in days supply between mail order and retail, increased 5.8% to 239.2 million for the first quarter of 2010 and reflects higher mail-order and retail volumes attributed to new clients. The increase in mail-order prescription volume for the first quarter of 2010 is driven by an increase in generic volumes, as brand-name volumes were consistent with the first quarter of 2009. The adjusted mail-order penetration rate was 33.9% for the first quarter of 2010, compared to 34.0% for the first quarter of 2009.
Our overall generic dispensing rate increased to 69.7% for the first quarter of 2010, from 66.8% for the first quarter of 2009, reflecting the impact of the introduction of new generic products since the first quarter of 2009, heightened use of previously released generics, and the effect of client plan design changes promoting the use of lower-priced and more steeply discounted generics. Higher generic volumes, which contribute to lower costs for clients and members, resulted in a reduction in net revenues of approximately $690 million for the first quarter of 2010.

 

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Our overall gross margin decreased to 6.1% in the first quarter of 2010, from 6.4% in the first quarter of 2009, reflecting a lower Specialty Pharmacy gross margin percentage, the effect of client renewal pricing, and the slightly higher mix of retail prescriptions. The gross margin percentage decline was partially offset by increased generic dispensing rates and mail-order generic volumes, as well as favorable retail pharmacy reimbursement rates. We anticipate the contribution from generics to increase throughout 2010.
SG&A expenses of $350.6 million for the first quarter of 2010 increased by $10.3 million, or 3.0%, from the first quarter of 2009. This increase primarily reflects higher technology-related expenses associated with strategic initiatives.
Amortization of intangible assets of $70.5 million for the first quarter of 2010 decreased $5.4 million from the first quarter of 2009, primarily reflecting lower intangible amortization from PolyMedica associated with scheduled accelerated amortization of customer relationships.
Interest expense of $40.7 million for the first quarter of 2010 decreased $4.4 million from the first quarter of 2009, primarily reflecting lower interest rates on the floating rate components of outstanding debt. Additionally, total outstanding debt was reduced as there were repayments on our accounts receivable financing facility of $600 million during the second half of 2009.
Interest (income) and other (income) expense, net, of ($1.4) million for the first quarter of 2010 decreased $2.1 million from ($3.5) million for the first quarter of 2009, reflecting decreased interest income driven by lower interest rates earned on higher average operating cash balances.
Our effective tax rate (defined as the percentage relationship of provision for income taxes to income before provision for income taxes) was 39.8% for the first quarter of 2010, compared to 40.2% for the first quarter of 2009.
Key Financial Statement Components
Consolidated Statements of Income
Our net revenues are comprised primarily of product net revenues and are derived principally from the sale of prescription drugs through our networks of contractually affiliated retail pharmacies and through our mail-order pharmacies, and are recorded net of certain discounts, rebates and guarantees payable to clients and members. The majority of our product net revenues are derived on a fee-for-service basis. Product net revenues also include revenues from the sale of diabetes supplies by PolyMedica. Our Specialty Pharmacy product net revenues represent revenues from the sale of primarily biopharmaceutical drugs and are reported at the net amount billed to third-party payors and patients.
In addition, our product net revenues include premiums associated with our Medicare Part D Prescription Drug Program (“PDP”) risk-based product offerings. These products involve prescription dispensing for beneficiaries enrolled in the CMS-sponsored Medicare Part D prescription drug benefit. Our two insurance company subsidiaries have been operating under contracts with CMS since 2006, and currently offer several Medicare PDP options. The products involve underwriting the benefit, charging enrollees applicable premiums, providing covered prescription drugs and administering the benefit as filed with CMS. We provide three Medicare drug benefit plan options for beneficiaries, including (i) a “standard Part D” benefit plan as mandated by statute, and (ii) two benefit plans with enhanced coverage, that exceed the standard Part D benefit plan, available for an additional premium. We also offer numerous customized benefit plan designs to employer group retiree plans under the Medicare Part D prescription drug benefit.
The PDP premiums are determined based on our annual bid and related contractual arrangements with CMS. The PDP premiums are primarily comprised of amounts received from CMS as part of a direct subsidy and an additional subsidy from CMS for low-income member premiums, as well as premium payments received from members. These premiums are recognized ratably to product net revenues over the period in which members are entitled to receive benefits. Premiums received in advance of the applicable benefit period are deferred and recorded in accrued expenses and other current liabilities on the consolidated balance sheets. There is a possibility that the annual costs of drugs may be higher or lower than premium revenues. As a result, CMS provides a risk corridor adjustment for the standard drug benefit that compares our actual annual drug costs incurred to the targeted premiums in our CMS-approved bid. Based on specific collars in the risk corridor, we will receive from CMS additional premium amounts or be required to refund to CMS previously received premium amounts. We calculate the risk corridor adjustment on a quarterly basis based on drug cost experience to date and record an adjustment to product net revenues with a corresponding account receivable from or payable to CMS reflected on the consolidated balance sheets.

 

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In addition to premiums, there are certain co-payments and deductibles (the “cost share”) due from members based on prescription orders by those members, some of which are subsidized by CMS in cases of low-income membership. For subsidies received in advance, the amount is deferred and recorded in accrued expenses and other current liabilities on the consolidated balance sheets. If there is cost share due from members or CMS, the amount is accrued and recorded in client accounts receivable, net, on the consolidated balance sheets. After the end of the contract year and based on actual annual drug costs incurred, cost share amounts are reconciled with CMS and the corresponding receivable or payable is settled. The cost share is treated consistently as other co-payments derived from providing PBM services, as a component of product net revenues on the consolidated statements of income where the requirements of Authoritative Guidance are met. For further details, see our critical accounting policies included in “—Use of Estimates and Critical Accounting Policies and Estimates” and Note 2, “Summary of Significant Accounting Policies,” to our audited consolidated financial statements included in Part II, Items 7 and 8, respectively, of our Annual Report on Form 10-K for the fiscal year ended December 26, 2009. Premium revenues for our PDP products, which exclude member cost share, were $182 million, or approximately 1% of total net revenues, in the first quarter of 2010, and $143 million, or approximately 1% of total net revenues, in the first quarter of 2009.
Our agreements with CMS, as well as applicable Medicare Part D regulations and federal and state laws, require us to, among other obligations: (i) comply with certain disclosure, filing, record-keeping and marketing rules; (ii) operate quality assurance, drug utilization management and medication therapy management programs; (iii) support e-prescribing initiatives; (iv) implement grievance, appeals and formulary exception processes; (v) comply with payment protocols, which include the return of overpayments to CMS and, in certain circumstances, coordination with state pharmacy assistance programs; (vi) use approved networks and formularies, and provide access to such networks to “any willing pharmacy;” (vii) provide emergency out-of-network coverage; and (viii) implement a comprehensive Medicare and Fraud, Waste and Abuse compliance program. We have various contractual and regulatory compliance requirements associated with participating in Medicare Part D. Similar to our requirements with other clients, our policies and practices associated with executing our PDP are subject to audit. If material contractual or regulatory non-compliance was to be identified, monetary penalties and/or applicable sanctions, including suspension of enrollment and marketing or debarment from participation in Medicare programs, may be imposed. Additionally, each calendar year, payment will vary based on the annual benchmark that applies as a result of Medicare Part D plan bids for the applicable year, as well as for changes in the CMS methodology for calculating risk adjustment factors.
Service revenues consist principally of administrative fees and clinical program fees earned from clients, sales of prescription services to pharmaceutical manufacturers, performance-oriented fees paid by Specialty Pharmacy manufacturers, and other non-product-related revenues.
Cost of revenues is comprised primarily of cost of product net revenues and is principally attributable to the dispensing of prescription drugs. Cost of product net revenues for prescriptions dispensed through our networks of retail pharmacies are comprised of the contractual cost of drugs dispensed by, and professional fees paid to, retail pharmacies in the networks, including the associated member co-payments. Our cost of product net revenues relating to drugs dispensed by our mail-order pharmacies consists primarily of the cost of inventory dispensed and our costs incurred to process and dispense the prescriptions, including the associated fixed asset depreciation. The operating costs of our call center pharmacies are also included in cost of product net revenues. In addition, cost of product net revenues includes a credit for rebates earned from brand-name pharmaceutical manufacturers whose drugs are included in our formularies. These rebates generally take the form of formulary rebates, which are earned based on the volume of a specific drug dispensed, or market share rebates, which are earned based on the achievement of contractually specified market share levels.

 

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Our cost of product net revenues also includes the cost of drugs dispensed by our mail-order pharmacies or retail network for members covered under our Medicare PDP product offerings and are recorded at cost as incurred. We receive a catastrophic reinsurance subsidy from CMS for approximately 80% of costs incurred by individual members in excess of the individual annual out-of-pocket maximum of $4,550 for coverage year 2010 and $4,350 for coverage year 2009. The subsidy is reflected as an offsetting credit in cost of product net revenues to the extent that catastrophic costs are incurred. Catastrophic reinsurance subsidy amounts received in advance are deferred and recorded in accrued expenses and other current liabilities on the consolidated balance sheets. If there are catastrophic reinsurance subsidies due from CMS, the amount is accrued and recorded in client accounts receivable, net, on the consolidated balance sheets. After the end of the contract year and based on actual annual drug costs incurred, catastrophic reinsurance amounts are reconciled with CMS and the corresponding receivable or payable is settled. Cost of service revenues consist principally of labor and operating costs for delivery of services provided, as well as costs associated with member communication materials.
SG&A expenses reflect the costs of operations dedicated to executive management, the generation of new sales, maintenance of existing client relationships, management of clinical programs, enhancement of technology capabilities, direction of pharmacy operations, and performance of reimbursement activities, in addition to finance, legal and other staff activities, and the effect of certain legal settlements. SG&A also includes direct response advertising expenses associated with PolyMedica, which are expensed as incurred.
Interest expense is incurred on our senior unsecured bank credit facilities, accounts receivable financing facility and other short-term debt, and senior notes, and includes net interest on our interest rate swap agreements on $200 million of the $500 million of 7.25% senior notes due in 2013. In addition, it includes amortization of the effective portion of our settled forward-starting interest rate swap agreements and amortization of debt issuance costs.
Interest (income) and other (income) expense, net, includes interest income generated by cash and cash equivalent investments, as well as short-term and long-term investments in marketable securities.
For further details, see our critical accounting policies included in “—Use of Estimates and Critical Accounting Policies and Estimates” and Note 2, “Summary of Significant Accounting Policies,” to our audited consolidated financial statements included in Part II, Items 7 and 8, respectively, of our Annual Report on Form 10-K for the fiscal year ended December 26, 2009.
Consolidated Balance Sheets
Our primary assets include cash and cash equivalents, short-term and long-term investments, manufacturer accounts receivable, client accounts receivable, inventories, fixed assets, deferred tax assets, goodwill and intangible assets. Cash and cash equivalents reflect the accumulation of net positive cash flows from our operations, investing and financing activities, and primarily include time deposits with banks or other financial institutions, and money market mutual funds. Our short-term and long-term investments include U.S. government securities that are held to satisfy statutory capital requirements for our insurance subsidiaries.
Manufacturer accounts receivable balances primarily include amounts due from brand-name pharmaceutical manufacturers for earned rebates and other prescription services. Client accounts receivable represent amounts due from clients, other payors and patients for prescriptions dispensed from retail pharmacies in our networks or from our mail-order pharmacies, including fees due to us, net of allowances for doubtful accounts, as well as contractual allowances and any applicable rebates and guarantees payable when these payables are settled on a net basis in the form of an invoice credit. In cases where rebates and guarantees are settled with the client on a net basis, and the rebates and guarantees payable are greater than the corresponding client accounts receivable balances, the net liability is reclassified to client rebates and guarantees payable. When these payables are settled in the form of a check or wire, they are recorded on a gross basis and the entire liability is reflected in client rebates and guarantees payable. Our client accounts receivable also includes receivables from CMS for our Medicare PDP product offerings and premiums from members. Additionally, we have receivables from Medicare and Medicaid for a portion of our Specialty Pharmacy business, and diabetes supplies dispensed by PolyMedica.

 

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Inventories reflect the cost of prescription products held for dispensing by our mail-order pharmacies and are recorded on a first-in, first-out basis, net of allowances for losses. Deferred tax assets primarily represent temporary differences between the financial statement basis and the tax basis of certain accrued expenses, stock-based compensation, and client rebate pass-back liabilities. Income taxes receivable represents amounts due from taxing authorities associated primarily with the approval of a favorable accounting method change received from the IRS in 2006 for the timing of the deductibility of certain rebates passed back to clients. The federal portion was received in the first quarter of 2010. Fixed assets include investments in our corporate headquarters, mail-order pharmacies, call center pharmacies, account service offices, and information technology, including capitalized software development. Goodwill and intangible assets are comprised primarily of the goodwill and intangibles that had been pushed down to our consolidated balance sheets and existed when we became an independent, publicly traded enterprise in 2003, goodwill and intangibles recorded upon our acquisition in 2007 of PolyMedica, and, for the Specialty Pharmacy segment, goodwill and intangible assets recorded primarily from our acquisition of Accredo Health, Incorporated (“Accredo”) in 2005 and Critical Care Systems, Inc. in 2007.
Our primary liabilities include claims and other accounts payable, client rebates and guarantees payable, accrued expenses and other current liabilities, debt and deferred tax liabilities. Claims and other accounts payable primarily consist of amounts payable to retail network pharmacies for prescriptions dispensed and services rendered by the retail pharmacies, as well as amounts payable for mail-order prescription inventory purchases and other purchases made in the normal course of business. Client rebates and guarantees payable include amounts due to clients that will ultimately be settled in the form of a check or wire, as well as any residual liability in cases where the payable is settled as an invoice credit and exceeds the corresponding client accounts receivable balances. Accrued expenses and other current liabilities primarily consist of employee- and facility-related cost accruals incurred in the normal course of business, as well as income taxes payable. Accrued expenses and other current liabilities are also comprised of certain premiums, and may also include cost share, and catastrophic reinsurance payments received in advance from CMS for our Medicare PDP product offerings. Our debt is primarily comprised of a senior unsecured term loan facility, a senior unsecured revolving credit facility, and senior notes. In addition, we have a net deferred tax liability primarily associated with our recorded intangible assets. We do not have any material off-balance sheet arrangements, other than purchase commitments and lease obligations. See “—Commitments and Contractual Obligations” below.
Our stockholders’ equity includes an offset for purchases of our common stock under our share repurchase program. The accumulated other comprehensive loss component of stockholders’ equity includes: unrealized investment gains and losses, foreign currency translation adjustments resulting primarily from the translation of Europa Apotheek’s assets and liabilities and results of operations, unrealized gains and losses on effective cash flow hedges, and the net gains and losses and prior service costs and credits related to our pension and other postretirement benefit plans.
Consolidated Statements of Cash Flows
An important element of our operating cash flows is the timing of billing cycles, which are generally two-week periods of accumulated billings for retail and mail-order prescriptions. We bill the cycle activity to clients on this bi-weekly schedule and generally collect from our clients before we pay our obligations to the retail pharmacies for that same cycle. At the end of any given reporting period, unbilled PBM receivables can represent up to two weeks of dispensing activity and will fluctuate at the end of a fiscal month depending on the timing of these billing cycles. A portion of the Specialty Pharmacy business includes reimbursement by payors, such as insurance companies, under a medical benefit, or by Medicare or Medicaid. These transactions also involve higher patient co-payments than experienced in the PBM business. As a result, this portion of the Specialty Pharmacy business, which yields a higher margin than the PBM business, experiences slower accounts receivable turnover than in the aforementioned PBM cycle and has a different credit risk profile. Our operating cash flows are also impacted by timing associated with our Medicare PDP product offerings, including premiums, cost share, and catastrophic reinsurance received from CMS. In addition, our operating cash flows include tax benefits for employee stock plans up to the amount associated with compensation expense.
Ongoing operating cash flows are associated with expenditures to support our mail-order, retail pharmacy network operations, call center pharmacies and other SG&A functions. The largest components of these expenditures include payments to retail pharmacies; mail-order inventory purchases, which are paid in accordance with payment terms offered by our suppliers to take advantage of appropriate discounts, rebate and guarantee payments to clients; employee payroll and benefits; facility operating expenses and income taxes. In addition, earned brand-name pharmaceutical manufacturers’ rebates are recorded monthly based upon prescription dispensing, with actual bills rendered on a quarterly basis and paid by the manufacturers within an agreed-upon term. Payments of rebates to clients are generally made after our receipt of the rebates from the brand-name pharmaceutical manufacturers, although some clients may receive more accelerated rebate payments in exchange for other elements of pricing in their contracts.

 

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Ongoing investing cash flows are primarily associated with capital expenditures including technology investments, as well as purchases of securities and other assets, and proceeds from securities and other investments, which primarily relate to investment activities of our insurance companies. Acquisitions will also generally result in cash outflows from investing activities. Ongoing financing cash flows primarily include share repurchases, proceeds from employee stock plans, and the benefits of realized tax deductions in excess of tax benefits on compensation expense.
Clients
We have clients in a broad range of industry categories, including various Blue Cross/Blue Shield plans; managed care organizations; insurance carriers; third-party benefit plan administrators; employers; federal, state and local government agencies; and union-sponsored benefit plans. For the first quarter of 2010, our ten largest clients based on revenue accounted for approximately 47% of our net revenues, including UnitedHealth Group Incorporated (“UnitedHealth Group”), our largest client, which represented approximately $2,800 million, or 17%, of our net revenues. For the first quarter of 2009, our ten largest clients based on revenue accounted for approximately 48% of our net revenues, including UnitedHealth Group, which represented approximately $2,900 million, or 19%, of our net revenues. The UnitedHealth Group account has a lower than average mail-order penetration and, because of its size, steeper pricing than the average client, and consequently generally yields lower profitability as a percentage of net revenues than smaller client accounts. In addition, with respect to mail-order volume, which is an important contributor to our overall profitability, the mail-order volume associated with this account represented less than 10% of our overall mail-order volume for both the first quarters of 2010 and 2009. Under our current agreement with UnitedHealth Group, we are providing pharmacy benefit services through December 31, 2012. None of our other clients individually represented more than 10% of our net revenues in the first quarter of 2010 or 2009.
Segment Discussion
We have two reportable segments, PBM and Specialty Pharmacy. The PBM segment involves sales of traditional prescription drugs and supplies to our clients and members, either through our network of contractually affiliated retail pharmacies or our mail-order pharmacies. The PBM segment also includes the operating results of PolyMedica, a provider of diabetes testing supplies and related products, as well as majority-owned Europa Apotheek, which primarily provides mail-order pharmacy services in Germany. The Specialty Pharmacy segment includes the sale of higher-margin specialty pharmacy products and services for the treatment of chronic and complex (potentially life-threatening) diseases including specialty infusion services.
We define the Specialty Pharmacy segment based on a product set and associated services, broadly characterized to include drugs that are usually high-cost, developed by biotechnology companies and often injectable or infusible, and may require elevated levels of patient support. When dispensed, these products frequently require ancillary administration equipment, special packaging, and a higher degree of patient-oriented customer service, including in-home nursing services and administration. Specialty pharmacy products and services are often covered through client PBM contracts. Specialty pharmacy products and services are also covered through medical benefit programs with the primary payors being insurance companies and government programs. Additionally, payors include patients, for co-payments and deductibles.
The PBM segment is measured and managed on an integrated basis, and there is no distinct measurement that separates the performance and profitability of mail order and retail. We offer fully integrated PBM services to virtually all of our PBM clients and their members. The PBM services we provide to our clients are generally delivered and managed under a single contract for each client. The PBM and Specialty Pharmacy segments primarily operate in the United States and have relatively small activities in Puerto Rico, Germany and the United Kingdom.
As a result of the nature of our integrated PBM services and contracts, the chief operating decision maker views Medco’s PBM operations as a single segment for purposes of making decisions about resource allocations and in assessing performance.

 

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Consolidated Results of Operations
The following table presents selected consolidated comparative results of operations and volume performance ($ and volumes in millions):
                                 
    Quarter                     Quarter  
    Ended                     Ended  
    March 27,                     March 28,  
    2010     Variance     2009  
Net Revenues
                               
Retail product(1)
  $ 10,035.7     $ 911.1       10.0 %   $ 9,124.6  
Mail-order product
    6,048.0       556.3       10.1 %     5,491.7  
 
                       
 
                               
Total product(1)
  $ 16,083.7     $ 1,467.4       10.0 %   $ 14,616.3  
 
                       
 
                               
Client and other service
    188.7       12.9       7.3 %     175.8  
Manufacturer service
    38.5       (3.3 )     (7.9 )%     41.8  
 
                       
 
                               
Total service
  $ 227.2     $ 9.6       4.4 %   $ 217.6  
 
                       
 
                               
Total net revenues(1)
  $ 16,310.9     $ 1,477.0       10.0 %   $ 14,833.9  
 
                       
 
                               
Cost of Revenues
                               
Product(1)
  $ 15,253.6     $ 1,421.6       10.3 %   $ 13,832.0  
Service
    64.6       6.8       11.8 %     57.8  
 
                       
 
                               
Total cost of revenues(1)
  $ 15,318.2     $ 1,428.4       10.3 %   $ 13,889.8  
 
                       
 
                               
Gross Margin(2)
                               
Product
  $ 830.1     $ 45.8       5.8 %   $ 784.3  
Product gross margin percentage
    5.2 %     (0.2 )%             5.4 %
Service
  $ 162.6     $ 2.8       1.8 %   $ 159.8  
Service gross margin percentage
    71.6 %     (1.8 )%             73.4 %
Total gross margin
  $ 992.7     $ 48.6       5.1 %   $ 944.1  
Gross margin percentage
    6.1 %     (0.3 )%             6.4 %
 
                       
 
                               
Volume Information
                               
Retail prescriptions
    158.1       8.7       5.8 %     149.4  
Mail-order prescriptions
    27.2       1.5       5.8 %     25.7  
 
                       
Total prescriptions
    185.3       10.2       5.8 %     175.1  
 
                       
 
                               
Adjusted prescriptions(3)
    239.2       13.1       5.8 %     226.1  
 
                       
Adjusted mail-order penetration(4)
    33.9 %     (0.1 )%             34.0 %
Other volume(5)
    2.1       0.4       23.5 %     1.7  
 
                               
Generic Dispensing Rate Information
                               
Retail generic dispensing rate
    71.4 %     2.9 %             68.5 %
Mail-order generic dispensing rate
    59.3 %     2.1 %             57.2 %
Overall generic dispensing rate
    69.7 %     2.9 %             66.8 %
     
(1)   Includes retail co-payments of $2,471 million for the first quarter of 2010 and $2,259 million for the first quarter of 2009.
 
(2)   Represents total net revenues minus total cost of revenues.
 
(3)   Adjusted prescription volume equals substantially all mail-order prescriptions multiplied by three, plus retail prescriptions. These mail-order prescriptions are multiplied by three to adjust for the fact that they include approximately three times the amount of product days supplied compared with retail prescriptions.
 
(4)   Represents the percentage of adjusted mail-order prescriptions to total adjusted prescriptions.
 
(5)   Represents over-the-counter drugs, as well as diabetes supplies primarily dispensed by PolyMedica.
Net Revenues
Retail. The increase in retail net revenues of $911 million for the first quarter of 2010 reflects net volume increases of $535 million, primarily from new business, partially offset by lower utilization and client terminations. Also contributing to the higher retail net revenues are net price increases of $376 million driven by higher prices charged by brand-name pharmaceutical manufacturers, partially offset by higher client price discounts. The aforementioned net price variance includes the offsetting effect of approximately $510 million from a greater representation of lower-priced generic drugs in the first quarter of 2010.

 

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Mail-Order. The increase in mail-order net revenues of $556 million for the first quarter of 2010 reflects net volume increases of $321 million driven by higher generic volumes. The higher-priced brand-name volumes were consistent with the first quarter of 2009; however, the less expensive generic volumes were higher in part as a result of the economy and plan design changes. Also contributing to the mail-order net revenue increase are net price increases of $235 million driven by higher prices charged by brand-name pharmaceutical manufacturers, partially offset by higher client price discounts. The aforementioned net price variance includes the offsetting effect of approximately $180 million from a greater representation of lower-priced generic drugs in the first quarter of 2010.
Our overall generic dispensing rate increased to 69.7% for the first quarter of 2010, compared to 66.8% for the first quarter of 2009. Mail-order and retail generic dispensing rates increased to 59.3% and 71.4%, respectively, for the first quarter of 2010, compared to 57.2% and 68.5%, respectively, for the first quarter of 2009. These increases reflect the impact of the introduction of new generic products since the first quarter of 2009 and the effect of programs and client plan design changes promoting the use of lower-priced and more steeply discounted generics.
Service revenues increased $9.6 million in the first quarter of 2010 as a result of higher client and other service revenues of $12.9 million, partially offset by lower manufacturer service revenues of $3.3 million. The higher client and other service revenues primarily reflect higher revenue associated with Medicare Part D-related product offerings and increased revenues from formulary management fees. The lower manufacturer service revenues reflect reduced administrative fees from manufacturer contract revisions.
Gross Margin
Our product gross margin percentage was 5.2% for the first quarter of 2010, compared to 5.4% for the first quarter of 2009, reflecting a lower Specialty Pharmacy gross margin percentage, the effect of client renewal pricing, and the slightly higher mix of retail prescriptions. The decline in gross margin percentage was partially offset by increased generic dispensing rates and mail-order generic volumes, as well as favorable retail pharmacy reimbursement rates.
Rebates from brand-name pharmaceutical manufacturers, which are reflected as a reduction in cost of product net revenues, totaled $1,452 million for the first quarter of 2010 and $1,306 million for the first quarter of 2009, with formulary rebates representing 83.6% and 67.7% of total rebates, respectively. The overall increases in rebates reflect volume from new clients and favorable pharmaceutical manufacturer rebate contract revisions, as well as improved formulary management and patient compliance, partially offset by brand-name drug volumes that have converted to generic drugs. The increase in the formulary rebate percentage of total rebates reflects the composition of new client business and manufacturer contract revisions. We retained approximately $176 million, or 12.1%, of total rebates in the first quarter of 2010, and $167 million, or 12.8%, in the first quarter of 2009. The decrease in the retained rebate percentage is reflective of client mix and the associated client preferences regarding the rebate sharing aspects of their overall contract pricing structure.
Service gross margin of $162.6 million for the first quarter of 2010 increased $2.8 million compared to $159.8 million for the first quarter of 2009, reflecting the aforementioned increase in service revenues of $9.6 million, partially offset by an increase in cost of service revenues of $6.8 million. The cost of service revenue increase reflects higher labor and other costs associated with Medicare Part D programs and formulary management fees.

 

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The following table presents additional selected consolidated comparative results of operations ($ in millions):
                                 
    Quarter                     Quarter  
    Ended                     Ended  
    March 27,                     March 28,  
    2010     Variance     2009  
 
                               
Gross margin(1)
  $ 992.7     $ 48.6       5.1 %   $ 944.1  
Selling, general and administrative expenses
    350.6       10.3       3.0 %     340.3  
Amortization of intangibles
    70.5       (5.4 )     (7.1 )%     75.9  
Interest expense
    40.7       (4.4 )     (9.8 )%     45.1  
Interest (income) and other (income) expense, net
    (1.4 )     2.1       (60.0 )%     (3.5 )
 
                       
 
                               
Income before provision for income taxes
    532.3       46.0       9.5 %     486.3  
Provision for income taxes
    211.8       16.5       8.4 %     195.3  
 
                       
 
                               
Net income
  $ 320.5     $ 29.5       10.1 %   $ 291.0  
 
                       
     
(1)   Represents total net revenues minus total cost of revenues.
Selling, General and Administrative Expenses
SG&A expenses for the first quarter of 2010 were $350.6 million and increased from the first quarter of 2009 by $10.3 million, or 3.0%. This increase primarily reflects higher technology-related expenses associated with strategic initiatives.
Amortization of Intangibles
Amortization of intangible assets of $70.5 million for the first quarter of 2010 decreased $5.4 million from the first quarter of 2009, primarily reflecting lower intangible amortization from PolyMedica associated with scheduled accelerated amortization of customer relationships.
Interest Expense
Interest expense of $40.7 million for the first quarter of 2010 decreased $4.4 million from the first quarter of 2009, primarily reflecting lower interest rates on the floating rate components of outstanding debt. Additionally, total outstanding debt was reduced as there were repayments on our accounts receivable financing facility of $600 million during the second half of 2009.
The weighted average interest rate on our indebtedness was approximately 4.0% for the first quarter of 2010, compared to approximately 3.8% for the first quarter of 2009. The slight increase in the weighted average interest rate reflects a higher mix of fixed rate compared with variable rate outstanding debt as a result of the aforementioned repayments. This is partially offset by lower interest rates on the floating rate components of outstanding debt.
Interest (Income) and Other (Income) Expense, Net
Interest (income) and other (income) expense, net, of ($1.4) million for the first quarter of 2010 decreased $2.1 million from ($3.5) million for the first quarter of 2009, reflecting decreased interest income driven by lower interest rates earned on higher average operating cash balances.
Provision for Income Taxes
Our effective tax rate (defined as the percentage relationship of provision for income taxes to income before provision for income taxes) was 39.8% for the first quarter of 2010, compared to 40.2% for the first quarter of 2009. The lower rate in the first quarter of 2010 reflects state-related items.

 

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Net Income and Earnings per Share
Net income as a percentage of net revenues was 2.0% for the first quarter of 2010, consistent with the first quarter of 2009, reflecting the aforementioned factors.
Diluted earnings per share increased 15.5% to $0.67 in the first quarter of 2010, from $0.58 in the first quarter of 2009. The diluted weighted average shares outstanding were 478.2 million for the first quarter of 2010, compared to 501.2 million for the first quarter of 2009, representing a decrease of 4.6%. The decrease primarily results from the repurchase of approximately 205.7 million shares of stock in connection with our share repurchase programs since inception in 2005 through the first quarter of 2010, compared to an equivalent amount of 164.3 million shares repurchased inception-to-date through the end of the first quarter of 2009. There were approximately 19.5 million shares repurchased in the first quarter of 2010, compared to approximately 5.3 million in the first quarter of 2009.
Segment Results of Operations
PBM Segment
The PBM segment involves sales of traditional prescription drugs and supplies to our clients and members, either through our networks of contractually affiliated retail pharmacies or our mail-order pharmacies. The following table presents selected PBM segment comparative results of operations ($ in millions):
                                 
    Quarter                     Quarter  
    Ended                     Ended  
    March 27,                     March 28,  
    2010     Variance     2009  
 
                               
Product net revenues
  $ 13,430.4     $ 1,078.0       8.7 %   $ 12,352.4  
Service revenues
    204.2       9.0       4.6 %     195.2  
 
                       
Total net revenues
    13,634.6       1,087.0       8.7 %     12,547.6  
Total cost of revenues
    12,831.0       1,050.0       8.9 %     11,781.0  
 
                       
 
                               
Total gross margin(1)
  $ 803.6     $ 37.0       4.8 %   $ 766.6  
Gross margin percentage
    5.9 %     (0.2 )%             6.1 %
 
                       
 
                               
Selling, general and administrative expenses
    278.7       13.2       5.0 %     265.5  
Amortization of intangibles
    59.8       (4.7 )     (7.3 )%     64.5  
 
                       
Operating income
  $ 465.1     $ 28.5       6.5 %   $ 436.6  
 
                       
     
(1)   Represents total net revenues minus total cost of revenues.
PBM total net revenues of $13,634.6 million for the first quarter of 2010 increased $1,087.0 million, compared to the revenues of $12,547.6 million for the first quarter of 2009. The increase primarily reflects higher mail-order generic and retail volume driven by new business, as well as higher prices charged by brand-name pharmaceutical manufacturers, partially offset by a greater representation of lower-priced generic drugs and higher client price discounts.
Gross margins were 5.9% of net revenues for the first quarter of 2010, compared to 6.1% for the first quarter of 2009, reflecting the effect of client renewal pricing and a slightly higher mix of retail prescriptions. The decline in gross margin percentage was partially offset by increased generic dispensing rates and mail-order generic volumes, as well as favorable retail pharmacy reimbursement rates.
SG&A expenses were $278.7 million for the first quarter of 2010, and increased from the first quarter of 2009 by $13.2 million. The increase primarily reflects higher technology-related expenses associated with strategic initiatives, as well as higher employee-related expenses.
Amortization of intangible assets was $59.8 million for the first quarter of 2010, compared to $64.5 million for the first quarter of 2009. The decrease primarily reflects lower intangible amortization from PolyMedica associated with scheduled accelerated amortization of customer relationships.

 

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Operating income of $465.1 million for the first quarter of 2010 increased $28.5 million, or 6.5%, from the first quarter of 2009, reflecting the aforementioned factors.
For additional information on the PBM segment, see Note 9, “Segment and Geographic Data,” to the unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Specialty Pharmacy Segment
The Specialty Pharmacy segment includes the sale of higher-margin specialty pharmacy products and services for the treatment of chronic and complex (potentially life-threatening) diseases. The following table presents selected Specialty Pharmacy segment comparative results of operations ($ in millions):
                                 
    Quarter                     Quarter  
    Ended                     Ended  
    March 27,                     March 28,  
    2010     Variance     2009  
 
                               
Product net revenues
  $ 2,653.3     $ 389.4       17.2 %   $ 2,263.9  
Service revenues
    23.0       0.6       2.7 %     22.4  
 
                       
Total net revenues
    2,676.3       390.0       17.1 %     2,286.3  
Total cost of revenues
    2,487.2       378.4       17.9 %     2,108.8  
 
                       
 
                               
Total gross margin (1)
  $ 189.1     $ 11.6       6.5 %   $ 177.5  
Gross margin percentage
    7.1 %     (0.7 )%             7.8 %
 
                       
 
                               
Selling, general and administrative expenses
    71.9       (2.9 )     (3.9 )%     74.8  
Amortization of intangibles
    10.7       (0.7 )     (6.1 )%     11.4  
 
                       
Operating income
  $ 106.5     $ 15.2       16.6 %   $ 91.3  
 
                       
     
(1)   Represents total net revenues minus total cost of revenues.
Specialty Pharmacy total net revenues of $2,676.3 million for the first quarter of 2010 increased $390.0 million, compared to revenues of $2,286.3 million for the first quarter of 2009, primarily reflecting increased volume from new and existing clients, as well as higher prices charged by pharmaceutical manufacturers.
Gross margins were 7.1% of net revenues for the first quarter of 2010, compared to 7.8% for the first quarter of 2009, primarily reflecting product, channel and new client mix, as well as lower manufacturer price increases.
SG&A expenses of $71.9 million for the first quarter of 2010 decreased $2.9 million compared to $74.8 million for the first quarter 2009, primarily reflecting lower technology and employee-related expenses. Amortization of intangible assets was $10.7 million for the first quarter of 2010, compared to $11.4 million for the first quarter of 2009.
Operating income of $106.5 million for the first quarter of 2010 increased $15.2 million, or 16.6%, from the first quarter of 2009, reflecting the aforementioned factors.
For additional information on the Specialty Pharmacy segment, see Note 9, “Segment and Geographic Data,” to the unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

 

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Liquidity and Capital Resources
Cash Flows
The following table presents selected data from our unaudited interim condensed consolidated statements of cash flows ($ in millions):
                         
    Quarter             Quarter  
    Ended             Ended  
    March 27,             March 28,  
    2010     Variance     2009  
Net cash provided by operating activities
  $ 300.3     $ (870.0 )   $ 1,170.3  
Net cash used by investing activities
    (64.8 )     32.1       (96.9 )
Net cash used by financing activities
    (1,201.6 )     (989.3 )     (212.3 )
 
                 
 
                       
Net (decrease) increase in cash and cash equivalents
    (966.1 )     (1,827.2 )     861.1  
Cash and cash equivalents at beginning of period
    2,528.2       1,589.8       938.4  
 
                 
Cash and cash equivalents at end of period
  $ 1,562.1     $ (237.4 )   $ 1,799.5  
 
                 
Operating Activities. Net cash provided by operating activities of $300.3 million for the first quarter of 2010 primarily reflects net income of $320.5 million, with non-cash adjustments for depreciation and amortization of $114.9 million and stock-based compensation of $37.3 million. In addition, there were net cash inflows of $183.2 million from a decrease in client accounts receivable, net, primarily due to the timing of our billing cycles, and cash inflows of $173.5 million from a decrease in income taxes receivable resulting from the receipt of an IRS refund for tax years 2003 through 2005. Net cash provided by operating activities for the first quarter of 2010 also includes net cash inflows of $166.3 million from an increase in client rebates and guarantees payable reflecting increased client rebates passed back to clients and payment timing, and net cash inflows of $34.3 million from a decrease in inventories, net, reflecting continued initiatives to optimize inventory levels. These increases were partially offset by net cash outflows of $666.2 million from a decrease in claims and other accounts payable, primarily due to the timing of payments, and net cash outflows of $109.0 million from an increase in manufacturer accounts receivable, net, due to increased prescription volume.
The $870.0 million decrease in net cash provided by operating activities for the first quarter of 2010 compared to the first quarter of 2009 is primarily due to a decrease in cash flows of $577.9 million from claims and other accounts payable due to higher retail volumes and business growth in the first quarter of 2009 compared to the first quarter of 2010, and timing of payments. Additionally there were decreased cash flows of $260.1 million from prepaid expenses and other current assets resulting from the timing of a significant prepaid client rebate, and $246.8 million from client rebates and guarantees payable, as well as a decrease in cash flows of $146.3 million from inventories, net, reflecting initiatives in 2009 to optimize inventory levels with decreased opportunities in the first quarter of 2010. These decreases were partially offset by increased cash flows of $182.3 million from client accounts receivable, net, and increased cash flows of $174.8 million due to the aforementioned IRS refund received in the first quarter of 2010.
Investing Activities. The net cash used by investing activities of $64.8 million for the first quarter of 2010 is primarily attributable to capital expenditures of $42.6 million associated with capitalized software development in connection with client-related programs and our Medicare PDP product offerings, technology and pharmacy operations hardware investments, and capital expenditures associated with the construction of our third automated dispensing pharmacy in Whitestown, Indiana. Additionally, net cash used by investing activities includes cash paid of $19.4 million, net of cash acquired, primarily reflecting our acquisition of DNA Direct, and purchases of securities and other assets of $19.5 million. These cash outflows were partially offset by proceeds from the sale of securities and other investments of $16.7 million. The $32.1 million decrease in net cash used by investing activities for the first quarter of 2010 compared to the first quarter of 2009 is primarily due to an $86.1 million decrease in purchases of securities and other assets, $63.0 million of which represents a diabetes patient list acquired in the first quarter of 2009. This decrease in net cash used by investing activities was partially offset by a $27.4 million decrease in proceeds from the sale of securities and other investments, cash paid of $19.4 million, net of cash acquired, primarily for the acquisition of DNA Direct, and an increase in capital expenditures of $7.2 million.

 

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Financing Activities. The net cash used by financing activities of $1,201.6 million for the first quarter of 2010 primarily results from $1,229.9 million in share repurchases, partially offset by excess tax benefits from stock-based compensation arrangements of $27.5 million. The increase in net cash used by financing activities of $989.3 million for the first quarter of 2010 compared to the first quarter of 2009 primarily results from higher share repurchases of $1,014.3 million.
Total cash and short-term investments as of March 27, 2010 were $1,580.3 million, including $1,562.1 million in cash and cash equivalents. Total cash and short-term investments as of December 26, 2009 were $2,548.3 million, including $2,528.2 million in cash and cash equivalents. The decrease of $968.0 million in cash and short-term investments for the first quarter of 2010 primarily reflects the use of cash associated with share repurchase activity, partially offset by the aforementioned net cash inflows from operating activities.
Looking Forward
We believe that our current liquidity and prospects for strong cash flows from operations by improved working capital management assist in limiting the effects on our business from the weaker economy. As of March 27, 2010, we had additional committed borrowing capacity under our revolving credit facility of approximately $1 billion and have no required long-term debt payments until 2012. We have additional borrowing capacity of $600 million from our 364-day accounts receivable financing facility, which is renewable annually at the option of both Medco and the banks and was renewed on July 27, 2009. For 2010, we anticipate that our cash flow from operations will decrease from 2009 as our residual working capital opportunities are not as significant.
Our March 27, 2010 cash balance decreased to $1,562.1 million from $2,528.2 million at December 26, 2009. Since 2005, we have executed share repurchases of 205.7 million shares at a cost of $8.2 billion through our share repurchase programs. We currently have a $3 billion share repurchase plan with $0.3 billion remaining as of March 27, 2010, and we expect to complete the program before its expiration in November 2010. From time to time, we may make share repurchases, which we intend to fund with our free cash flow (cash flow from operations less capital expenditures). For our cash on hand, any investments we make are within approved investing guidelines and we continue to monitor ongoing events and make investment decisions accordingly.
We anticipate that our 2010 capital expenditures, for items such as capitalized software development for strategic initiatives, infrastructure enhancements, and the completion of our third automated dispensing pharmacy in Whitestown, Indiana, will be approximately $245 million. We expect that capital expenditures will be funded by our cash flows from operations.
We have clients in various industries, including the automobile manufacturer industry and the financial industry, as well as governmental agencies. We actively monitor the status of our accounts receivable and have mechanisms in place to minimize the potential for incurring material accounts receivable credit risk. To date, we have not experienced any significant deterioration in our client or manufacturer rebates accounts receivables.
We currently have no plans to pay cash dividends in the foreseeable future.
Financing Facilities
Five-Year Credit Facilities
We have senior unsecured bank credit facilities consisting of a $1 billion, 5-year senior unsecured term loan and a $2 billion, 5-year senior unsecured revolving credit facility. The term loan matures on April 30, 2012, at which time the entire facility is required to be repaid. If there are pre-payments on the term loan prior to the maturity date, that portion of the loan would be extinguished. At our current debt ratings, the credit facilities bear interest at London Interbank Offered Rate (“LIBOR”) plus a 0.45 percent margin, with a 10 basis point commitment fee due on the unused portion of the revolving credit facility.

 

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The outstanding balance under the revolving credit facility was $1.0 billion as of March 27, 2010 and December 26, 2009. There was no activity under the revolving credit facility during the first quarter of 2010. As of March 27, 2010, we had $994 million available for borrowing under our revolving credit facility, after giving effect to prior net draw-downs of $1 billion and $6 million in issued letters of credit. As of December 26, 2009, we had $993 million available for borrowing under our revolving credit facility, after giving effect to prior net draw-downs of $1 billion and $7 million in issued letters of credit. The revolving credit facility is available through April 30, 2012.
Accounts Receivable Financing Facility and Other Short-Term Debt
Through a wholly-owned subsidiary, we have a $600 million, 364-day renewable accounts receivable financing facility that is collateralized by our pharmaceutical manufacturer rebates accounts receivable. As of March 27, 2010 and December 26, 2009, there were no amounts outstanding and $600 million available for borrowing under the facility. We pay interest on amounts borrowed under the agreement based on the funding rates of the bank-related commercial paper programs that provide the financing, plus an applicable margin and liquidity fee determined by our credit rating. This facility is renewable annually at the option of both Medco and the banks. Additionally, we have short-term debt of $21.1 million and $15.8 million outstanding as of March 27, 2010 and December 26, 2009, respectively, under a short-term revolving credit facility.
Interest Rates
The weighted average interest rate on our indebtedness was approximately 4.0% and 3.8% for the quarters ended March 27, 2010 and March 28, 2009, respectively, and reflects the fixed interest rate compared with variable interest rate mix of our debt. Several factors could change the weighted average interest rate, including, but not limited to, a change in our debt ratings, reference rates used under our bank credit facility and accounts receivable financing facility, swap agreements and the mix of our debt.
Swap Agreements
On December 12, 2007, we entered into forward-starting interest rate swap agreements in contemplation of the issuance of long-term fixed-rate financing. We entered into these cash flow hedges to manage our exposure to changes in benchmark interest rates and to mitigate the impact of fluctuations in the interest rates prior to the issuance of the long-term financing. The cash flow hedges entered into were for a notional amount of $500 million on the then-current 10-year treasury interest rate, and for a notional amount of $250 million on the then-current 30-year treasury interest rate, both with a settlement date of March 31, 2008. At the time of purchase, the cash flow hedges were anticipated to be effective in offsetting the changes in the expected future interest rate payments on the proposed debt offering attributable to fluctuations in the treasury benchmark interest rate.
In connection with the issuance of $300 million aggregate principal amount of 5-year senior notes and $1.2 billion aggregate principal amount of 10-year senior notes in 2008, a portion of the $250 million notional amount 30-year treasury interest rate cash flow hedge was deemed an ineffective hedge. The cash flow hedges were settled on March 17, 2008 for $45.4 million. The ineffective portion of $9.8 million was immediately expensed and recorded to interest (income) and other (income), expense, net. The effective portion was recorded in accumulated other comprehensive income and is reclassified to interest expense over the ten-year period in which we hedged our exposure to variability in future cash flows. The unamortized effective portion reflected in accumulated other comprehensive loss as of March 27, 2010 and December 26, 2009 was $17.6 million and $18.1 million, net of tax, respectively.
In 2004, we entered into five interest rate swap agreements on $200 million of the $500 million in 7.25% senior notes due in 2013. These swap agreements were entered into as an effective hedge to (i) convert a portion of the senior note fixed rate debt into floating rate debt; (ii) maintain a capital structure containing appropriate amounts of fixed and floating rate debt; and (iii) lower the interest expense on these notes in the near term. The fair value of our obligation under our interest rate swap agreements, represented net receivables of $14.1 million and $14.0 million as of March 27, 2010 and December 26, 2009, respectively, which are reported in other noncurrent assets, with offsetting amounts recorded in long-term debt, net, on our consolidated balance sheets. We do not expect our future cash flows to be affected to any significant degree by a sudden change in market interest rates.

 

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Covenants
All of the senior notes discussed above are subject to customary affirmative and negative covenants, including limitations on sale/leaseback transactions; limitations on liens; limitations on mergers and similar transactions; and a covenant with respect to certain change of control triggering events. The 6.125% senior notes and the 7.125% senior notes are also subject to an interest rate adjustment in the event of a downgrade in the ratings to below investment grade. In addition, the senior unsecured bank credit facilities and the accounts receivable financing facility are subject to covenants, including, among other items, maximum leverage ratios. We were in compliance with all covenants at March 27, 2010 and December 26, 2009.
Debt Ratings
Medco’s debt ratings, all of which represent investment grade, reflect the following as of the filing date of this Quarterly Report on Form 10-Q: Moody’s Investors Service, Baa3; Standard & Poor’s, BBB; and Fitch Ratings, BBB.
EBITDA
We calculate and use EBITDA and EBITDA per adjusted prescription as indicators of our ability to generate cash from our reported operating results. These measurements are used in concert with net income and cash flows from operations, which measure actual cash generated in the period. In addition, we believe that EBITDA and EBITDA per adjusted prescription are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. EBITDA does not represent funds available for our discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from operations data as measured under U.S. generally accepted accounting principles. The items excluded from EBITDA, but included in the calculation of reported net income, are significant components of the consolidated statements of income and must be considered in performing a comprehensive assessment of overall financial performance. EBITDA, and the associated year-to-year trends, should not be considered in isolation. Our calculation of EBITDA may not be consistent with calculations of EBITDA used by other companies.
EBITDA per adjusted prescription is calculated by dividing EBITDA by the adjusted prescription volume for the period. This measure is used as an indicator of EBITDA performance on a per-unit basis, providing insight into the cash-generating ability of each prescription. EBITDA, and as a result, EBITDA per adjusted prescription, are affected by the changes in prescription volumes between retail and mail order, the relative representation of brand-name, generic and specialty pharmacy drugs, as well as the level of efficiency in the business. Adjusted prescription volume equals substantially all mail-order prescriptions multiplied by three, plus retail prescriptions. These mail-order prescriptions are multiplied by three to adjust for the fact that they include approximately three times the amount of product days supplied compared with retail prescriptions.
The following table reconciles our reported net income to EBITDA and presents EBITDA per adjusted prescription for each of the respective periods (in millions, except for EBITDA per adjusted prescription data):
                 
    Quarters Ended  
    March 27,     March 28,  
    2010     2009  
Net income
  $ 320.5     $ 291.0  
Add:
               
Interest expense
    40.7       45.1  
Interest (income) and other (income) expense, net
    (1.4 )     (3.5 )
Provision for income taxes
    211.8       195.3  
Depreciation expense
    44.4       43.2  
Amortization expense
    70.5       75.9  
 
           
EBITDA
  $ 686.5     $ 647.0  
 
           
 
               
Adjusted prescriptions(1)
    239.2       226.1  
 
           
 
               
EBITDA per adjusted prescription
  $ 2.87     $ 2.86  
 
           
     
(1)   Adjusted prescription volume equals substantially all mail-order prescriptions multiplied by three, plus retail prescriptions. These mail-order prescriptions are multiplied by three to adjust for the fact that they include approximately three times the amount of product days supplied compared with retail prescriptions.

 

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For the first quarter of 2010 compared to the first quarter of 2009, EBITDA increased by 6.1%, compared to an increase in net income of 10.1%, and an increase in EBITDA per adjusted prescription of 0.3%. The lower rate of increase for EBITDA compared with net income primarily reflects the aforementioned lower interest expense and amortization of intangibles. The lower rate of increase for EBITDA per adjusted prescription compared to EBITDA reflects new and renewed client volumes.
Commitments and Contractual Obligations
The following table presents our commitments and contractual obligations as of March 27, 2010, as well as our long-term debt obligations ($ in millions):
                                         
Payments Due By Period  
            Remainder                    
    Total     of 2010     2011-2012     2013-2014     Thereafter  
 
                                       
Long-term debt obligations (1)
  $ 4,000.0     $     $ 2,000.0     $ 800.0     $ 1,200.0  
Interest payments on long-term debt obligations(2)
    888.3       116.3       300.2       197.5       274.3  
Operating lease obligations(3)
    178.2       37.0       91.6       30.9       18.7  
Prescription drug purchase commitments(4)
    335.7       335.7                    
Other(5)
    182.1       52.0       90.8       39.3        
 
                             
Total
  $ 5,584.3     $ 541.0     $ 2,482.6     $ 1,067.7     $ 1,493.0  
 
                             
     
(1)   Long-term debt obligations exclude $13.4 million in total unamortized discounts on our 7.25%, 6.125% and 7.125% senior notes and the fair value of interest rate swap agreements of $14.1 million on $200 million of the $500 million in 7.25% senior notes.
 
(2)   The variable component of interest expense for the senior unsecured credit facility is based on the March 2010 LIBOR. The LIBOR fluctuates and may result in differences in the presented interest expense on long-term debt obligations.
 
(3)   Primarily reflects contractual operating lease commitments to lease pharmacy and call center pharmacy facilities, offices and warehouse space, as well as pill dispensing and counting devices and other operating equipment for use in our mail-order pharmacies and computer equipment for use in our data centers and corporate headquarters.
 
(4)   Represents contractual commitments to purchase inventory from certain biopharmaceutical manufacturers and a brand-name pharmaceutical manufacturer, the majority of which is associated with our Specialty Pharmacy business. These consist of a firm commitment of $248.9 million, and firm commitments for 2010 of $86.8 million with additional commitments through 2012 subject to price increases or variable quantities based on patient usage or days on hand.
 
(5)   Consists of purchase commitments for diabetes supplies of $58.8 million, technology-related agreements of $71.7 million and advertising commitments of $9.1 million. Additionally, $42.5 million represents various purchase obligations anticipated to be fully settled by 2014, which are included in other noncurrent liabilities on the unaudited interim condensed consolidated balance sheet as of March 27, 2010.
We have a remaining minimum pension funding requirement of $16.3 million under the Internal Revenue Code (“IRC”) during 2010 for the 2009 plan year. From time to time, we make additional voluntary contributions within the maximum deductible limits set by the IRS.
As of March 27, 2010, we had letters of credit outstanding of approximately $6.0 million, which were issued under our senior unsecured revolving credit facility primarily as collateral for the deductible portion of our workers’ compensation coverage.
As of March 27, 2010, we have total gross liabilities for income tax contingencies of $106.6 million on our consolidated balance sheet. The majority of the income tax contingencies are subject to statutes of limitations that are scheduled to expire by the end of 2014. In addition, approximately 30% of the income tax contingencies are scheduled to settle over the next twelve months.

 

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For additional information regarding operating lease obligations, long-term debt, pension and other postretirement obligations, and information on deferred income taxes, see Notes 6, 8, 9 and 10, respectively, to our audited consolidated financial statements included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 26, 2009.
Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements, other than purchase commitments and lease obligations. See “—Commitments and Contractual Obligations” above.
Share Repurchase Program
Since 2005, we have executed share repurchases of 205.7 million shares at a cost of $8.2 billion through our share repurchase programs. We currently have a $3 billion share repurchase program, with $0.3 billion remaining as of March 27, 2010 and we expect to complete the program before its expiration in November 2010. Through the first quarter of 2010 under the current program, a total of 19.5 million shares were repurchased at a total cost of $1.23 billion with an average per-share cost of $63.17. Since the inception of the current program in November 2008, we have repurchased 51.9 million shares for a total cost of $2.67 billion with an average per-share cost of $51.40. From time to time, we may make share repurchases, which we intend to fund with our free cash flow (cash flow from operations less capital expenditures). Our Board of Directors periodically reviews our share repurchase programs and approves the associated trading parameters. For more information, see Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds,” included in Part II of this Quarterly Report on Form 10-Q.
Recently Adopted Financial Accounting Standards
Subsequent Events. In May 2009, the Financial Accounting Standards Board (“FASB”) issued a standard which established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date; that is, whether that date represents the date the financial statements were issued or were available to be issued. This guidance was subsequently amended in February 2010 for SEC filers and no longer requires disclosure of the date through which an entity has evaluated subsequent events. Our adoption of the standard had no impact on the unaudited interim condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Improving Disclosures about Fair Value Measurements. In January 2010, the FASB issued a standard which requires additional disclosure about the amounts of, and reasons for, significant transfers in and out of Level 1 and Level 2 fair value measurements. This standard also clarifies existing disclosure requirements related to the level of disaggregation of fair value measurements for each class of assets and liabilities and disclosures about inputs and valuation techniques used to measure fair value for both recurring and nonrecurring Level 2 and Level 3 measurements. The new disclosures are effective for interim and annual reporting periods beginning after December 15, 2009. In addition, effective for interim and annual periods beginning after December 15, 2010, this standard will require disaggregated information about activity in Level 3 fair value measurements on a gross basis, rather than as one net amount. Our adoption of the standard in 2010 did not have a material impact on our unaudited interim condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Item 3.   Quantitative and Qualitative Disclosures About Market Risk
We have floating rate debt with our bank credit facility and accounts receivable financing facility, and investments in marketable securities that are subject to interest rate volatility, which is our principal market risk. In addition, we have interest rate swap agreements on $200 million of the $500 million in 7.25% senior notes. As a result of these interest rate swap agreements, the $200 million of senior notes is subject to interest rate volatility. A 25 basis point change in the weighted average interest rate relating to the credit facilities’ balances outstanding and interest rate swap agreements as of March 27, 2010, which are subject to variable interest rates based on LIBOR, and the accounts receivable financing facility, which is subject to the commercial paper rate, would yield a change of approximately $5.5 million in annual interest expense. We do not expect our future cash flows to be affected to any significant degree by a sudden change in market interest rates.

 

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We operate our business primarily within the United States and execute the vast majority of our transactions in U.S. dollars. However, as a result of our acquisition of a majority interest in Europa Apotheek, which is based in the Netherlands, and our joint venture with United Drug plc, we are subject to foreign currency translation risk. This foreign currency translation risk is not expected to have a material impact on our consolidated financial statements.
Item 4.   Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed by the Company in reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of the end of the period covered by this Report, our management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective to provide reasonable assurance that the objectives described above were met as of the end of the period covered by this Quarterly Report on Form 10-Q.
There have been no changes in internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II — OTHER INFORMATION
Item 1.   Legal Proceedings
In the ordinary course of business, the Company is involved in litigation, claims, government inquiries, investigations, charges and proceedings, including, but not limited to, those relating to regulatory, commercial, employment, employee benefits and securities matters. Descriptions of certain legal proceedings to which the Company is a party are contained in Note 10, “Commitments and Contingencies—Legal Proceedings,” to the unaudited interim condensed consolidated financial statements included in Part I of this Quarterly Report on Form 10-Q and are incorporated by reference herein. Such descriptions include the following recent developments:
Government Proceedings and Requests for Information. With respect to the third qui tam matter relating to PolyMedica, the Company has learned that the Government declined to intervene in the qui tam matter. This matter will now progress as a civil litigation, United States of America ex. rel. Lucas W. Matheny and Deborah Loveland vs. Medco Health Solutions, Inc., et al., in the U.S. District Court for the Southern District of Florida, although the government could decide to intervene at any point during the course of the litigation. The complaint largely includes allegations regarding the application of invoice payments.
ERISA and Similar Litigation. With respect to Betty Jo Jones v. Merck-Medco Managed Care, L.L.C., et al., wherein the plaintiff had filed a Second Amended Complaint in which she sought to represent a class of all participants and beneficiaries of ERISA plans that required such participants to pay a percentage co-payment on prescription drugs, the U.S. District Court subsequently found that the plaintiff in this action did not have the authority to opt out on behalf of her plan and denied and overruled her objection to the settlement, thereby resulting in this case being terminated.
PolyMedica Shareholder Litigation. In May 2008, the Court granted final approval of the settlement and dismissed the actions with prejudice on the merits. Plaintiffs’ counsel’s application for attorneys’ fees was rejected by the Court, resulting in the award of costs only. Plaintiffs’ counsel had filed a motion for reconsideration of the fees with the Court. The Court has denied this motion and the plaintiff did not appeal this denial.

 

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Item 1A.   Risk Factors
Reference is made to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the fiscal year ended December 26, 2009, which are incorporated by reference herein. There have been no material changes with regard to the risk factors disclosed in such reports.
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
We currently have a $3 billion share repurchase program, which expires in November 2010 (the “2008 Program”). The Company’s Board of Directors periodically reviews any share repurchase programs and approves the associated trading parameters.
The following is a summary of the Company’s share repurchase activity for the three months ended March 27, 2010:
                                 
Issuer Purchases of Equity Securities(1)  
                    Total number of     Approximate  
                    shares purchased as     dollar value of  
                    part of a publicly     shares  
                    announced     that may yet be  
    Total number of     Average     program since     purchased under  
    shares     price paid     inception of latest     the program(4)  
Fiscal Period   purchased     per share(2)     program(3)     (in thousands)  
Balances at December 26, 2009
                    32,444,190     $ 1,561,458  
 
                           
 
                               
December 27 to January 23, 2010
    3,216,849     $ 64.60       3,216,849     $ 1,353,637  
January 24 to February 20, 2010
    8,616,437     $ 62.19       8,616,437     $ 817,792  
February 21 to March 27, 2010
    7,635,895     $ 63.68       7,635,895     $ 331,573  
 
                         
First quarter 2010 totals
    19,469,181     $ 63.17       19,469,181          
 
                         
     
(1)   All information set forth in the table above relates to the Company’s 2008 Program. The 2008 Program was announced in November 2008 and pursuant to the 2008 Program, the Company is authorized to repurchase up to $3 billion of its common stock, and we expect to complete the 2008 Program before its expiration in November 2010.
 
(2)   Dollar amounts include transaction costs. The total average price paid per share in the table above represents the average price paid per share for repurchases settled during the three months ended March 27, 2010. The average per-share cost for repurchases under the 2008 Program from inception through March 27, 2010 is $51.40.
 
(3)   The Company repurchased all of the above-referenced shares of its common stock through its publicly announced 2008 Program.
 
(4)   The balances at March 27, 2010 reflect the remaining authorized repurchases under the 2008 Program.
Item 3.   Defaults Upon Senior Securities
Not applicable.
Item 4.   (Removed and Reserved)
Item 5.   Other Information
(a) Rule 10b5-1 Sales Plans. Medco’s comprehensive compliance program includes a broad policy against insider trading. The procedures promulgated under that policy include regularly scheduled blackout periods that apply to over 600 employees. Executive officers are prohibited from trading in Company stock during the period that begins on the first day of the last month of the fiscal period and ends on the third trading day after the release of earnings. In addition, executive officers are required to pre-clear all of their trades. Medco’s executive officers are also subject to share ownership guidelines and retention requirements. The ownership targets are based on a multiple of salary (5, 3 or 1.5 times salary), but are expressed as a number of shares. The targets are determined using base salary and the closing price of our stock on the date of our Annual Meeting of Shareholders. The number of shares required to be held has been calculated using a $44.38 stock price, the closing price of our stock on the date of the 2009 Annual Meeting of Shareholders.

 

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To facilitate compliance with the ownership guidelines and retention requirements, Medco’s Board of Directors authorized the use of prearranged trading plans under Rule 10b5-1 of the Securities Exchange Act of 1934. Rule 10b5-1 permits insiders to adopt predetermined plans for selling specified amounts of stock or exercising stock options under specified conditions and at specified times. Executive officers may only enter into a trading plan during an open trading window and they must not possess material nonpublic information regarding the Company at the time they adopt the plan. Using trading plans, insiders can diversify their investment portfolios while avoiding concerns about transactions occurring at a time when they might possess material nonpublic information. Under Medco’s policy, sales instructions made pursuant to a written trading plan may be executed during a blackout period. In addition, the use of trading plans provides Medco with a greater ability to monitor trading and compliance with its stock ownership guidelines. Generally, under these trading plans, the individual relinquishes control over the transactions once the trading plan is put into place. Accordingly, sales under these plans may occur at any time, including possibly before, simultaneously with, or immediately after significant events involving our company.
All trading plans adopted by Medco executives are reviewed and approved by the Office of the General Counsel. For ease of administration, executives have been permitted to add new orders to existing plans rather than requiring the adoption of a new plan. Once modified, a plan cannot be changed for at least 90 days. Both new plans and modifications are subject to a mandatory “waiting period” designed to safeguard the plans from manipulation or market timing.
The following table, which we are providing on a voluntary basis, sets forth the Rule 10b5-1 sales plans entered into by our executive officers in effect as of April 26, 2010(1):
                                     
                Number of              
    Number of Shares         Shares Sold     Projected     Projected  
    to be Sold Under         Under the     Beneficial     Aggregate  
Name and Position   the Plan(2)     Timing of Sales Under the Plan   Plan(3)     Ownership(4)     Holdings(5)  
 
                                   
Brian T. Griffin(6)
Group President, Health Plans
    277,990     Option exercise of 268,164 shares shall occur when stock reaches specific prices; sale of 9,826 previously acquired shares shall occur when stock reaches a specific price. See footnote(6).     0       40,943       315,253  
 
                                   
Timothy C. Wentworth
Group President, Employer Accounts
    121,487     Option exercise of 121,487 shares shall occur when stock reaches specific prices.     14,678       49,424       323,957  
 
     
(1)   This table does not include any trading plans entered into by any executive officer that have been terminated or expired by their terms or have been fully executed through April 26, 2010.
 
(2)   This column reflects the number of shares remaining to be sold as of April 26, 2010.
 
(3)   This column reflects the number of shares sold under the plan through April 26, 2010.
 
(4)   This column reflects an estimate of the number of whole shares each identified executive officer will beneficially own following the sale of all shares under the Rule 10b5-1 sales plans currently in effect. This information reflects the beneficial ownership of our common stock as of April 26, 2010, and includes shares of our common stock subject to options or restricted stock units that were then vested or exercisable and unvested options and restricted stock units that are included in a current trading plan for sales periods that begin after the applicable vesting date. Options cannot be exercised and restricted stock units cannot be converted prior to vesting. The estimates reflect option exercises and sales under the plan, but do not reflect any changes to beneficial ownership that may have occurred since April 26, 2010 outside of the plan.
 
(5)   This column reflects an estimate of the total aggregate number of whole shares each identified executive officer will have an interest in following the sale of all shares under the Rule 10b5-1 sales plans currently in effect. This information reflects the beneficial ownership of our common stock as of April 26, 2010, and includes shares of our common stock subject to options (whether or not currently exercisable) or restricted stock units (whether or not vested). Options cannot be exercised and restricted stock units cannot be converted prior to vesting. The estimates reflect option exercises and sales under the plan, but do not reflect any changes to beneficial ownership that may have occurred since April 26, 2010 outside of the plan.
 
(6)   The trading plan for Mr. Griffin also covers 100 percent of the net shares that will be delivered upon the vesting of Mr. Griffin’s restricted stock units granted on August 31, 2007, after the payment of withholding taxes and provided the stock reaches a specific price. The exact number of shares will be determined on the vesting date. As a result, the shares are not reflected in this table.

 

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(b) Additional Information. Medco’s public Internet site is http://www.medcohealth.com. Medco makes available free of charge, through the Investor Relations page of its Internet site at http://www.medcohealth.com/investor, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the SEC. Medco also makes available, through the Investor Relations page of its Internet site, statements of beneficial ownership of Medco’s equity securities filed by its directors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act. In addition, Medco makes available on the Investor Relations page of its Internet site, its most recent proxy statements and its most recent annual reports to stockholders. Medco uses the Investor Relations page of its Internet site at http://www.medcohealth.com/investor to disclose important information to the public.
Information contained on Medco’s Internet site, or that can be accessed through its Internet site, does not constitute a part of this Quarterly Report on Form 10-Q. Medco has included its Internet site address only as an inactive textual reference and does not intend it to be an active link to its Internet site. Our corporate headquarters are located at 100 Parsons Pond Drive, Franklin Lakes, New Jersey 07417 and the telephone number at this location is (201) 269-3400.
Item 6.   Exhibits
             
Number   Description   Method of Filing
       
 
   
  3.1    
Third Amended and Restated Articles of Incorporation of Medco Health Solutions, Inc. (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed May 23, 2008).
  Incorporated by reference.
       
 
   
  3.2    
Amended and Restated Bylaws of Medco Health Solutions, Inc. as of December 10, 2008 (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed December 11, 2008).
  Incorporated by reference.
       
 
   
  31.1    
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  Filed with this document.
       
 
   
  31.2    
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  Filed with this document.
       
 
   
  32.1    
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  Filed with this document.
       
 
   
  32.2    
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  Filed with this document.
       
 
   
101.INS  
XBRL Instance Document.
  Furnished with this document.
       
 
   
101.SCH  
XBRL Taxonomy Extension Schema.
  Furnished with this document.
       
 
   
101.CAL  
XBRL Taxonomy Extension Calculation Linkbase.
  Furnished with this document.
       
 
   
101.DEF  
XBRL Taxonomy Extension Definition Linkbase.
  Furnished with this document.
       
 
   
101.LAB  
XBRL Taxonomy Extension Label Linkbase.
  Furnished with this document.
       
 
   
101.PRE  
XBRL Taxonomy Extension Presentation Linkbase.
  Furnished with this document.

 

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Signatures
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 hereunto duly authorized.
         
  MEDCO HEALTH SOLUTIONS, INC.
                          (Registrant)
 
 
Date: April 28, 2010  By:   /s/ David B. Snow, Jr.    
    Name:   David B. Snow, Jr.   
    Title:   Chairman and Chief Executive Officer   
     
Date: April 28, 2010  By:   /s/ Richard J. Rubino    
    Name:   Richard J. Rubino   
    Title:   Senior Vice President, Finance and
Chief Financial Officer 
 

 

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