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 June 26, 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		22-3461740
(State or other jurisdiction of incorporation)		(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 July 16, 2010, the registrant had 433,652,361 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
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (Unaudited) — June 26, 2010 and December 26, 2009			1
Condensed Consolidated Statements of Income (Unaudited) — Fiscal Quarters and Six Months Ended June 26, 2010 and June 27, 2009			2
Condensed Consolidated Statement of Stockholders’ Equity (Unaudited) — Fiscal Six Months Ended June 26, 2010			3
Condensed Consolidated Statements of Cash Flows (Unaudited) — Fiscal Six Months Ended June 26, 2010 and June 27, 2009			4
Notes to Condensed Consolidated Financial Statements (Unaudited)			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 3. Quantitative and Qualitative Disclosures About Market Risk			35
Item 4. Controls and Procedures			35
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			36
Item 1A. Risk Factors			36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			37
Item 3. Defaults Upon Senior Securities			37
Item 4. (Removed and Reserved)			37
Item 5. Other Information			37
Item 6. Exhibits			41
SIGNATURES			42
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

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

MEDCO HEALTH SOLUTIONS, INC.

		June 26,				December 26,
		2010				2009
ASSETS
Current assets:
Cash and cash equivalents		$	1,183.7			$	2,528.2
Short-term investments			54.0				20.1
Manufacturer accounts receivable, net			1,796.4				1,765.5
Client accounts receivable, net			2,083.6				2,063.3
Income taxes receivable			23.7				198.3
Inventories, net			1,162.1				1,285.3
Prepaid expenses and other current assets			77.0				67.1
Deferred tax assets			232.6				230.8
Total current assets			6,613.1				8,158.6
Property and equipment, net			923.3				912.5
Goodwill			6,345.4				6,333.0
Intangible assets, net			2,296.3				2,428.8
Other noncurrent assets			61.9				82.6
Total assets		$	16,240.0			$	17,915.5
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Claims and other accounts payable		$	3,158.3			$	3,506.4
Client rebates and guarantees payable			2,454.9				2,106.9
Accrued expenses and other current liabilities			553.0				718.6
Short-term debt			19.1				15.8
Total current liabilities			6,185.3				6,347.7
Long-term debt, net			4,004.8				4,000.1
Deferred tax liabilities			897.1				958.8
Other noncurrent liabilities			227.5				221.7
Total liabilities			11,314.7				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: 664,015,857 shares at June 26, 2010 and 660,846,867 shares at December 26, 2009			6.6				6.6
Accumulated other comprehensive loss			(61.1	)			(44.2	)
Additional paid-in capital			8,292.2				8,156.7
Retained earnings			5,887.0				5,209.6
			14,124.7				13,328.7
Treasury stock, at cost: 223,411,093 shares at June 26, 2010 and 186,353,868 shares at December 26, 2009			(9,199.4	)			(6,941.5	)
Total stockholders’ equity			4,925.3				6,387.2
Total liabilities and stockholders’ equity		$	16,240.0			$	17,915.5

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

MEDCO HEALTH SOLUTIONS, INC.

		Quarters Ended								Six Months Ended
		June 26, 2010				June 27, 2009				June 26, 2010				June 27, 2009
Product net revenues (Includes retail co-payments of $2,279 and $2,114 in the second quarters of 2010 and 2009, and $4,750 and $4,373 in the six months of 2010 and 2009)		$	16,163.3			$	14,729.6			$	32,247.0			$	29,345.8
Service revenues			244.2				200.8				471.4				418.5
Total net revenues			16,407.5				14,930.4				32,718.4				29,764.3
Cost of operations:
Cost of product net revenues (Includes retail co-payments of $2,279 and $2,114 in the second quarters of 2010 and 2009, and $4,750 and $4,373 in the six months of 2010 and 2009)			15,284.5				13,856.1				30,538.1				27,688.0
Cost of service revenues			61.3				58.5				125.8				116.3
Total cost of revenues			15,345.8				13,914.6				30,663.9				27,804.3
Selling, general and administrative expenses			376.4				370.7				727.0				711.0
Amortization of intangibles			70.7				75.9				141.2				151.8
Interest expense			38.8				43.4				79.5				88.5
Interest (income) and other (income) expense, net			(6.3	)			(2.2	)			(7.7	)			(5.7	)
Total costs and expenses			15,825.4				14,402.4				31,603.9				28,749.9
Income before provision for income taxes			582.1				528.0				1,114.5				1,014.4
Provision for income taxes			225.2				215.9				437.1				411.2
Net income		$	356.9			$	312.1			$	677.4			$	603.2
Basic weighted average shares outstanding			453.0				479.6				460.4				485.9
Basic earnings per share		$	0.79			$	0.65			$	1.47			$	1.24
Diluted weighted average shares outstanding			462.0				488.0				470.1				494.5
Diluted earnings per share		$	0.77			$	0.64			$	1.44			$	1.22

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

MEDCO HEALTH SOLUTIONS, INC.

		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			—				—				—				—				—				677.4				—				677.4
Other comprehensive income (loss):
Foreign currency translation loss			—				—				—				(17.6	)			—				—				—				(17.6	)
Amortization of unrealized loss on cash flow hedge, net of tax of $(0.7)			—				—				—				1.1				—				—				—				1.1
Defined benefit plans, net of tax:
Amortization of prior service credit included in net periodic benefit cost, net of tax of $0.8			—				—				—				(1.2	)			—				—				—				(1.2	)
Net gains included in net periodic benefit cost, net of tax of $(0.5)			—				—				—				0.8				—				—				—				0.8
Other comprehensive income (loss)			—				—				—				(16.9	)			—				—				—				(16.9	)
Total comprehensive income (loss)			—				—				—				(16.9	)			—				677.4				—				660.5
Stock option activity, including tax benefit			1,866				—				—				—				113.4				—				—				113.4
Issuance of common stock under employee stock purchase plan			169				—				—				—				10.9				—				—				10.9
Restricted stock unit activity, including tax benefit			1,134				—				—				—				11.2				—				—				11.2
Treasury stock acquired			—				37,057				—				—				—				—				(2,257.9	)			(2,257.9	)
Balances at June 26, 2010			664,016				223,411			$	6.6			$	(61.1	)		$	8,292.2			$	5,887.0			$	(9,199.4	)		$	4,925.3

The accompanying notes are an integral part of this condensed consolidated financial statement.

MEDCO HEALTH SOLUTIONS, INC.

		Six Months Ended
		June 26,				June 27,
		2010				2009
Cash flows from operating activities:
Net income		$	677.4			$	603.2
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			89.2				87.4
Amortization of intangibles			141.2				151.8
Deferred income taxes			(91.0	)			(132.9	)
Stock-based compensation on employee stock plans			77.8				71.2
Tax benefit on employee stock plans			63.4				43.8
Excess tax benefits from stock-based compensation arrangements			(34.1	)			(20.4	)
Other			49.1				83.1
Net changes in assets and liabilities (net of acquisition effects for 2010):
Manufacturer accounts receivable, net			(30.9	)			(20.9	)
Client accounts receivable, net			(80.3	)			(334.3	)
Income taxes receivable			174.6				17.5
Inventories, net			121.8				359.3
Prepaid expenses and other current assets			(9.9	)			257.1
Other noncurrent assets			(11.2	)			7.0
Claims and other accounts payable			(345.3	)			644.1
Client rebates and guarantees payable			348.0				510.4
Accrued expenses and other current and noncurrent liabilities			(149.0	)			(61.9	)
Net cash provided by operating activities			990.8				2,265.5
Cash flows from investing activities:
Capital expenditures			(100.4	)			(98.1	)
Purchases of securities and other assets			(23.2	)			(105.2	)
Acquisitions of businesses, net of cash acquired			(33.8	)			—
Proceeds from sale of securities and other investments			18.5				44.1
Net cash used by investing activities			(138.9	)			(159.2	)
Cash flows from financing activities:
Proceeds from revolving credit facility			200.0				—
Repayments on revolving credit facility			(200.0	)			—
Proceeds from short-term debt			3.3				9.1
Purchases of treasury stock			(2,257.9	)			(1,007.1	)
Excess tax benefits from stock-based compensation arrangements			34.1				20.4
Net proceeds from employee stock plans			24.1				18.4
Net cash used by financing activities			(2,196.4	)			(959.2	)
Net (decrease) increase in cash and cash equivalents			(1,344.5	)			1,147.1
Cash and cash equivalents at beginning of period			2,528.2				938.4
Cash and cash equivalents at end of period		$	1,183.7			$	2,085.5

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

MEDCO HEALTH SOLUTIONS, INC.

1. BASIS OF PRESENTATION AND ACQUISITIONS OF BUSINESSES

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 (“SEC”) 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 second fiscal quarters for 2010 and 2009 each consisted of 13 weeks and ended on June 26, 2010 and June 27, 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 inclusion of DNA Direct, Inc.’s results of operations since the acquisition or its pro forma inclusion on prior period results did not have a material impact on the unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

On June 21, 2010, the Company and Celesio AG (“Celesio”), a company based in Germany and one of the leading international service providers within the pharmaceutical and healthcare markets, announced a joint venture with a long-term goal of improving patient health and helping to relieve the significant financial burden on healthcare payors across Europe. Headquartered in the Netherlands, the 50/50 joint venture, Medco Celesio B.V., will combine Medco’s and Celesio’s strengths in pharmacy-driven clinical care. Medco Celesio B.V. will target patients with chronic or complex conditions, such as diabetes, asthma, high-cholesterol and heart disease. It will concentrate on innovative, integrated clinical services designed to improve patient adherence, integrate care across multiple providers, enhance safety and deliver greater value across the healthcare system. The transaction is expected to close in the second half of fiscal 2010.

In conjunction with the Medco Celesio B.V. joint venture, Medco intends to contribute Europa Apotheek Venlo B.V. (“Europa Apotheek”), a wholly-owned subsidiary, subject to receipt of regulatory approvals. On April 28, 2008, the Company had acquired a majority interest in Europa Apotheek, which primarily provides mail-order pharmacy services in Germany. During the second quarter of 2010, and in connection with the Medco Celesio B.V. joint venture, the Company settled its purchase obligation for the remaining interest in Europa Apotheek. As of June 26, 2010, approximately half of the accumulated other comprehensive loss component of the Company’s stockholders’ equity represents an unrecognized foreign currency translation loss associated with Europa Apotheek, reflecting the weakened euro. Concurrent with the expected closing of the Medco Celesio B.V. transaction in the second half of fiscal 2010 and based on the foreign currency translation at that time, this item will be reflected in the Company’s results of operations. In addition, the Company’s investment in the joint venture will be recorded at fair value, and the difference between the fair value and the book value of the Europa Apotheek asset contributed to the joint venture will be reflected in our results of operations.

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 requires 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

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.

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):

Fair Value Measurements at Reporting Date

		June 26,
Description		2010				Level 1				Level 2
Money market mutual funds		$	854.0	(1)		$	854.0			$	—
Fair value of interest rate swap agreements			17.8	(2)			—				17.8

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

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 differences 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 amounts 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 June 26, 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 amounts and the fair values of the Company’s senior notes are shown in the following table ($ in millions):

		June 26, 2010								December 26, 2009
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
7.25% senior notes due 2013		$	498.4	(1)		$	572.6			$	498.2	(1)		$	560.8
6.125% senior notes due 2013			299.0	(1)			330.3				298.8	(1)			322.4
7.125% senior notes due 2018			1,189.6	(1)			1,404.6				1,189.1	(1)			1,341.2

The fair values of the senior notes are based on observable relevant market information. Fluctuations between the carrying amounts and the fair values of the senior notes for the periods presented are associated with changes in market interest rates.

4. 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								Six Months Ended
		June 26, 2010				June 27, 2009				June 26, 2010				June 27, 2009
Basic weighted average shares outstanding			453.0				479.6				460.4				485.9
Dilutive common stock equivalents:
Outstanding stock options and restricted stock units			9.0				8.4				9.7				8.6
Diluted weighted average shares outstanding			462.0				488.0				470.1				494.5

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 both the quarter and six months ended June 26, 2010, there were outstanding options to purchase 6.0 million shares of Medco stock, which were not dilutive to the EPS calculations when applying the treasury stock method. These outstanding options may be dilutive to future EPS calculations. For both the quarter and six months ended June 27, 2009, there were outstanding options to purchase 11.2 million shares of Medco stock, which were not dilutive to the EPS calculations. The decreases in the basic weighted average shares outstanding and diluted weighted average shares outstanding for the quarter and six months ended June 26, 2010 compared to the same periods in 2009 result from the repurchase of approximately 223.3 million shares of stock in connection with the Company’s share repurchase programs since inception in 2005 through the second quarter of 2010, compared to an equivalent amount of 182.6 million shares purchased inception-to-date through the end of the second quarter of 2009. The Company repurchased approximately 17.6 million and 37.1 million shares of stock in the second quarter and six months of 2010, respectively, compared to approximately 18.3 million and 23.6 million shares in the second quarter and six months of 2009, respectively. In accordance with the standard, weighted average treasury shares are not considered part of the basic or diluted shares outstanding.

5. 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 June 26, 2010 and December 26, 2009, identified net Specialty Pharmacy accounts receivable, primarily due from payors and patients, amounted to $512.7 million and $483.1 million, respectively.

The Company’s allowance for doubtful accounts as of June 26, 2010 and December 26, 2009 of $145.1 million and $133.3 million, respectively, includes $94.2 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 June 26, 2010 and December 26, 2009 also includes $39.9 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.

6. GOODWILL AND INTANGIBLE ASSETS, NET

The changes in the Company’s carrying amount of goodwill for the six months ended June 26, 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			26.4				1.3				27.7
Translation adjustments and other			(15.1	)			(0.2	)			(15.3	)
Balances as of June 26, 2010		$	4,428.4			$	1,917.0			$	6,345.4

The following is a summary of the Company’s intangible assets ($ in millions):

		June 26, 2010												December 26, 2009
		Gross												Gross
		Carrying				Accumulated								Carrying				Accumulated
		Value				Amortization				Net				Value				Amortization				Net
Client relationships		$	3,447.6			$	2,073.4			$	1,374.2			$	3,446.1			$	1,977.2			$	1,468.9
Trade names			568.0				56.5				511.5				569.3				47.6				521.7
Manufacturer relationships			357.5				86.4				271.1				357.5				77.5				280.0
Patient relationships			282.1				149.9				132.2				280.1				127.8				152.3
Other intangible assets			39.0				31.7				7.3				33.7				27.8				5.9
Total		$	4,694.2			$	2,397.9			$	2,296.3			$	4,686.7			$	2,257.9			$	2,428.8

For intangible assets existing as of June 26, 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)		$	140.5
2011			262.6
2012			253.6
2013			248.8
2014			246.0
Total		$	1,151.5

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 June 26, 2010 is approximately 1.8 years. The Company has experienced client retention rates of approximately 98% for the past two years.

7. 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								Six Months Ended
		June 26, 2010				June 27, 2009				June 26, 2010				June 27, 2009
Service cost		$	6.2			$	5.6			$	12.8			$	12.1
Interest cost			3.5				3.8				6.8				6.6
Expected return on plan assets			(3.1	)			(2.5	)			(6.1	)			(4.9	)
Amortization of prior service cost			—				—				0.1				0.1
Net amortization of actuarial losses			0.5				1.6				1.0				2.7
Net pension cost		$	7.1			$	8.5			$	14.6			$	16.6

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								Six Months Ended
		June 26, 2010				June 27, 2009				June 26, 2010				June 27, 2009
Service cost		$	0.4			$	0.2			$	0.7			$	0.5
Interest cost			0.2				0.2				0.4				0.4
Amortization of prior service credit			(1.1	)			(1.0	)			(2.1	)			(2.0	)
Net amortization of actuarial losses			0.1				0.1				0.2				0.2
Net postretirement benefit credit		$	(0.4	)		$	(0.5	)		$	(0.8	)		$	(0.9	)

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.

8. SHARE REPURCHASE PROGRAMS

Since 2005, when the Company commenced its first share repurchase program, the Company has executed share repurchases of 223.3 million shares at a cost of $9.2 billion and at an average per-share cost of $41.18. During the six months of 2010, the Company repurchased 37.1 million shares at a total cost of $2,257.9 million with an average per-share cost of $60.93 under its share repurchase programs. The Company’s $3 billion share repurchase program, which was announced in November 2008 (the “2008 Program”), was completed in May 2010. From the inception of the 2008 Program through completion, the Company repurchased 57.5 million shares at an average per-share cost of $52.15.

In May 2010, the Company’s Board of Directors approved a new $3 billion share repurchase program (the “2010 Program”), authorizing the purchase of up to $3 billion of the Company’s common stock over a two-year period commencing May 17, 2010. During the second quarter of 2010, the Company repurchased 12.0 million shares at a total cost of $696.5 million and at an average per-share cost of $58.14 under the 2010 Program. The timing and extent of any repurchases will depend upon market conditions, corporate requirements and other factors. The Company intends to fund share repurchases with the Company’s free cash flow (cash flow from operations less capital expenditures) and existing sources of capital. The Company’s Board of Directors periodically reviews the Company’s share repurchase programs and approves the associated trading parameters.

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, which provides diabetes testing supplies and related products in conjunction with the Company’s diabetes pharmacy care practice and Therapeutic Resource Center activities, as well as 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.

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):

Quarterly Results:		Quarter Ended June 26, 2010												Quarter Ended June 27, 2009
						Specialty												Specialty
		PBM				Pharmacy				Total				PBM				Pharmacy				Total
Product net revenues		$	13,374.8			$	2,788.5			$	16,163.3			$	12,367.9			$	2,361.7			$	14,729.6
Service revenues			217.8				26.4				244.2				178.3				22.5				200.8
Total net revenues			13,592.6				2,814.9				16,407.5				12,546.2				2,384.2				14,930.4
Total cost of revenues			12,728.9				2,616.9				15,345.8				11,706.4				2,208.2				13,914.6
Selling, general and administrative expenses			299.0				77.4				376.4				294.6				76.1				370.7
Amortization of intangibles			60.0				10.7				70.7				64.5				11.4				75.9
Operating income		$	504.7			$	109.9			$	614.6			$	480.7			$	88.5			$	569.2
Reconciling items to income before provision for income taxes:
Interest expense											38.8												43.4
Interest (income) and other (income) expense, net											(6.3	)											(2.2	)
Income before provision for income taxes										$	582.1											$	528.0
Capital expenditures		$	47.9			$	9.9			$	57.8			$	57.1			$	5.6			$	62.7

Year-to-Date Results:		Six Months Ended June 26, 2010												Six Months Ended June 27, 2009
						Specialty												Specialty
		PBM				Pharmacy				Total				PBM				Pharmacy				Total
Product net revenues		$	26,805.2			$	5,441.8			$	32,247.0			$	24,720.2			$	4,625.6			$	29,345.8
Service revenues			422.0				49.4				471.4				373.6				44.9				418.5
Total net revenues			27,227.2				5,491.2				32,718.4				25,093.8				4,670.5				29,764.3
Total cost of revenues			25,559.8				5,104.1				30,663.9				23,487.3				4,317.0				27,804.3
Selling, general and administrative expenses			577.8				149.2				727.0				560.1				150.9				711.0
Amortization of intangibles			119.8				21.4				141.2				129.0				22.8				151.8
Operating income		$	969.8			$	216.5			$	1,186.3			$	917.4			$	179.8			$	1,097.2
Reconciling items to income before provision for income taxes:
Interest expense											79.5												88.5
Interest (income) and other (income) expense, net											(7.7	)											(5.7	)
Income before provision for income taxes										$	1,114.5											$	1,014.4
Capital expenditures		$	85.1			$	15.3			$	100.4			$	87.7			$	10.4			$	98.1

Identifiable Assets:		As of June 26, 2010												As of December 26, 2009
						Specialty												Specialty
		PBM				Pharmacy				Total				PBM				Pharmacy				Total
Total identifiable assets		$	12,470.5			$	3,769.5			$	16,240.0			$	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 and six months ended June 26, 2010 and June 27, 2009. All other revenues are primarily earned in the United States.

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 learned that the Government declined to intervene in the qui tam matter. This matter is progressing 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. In July 2010, the U.S. District Court for the Southern District of Florida dismissed the action without prejudice.

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 alleged 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.

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 May 2010, the District Court approved the distribution of the settlement funds to members of the settlement class under the revised plan of allocation. The plaintiff in one action in the Gruer series of cases discussed above, Blumenthal v. Merck-Medco Managed Care, L.L.C., et al., elected to opt out of the settlement.

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 only remaining matter of these similar ERISA-based complaints, Betty Jo Jones, v. Merck-Medco Managed Care, L.L.C., et al., was later resolved as part of the Gruer settlement. In addition to these cases, a proposed class action complaint against Merck and the Company was 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 also elected to opt out of the Gruer settlement, and this action was subsequently 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 June 2010, the Company filed for summary judgment in both the Blumenthal v. Merck-Medco Managed Care, L.L.C., et al. and 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. actions.

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. In May 2010, the parties entered into a Stipulation and Order of Dismissal, agreeing to dismiss this matter with prejudice.

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.

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 had 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 acted as a purchasing agent for its plan sponsor customers, resulting in a system that serves to suppress competition.

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 June 26, 2010, the Company has 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 $171.0 million, and firm commitments of $114.2 million and $3.6 million for 2010 and 2011, respectively, 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 $50.7 million, technology-related agreements of $60.0 million and advertising commitments of $6.5 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;

•

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.

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, our capabilities were extended abroad when we acquired Europa Apotheek Venlo B.V. (“Europa Apotheek”), which primarily provides mail-order pharmacy services in Germany. In 2009, we advanced our 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 partnered with Sweden’s largest pharmacy chain, Apoteket, developing, and providing ongoing support for a national centralized drug utilization review system 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.

On June 21, 2010, Medco and Celesio AG (“Celesio”), a company based in Germany and one of the leading international service providers within the pharmaceutical and healthcare markets, announced a joint venture with a long-term goal of improving patient health and helping to relieve the significant financial burden on healthcare payors across Europe. Headquartered in the Netherlands, the 50/50 joint venture, Medco Celesio B.V., will combine Medco’s and Celesio’s strengths in pharmacy-driven clinical care. Medco Celesio B.V. will target patients with chronic or complex conditions, such as diabetes, asthma, high-cholesterol and heart disease. It will concentrate on innovative, integrated clinical services designed to improve patient adherence, integrate care across multiple providers, enhance safety and deliver greater value across the healthcare system. The transaction is expected to close in the second half of fiscal 2010.

In conjunction with the Medco Celesio B.V. joint venture, Medco intends to contribute Europa Apotheek, a wholly-owned subsidiary, subject to receipt of regulatory approvals. As of June 26, 2010, approximately half of the accumulated other comprehensive loss component of our stockholders’ equity represents an unrecognized foreign currency translation loss associated with Europa Apotheek, reflecting the weakened euro. Concurrent with the expected closing of the Medco Celesio B.V. transaction in the second half of fiscal 2010 and based on the foreign currency translation at that time, this item will be reflected in our results of operations. In addition, our investment in the joint venture will be recorded at fair value, and the difference between the fair value and the book value of the Europa Apotheek asset contributed to the joint venture will be reflected in our results of operations.

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.

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 and Six Months Ended June 26, 2010

Our diluted earnings per share increased 20.3% to $0.77 and net income increased 14.4% to $356.9 million for the second quarter of 2010 compared to $0.64 per share and $312.1 million, respectively, for the second quarter of 2009. Our diluted earnings per share increased 18.0% to $1.44 and net income increased 12.3% to $677.4 million for the six months of 2010 compared to $1.22 per share and $603.2 million, respectively, for the six months of 2009. These increases primarily reflect higher generic dispensing rates and mail-order generic volumes, increased service margin, a decrease in the diluted weighted average shares outstanding, growth in the Specialty Pharmacy business, a second-quarter 2010 benefit of approximately $27 million associated with our receipt of a settlement award in a class action antitrust lawsuit brought by direct purchasers of a brand-name medication, and a lower effective tax rate. These are partially offset by the effect of client renewal pricing, as well as increased selling, general and administrative (“SG&A”) expenses. For the six months ended June 26, 2010, we generated cash flow from operations of $990.8 million and had cash and cash equivalents of $1,183.7 million on our unaudited interim condensed consolidated balance sheet at June 26, 2010.

The diluted weighted average shares outstanding were 462.0 million for the second quarter and 470.1 million for the six months of 2010, compared to 488.0 million for the second quarter and 494.5 million for the six months of 2009, representing decreases of 5.3% and 4.9%, respectively, resulting primarily from our share repurchase programs.

Our total net revenues increased 9.9% to $16,407.5 million for the second quarter, and increased 9.9% to $32,718.4 million for the six months of 2010. Product net revenues increased 9.7% to $16,163.3 million for the second quarter, and 9.9% to $32,247.0 million for the six months of 2010, 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 21.6% to $244.2 million for the second quarter and 12.6% to $471.4 million for the six months 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, as well as higher claims processing administrative fees and increased revenues from clinical programs.

The total adjusted prescription volume, which adjusts mail-order prescription volume for the difference in days supply between mail order and retail, increased 6.0% to 238.4 million for the second quarter and 5.9% to 477.6 million for the six months of 2010, and reflects higher mail-order and retail volumes attributed to new clients. The increases in mail-order prescription volume for the second quarter and six months of 2010 are driven by an increase in generic volumes, as brand-name volumes were lower than the second quarter and six months of 2009. The adjusted mail-order penetration rate was 34.3% for the second quarter and 34.1% for the six months of 2010, compared to 34.4% for the second quarter and 34.2% for the six months of 2009.

Our overall generic dispensing rate increased to 70.6% for the second quarter and 70.1% for the six months of 2010, from 67.3% for the second quarter and 67.1% for the six months of 2009, reflecting the impact of the introduction of new generic products since the second 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 reductions to net revenues of approximately $870 million and $1,560 million for the second quarter and six months of 2010, respectively.

Our overall gross margin percentage decreased to 6.5% in the second quarter and 6.3% in the six months of 2010, from 6.8% in the second quarter and 6.6% in the six months of 2009, primarily reflecting the effect of client renewal pricing, higher retail volumes, and a lower Specialty Pharmacy gross margin percentage due to product, channel and new client mix. The gross margin percentage declines were partially offset by increased generic dispensing rates and mail-order generic volumes, as well as the aforementioned settlement award of approximately $27 million. We anticipate the contribution from generics to increase throughout 2010.

SG&A expenses of $376.4 million for the second quarter of 2010 increased by $5.7 million, or 1.5%, from the second quarter of 2009. SG&A expenses of $727.0 million for the six months of 2010 increased by $16.0 million, or 2.3%, from the six months of 2009. These increases primarily reflect higher technology-related expenses associated with strategic initiatives.

Amortization of intangible assets of $70.7 million for the second quarter and $141.2 million for the six months of 2010 decreased $5.2 million and $10.6 million from the second quarter and six months of 2009, respectively, primarily reflecting lower intangible amortization from PolyMedica associated with scheduled accelerated amortization of customer relationships.

Interest expense of $38.8 million for the second quarter and $79.5 million for the six months of 2010 decreased $4.6 million and $9.0 million from the second quarter and six months of 2009, respectively. These decreases primarily reflect 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 ($6.3) million for the second quarter and ($7.7) million for the six months of 2010 increased $4.1 million and $2.0 million, respectively, from ($2.2) million for the second quarter and ($5.7) million for the six months of 2009, primarily reflecting foreign currency favorability, partially offset by decreased interest income driven by lower interest rates earned on lower average operating cash balances, and our joint venture activity.

Our effective tax rate (defined as the percentage relationship of provision for income taxes to income before provision for income taxes) was 38.7% for the second quarter and 39.2% for the six months of 2010, compared to 40.9% for the second quarter and 40.5% for the six months of 2009, reflecting our lower state income tax rates.

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 as part of our diabetes pharmacy care practice. 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.

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. In the second quarter and six months of 2010, premium revenues for our PDP products, which exclude member cost share, were $181 million and $363 million, respectively, or 1% of total net revenues. In the second quarter and six months of 2009, premium revenues for our PDP products, which exclude member cost share, were $148 million and $291 million, respectively, or less than 1% of total net revenues.

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 is 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.

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 consists 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 our 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, and short-term and long-term investments in marketable securities, as well as other (income) expense from the effect of foreign currency translation and our joint venture activity.

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.

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 of PolyMedica in 2007, and, for the Specialty Pharmacy segment, goodwill and intangible assets recorded primarily from our acquisitions 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 programs. 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.

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 the sale of 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 second quarter and six months 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 $2,700 million and $5,500 million, or 17%, of our net revenues, respectively. For the second quarter and six months of 2009, our ten largest clients based on revenue accounted for approximately 49% of our net revenues, including UnitedHealth Group, which represented approximately $2,800 million and $5,600 million, or 19%, of our net revenues, respectively. 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 second quarters and six months 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 second quarters and six months 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, which provides diabetes testing supplies and related products in conjunction with our diabetes pharmacy care practice and Therapeutic Resource Center activities, as well as 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.

Consolidated Results of Operations

The following table presents selected consolidated comparative results of operations and volume performance ($ and volumes in millions):

		Quarter												Quarter				Six Months												Six Months
		Ended												Ended				Ended												Ended
		June 26,												June 27,				June 26,												June 27,
		2010				Variance								2009				2010				Variance								2009
Net Revenues
Retail product(1)		$	10,015.2			$	880.5				9.6	%		$	9,134.7			$	20,050.8			$	1,791.6				9.8	%		$	18,259.2
Mail-order product			6,148.1				553.2				9.9	%			5,594.9				12,196.2				1,109.6				10.0	%			11,086.6
Total product(1)		$	16,163.3			$	1,433.7				9.7	%		$	14,729.6			$	32,247.0			$	2,901.2				9.9	%		$	29,345.8
Client and other service			202.9				37.8				22.9	%			165.1				391.7				50.8				14.9	%			340.9
Manufacturer service			41.3				5.6				15.7	%			35.7				79.7				2.1				2.7	%			77.6
Total service		$	244.2			$	43.4				21.6	%		$	200.8			$	471.4			$	52.9				12.6	%		$	418.5
Total net revenues(1)		$	16,407.5			$	1,477.1				9.9	%		$	14,930.4			$	32,718.4			$	2,954.1				9.9	%		$	29,764.3
Cost of Revenues
Product(1)		$	15,284.5			$	1,428.4				10.3	%		$	13,856.1			$	30,538.1			$	2,850.1				10.3	%		$	27,688.0
Service			61.3				2.8				4.8	%			58.5				125.8				9.5				8.2	%			116.3
Total cost of revenues(1)		$	15,345.8			$	1,431.2				10.3	%		$	13,914.6			$	30,663.9			$	2,859.6				10.3	%		$	27,804.3
Gross Margin(2)
Product		$	878.8			$	5.3				0.6	%		$	873.5			$	1,708.9			$	51.1				3.1	%		$	1,657.8
Product gross margin percentage			5.4	%			(0.5	)%							5.9	%			5.3	%			(0.3	)%							5.6	%
Service		$	182.9			$	40.6				28.5	%		$	142.3			$	345.6			$	43.4				14.4	%		$	302.2
Service gross margin percentage			74.9	%			4.0	%							70.9	%			73.3	%			1.1	%							72.2	%
Total gross margin		$	1,061.7			$	45.9				4.5	%		$	1,015.8			$	2,054.5			$	94.5				4.8	%		$	1,960.0
Gross margin percentage			6.5	%			(0.3	)%							6.8	%			6.3	%			(0.3	)%							6.6	%
Volume Information
Retail prescriptions			156.7				9.1				6.2	%			147.6				314.8				17.9				6.0	%			296.9
Mail-order prescriptions			27.5				1.6				6.2	%			25.9				54.7				3.0				5.8	%			51.7
Total prescriptions			184.2				10.7				6.2	%			173.5				369.5				20.9				6.0	%			348.6
Adjusted prescriptions(3)			238.4				13.5				6.0	%			224.9				477.6				26.5				5.9	%			451.1
Adjusted mail-order penetration(4)			34.3	%			(0.1	)%							34.4	%			34.1	%			(0.1	)%							34.2	%
Other volume(5)			2.1				0.4				23.5	%			1.7				4.2				0.7				20.0	%			3.5
Generic Dispensing Rate Information
Retail generic dispensing rate			72.3	%			3.3	%							69.0	%			71.8	%			3.1	%							68.7	%
Mail-order generic dispensing rate			61.2	%			3.5	%							57.7	%			60.3	%			2.9	%							57.4	%
Overall generic dispensing rate			70.6	%			3.3	%							67.3	%			70.1	%			3.0	%							67.1	%