Medco Health Solutions (MHS) 10-Q 2008 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 29, 2008

OR

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

For the transition period from                    to                    

Commission File Number: 1-31312

MEDCO HEALTH SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation)	22-3461740 (I.R.S. Employer Identification No.)
100 Parsons Pond Drive, Franklin Lakes, NJ (Address of principal executive offices)	07417-2603 (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. Yesþ Noo

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

Large accelerated filerþ	Accelerated filero
Non-Accelerated filero	Smaller reporting companyo

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

     As of the close of business on April 25, 2008, the registrant had 506,657,842 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) — March 29, 2008 and December 29, 2007	1
	Condensed Consolidated Statements of Income (Unaudited) — Fiscal Quarters Ended March 29, 2008 and March 31, 2007	2
	Condensed Consolidated Statement of Stockholders’ Equity (Unaudited) — Fiscal Quarter Ended March 29, 2008	3
	Condensed Consolidated Statements of Cash Flows (Unaudited) — Fiscal Quarters Ended March 29, 2008 and March 31, 2007	4
	Notes to Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4.	Controls and Procedures	39
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3.	Defaults Upon Senior Securities	41
Item 4.	Submission of Matters to a Vote of Security Holders	41
Item 5.	Other Information	42
Item 6.	Exhibits	43
SIGNATURES		44
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32.1: CERTIFICATION
EX-32.2: CERTIFICATION

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

MEDCO HEALTH SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In millions, except for share data)

	March 29,			December 29,
ASSETS	2008			2007
Current assets:
Cash and cash equivalents	$	540.6		$	774.1
Short-term investments		70.4			70.3
Manufacturer accounts receivable, net		1,692.4			1,516.2
Client accounts receivable, net		1,443.2			1,340.3
Income taxes receivable		208.1			216.0
Inventories, net		1,967.0			1,946.0
Prepaid expenses and other current assets		292.3			285.4
Deferred tax assets		151.7			154.4
Total current assets		6,365.7			6,302.7
Property and equipment, net		724.0			725.5
Goodwill		6,234.0			6,230.2
Intangible assets, net		2,835.8			2,905.0
Other noncurrent assets		75.0			54.5
Total assets	$	16,234.5		$	16,217.9
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Claims and other accounts payable	$	2,447.5		$	2,812.9
Client rebates and guarantees payable		1,481.9			1,092.2
Accrued expenses and other current liabilities		674.5			624.1
Short-term debt		600.0			600.0
Total current liabilities		5,203.9			5,129.2
Long-term debt, net		3,589.9			2,894.4
Deferred tax liabilities		1,125.7			1,167.0
Other noncurrent liabilities		140.4			152.0
Total liabilities		10,059.9			9,342.6
Commitments and contingencies (See Note 11)
Stockholders’ equity:
Preferred stock, par value $0.01—authorized: 10,000,000 shares; issued and outstanding: 0		—			—
Common stock, par value $0.01—authorized: 1,000,000,000 shares; issued: 649,458,369 shares at March 29, 2008 and 647,384,634 shares at December 29, 2007		6.5			6.4
Accumulated other comprehensive income (loss)		(11.1	)		6.4
Additional paid-in capital		7,600.3			7,553.0
Retained earnings		3,096.6			2,826.4
		10,692.3			10,392.2
Treasury stock, at cost: 132,494,789 shares at March 29, 2008 and 111,445,348 shares at December 29, 2007		(4,517.7	)		(3,516.9	)
Total stockholders’ equity		6,174.6			6,875.3
Total liabilities and stockholders’ equity	$	16,234.5		$	16,217.9

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

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MEDCO HEALTH SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In millions, except for per share data)

	Quarters Ended
	March 29,		March 31,
	2008		2007
Product net revenues (Includes retail co-payments of $2,102 for 2008, and $1,986 for 2007)	$	12,806.9	$	11,026.3
Service revenues		156.0		133.3
Total net revenues		12,962.9		11,159.6
Cost of operations:
Cost of product net revenues (Includes retail co-payments of $2,102 for 2008, and $1,986 for 2007)		12,016.8		10,349.9
Cost of service revenues		45.9		36.0
Total cost of revenues		12,062.7		10,385.9
Selling, general and administrative expenses		328.4		248.4
Amortization of intangibles		69.5		54.6
Interest and other (income) expense, net		54.3		14.9
Total cost of operations		12,514.9		10,703.8
Income before provision for income taxes		448.0		455.8
Provision for income taxes		177.8		181.0
Net income	$	270.2	$	274.8
Basic earnings per share:
Weighted average shares outstanding		526.9		573.5
Earnings per share	$	0.51	$	0.48
Diluted earnings per share:
Weighted average shares outstanding		537.8		582.3
Earnings per share	$	0.50	$	0.47

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

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MEDCO HEALTH SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(UNAUDITED)
(Shares in thousands; $ in millions, except for per share data)

	Shares of				$0.01		Accumulated
	Common		Shares of		Par Value		Other			Additional
	Stock		Treasury		Common		Comprehensive			Paid-in		Retained			Treasury
	Issued		Stock		Stock		Income (Loss)			Capital		Earnings			Stock			Total
Balances at December 29, 2007		647,385		111,445	$	6.4	$	6.4		$	7,553.0	$	2,826.4		$	(3,516.9	)	$	6,875.3
Comprehensive income:
Net income		—		—		—		—			—		270.2			—			270.2
Other comprehensive income, net of tax:
Unrealized loss on investments		—		—		—		(0.1	)		—		—			—			(0.1	)
Unrealized loss on cash flow hedge, net of tax of $10.8		—		—		—		(16.9	)		—		—			—			(16.9	)
Amortization of effective portion of cash flow hedge, net of tax		—		—		—		0.1			—		—			—			0.1
Defined benefit plans:
Amortization of prior service cost included in net periodic benefit cost, net of tax of $0.4		—		—		—		(0.7	)		—		—			—			(0.7	)
Net gains (losses) included in net periodic benefit cost, net of tax of $(0.1)		—		—		—		0.1			—		—			—			0.1
Other comprehensive income		—		—		—		(17.5	)		—		—			—			(17.5	)
Total comprehensive income		—		—		—		(17.5	)		—		270.2			—			252.7
Issuance of common stock for options exercised, including tax benefit		981		—		0.1		—			28.5		—			—			28.6
														��
Issuance of common stock under employee stock purchase plans		86		—		—		—			4.4		—			—			4.4
Restricted stock and restricted stock unit activity, including tax benefit		1,006		—		—		—			0.1		—			—			0.1
Stock-based compensation related to options		—		—		—		—			14.3		—			—			14.3
Treasury stock acquired		—		21,050		—		—			—		—			(1,000.8	)		(1,000.8	)
Balances at March 29, 2008		649,458		132,495	$	6.5	$	(11.1	)	$	7,600.3	$	3,096.6		$	(4,517.7	)	$	6,174.6

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

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MEDCO HEALTH SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
($ in millions)

	Quarters Ended
	March 29,			March 31,
	2008			2007
Cash flows from operating activities:
Net income	$	270.2		$	274.8
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		40.1			41.5
Amortization of intangibles		69.5			54.6
Deferred income taxes		(42.4	)		(35.7	)
Stock-based compensation on employee stock plans		29.4			20.2
Tax benefit on employee stock plans		40.9			41.9
Excess tax benefits from stock-based compensation arrangements		(24.2	)		(27.3	)
Other		33.8			12.0
Net changes in assets and liabilities:
Manufacturer accounts receivable, net		(176.2	)		(37.0	)
Client accounts receivable, net		(125.8	)		(42.4	)
Inventories, net		(21.0	)		(28.8	)
Prepaid expenses and other current assets		(5.8	)		(4.6	)
Income taxes receivable		7.9			(2.9	)
Other noncurrent assets		(4.0	)		4.9
Claims and other accounts payable		(365.4	)		(559.5	)
Client rebates and guarantees payable		389.7			274.5
Accrued expenses and other current and noncurrent liabilities		48.8			114.3
Net cash provided by operating activities		165.5			100.5
Cash flows from investing activities:
Capital expenditures		(39.1	)		(25.0	)
Purchases of securities and other investments		(6.5	)		(5.9	)
Proceeds from sale of securities and other investments		—			2.6
Net cash used by investing activities		(45.6	)		(28.3	)
Cash flows from financing activities:
Proceeds from long-term debt		1,885.7			—
Repayments on long-term debt		(1,200.0	)		(18.9	)
Proceeds under accounts receivable financing facility		—			275.0
Debt issuance costs		(10.1	)		—
Settlement of cash flow hedge		(45.4	)		—
Purchase of treasury stock		(1,000.8	)		(781.9	)
Excess tax benefits from stock-based compensation arrangements		24.2			27.3
Net (payments) proceeds from employee stock plans		(7.0	)		90.9
Net cash used by financing activities		(353.4	)		(407.6	)
Net decrease in cash and cash equivalents		(233.5	)		(335.4	)
Cash and cash equivalents at beginning of period		774.1			818.5
Cash and cash equivalents at end of period	$	540.6		$	483.1

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

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MEDCO HEALTH SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

     The accompanying unaudited interim condensed consolidated financial statements of Medco Health Solutions, Inc. and its subsidiaries (“Medco” or the “Company”) have been prepared pursuant to the Securities and Exchange Commission’s (“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 29, 2007. The Company’s fiscal quarters for 2008 and 2007 each consisted of 13 weeks and ended on March 29, 2008 and March 31, 2007, respectively.

     The Company previously disclosed a two-for-one stock split, which was effected in the form of a 100% stock dividend and distributed on January 24, 2008, to shareholders of record at the close of business on January 10, 2008. All share and per share amounts, including those as of and for the first quarter of 2007, have been adjusted for the increase in issued and outstanding shares after giving effect to the stock split. See Note 1, “Background and Basis of Presentation,” to the audited consolidated financial statements included in Part II, Item 8 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2007 for additional information.

2. RECENTLY ADOPTED FINANCIAL ACCOUNTING STANDARD

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 does not require any new fair value measurements. SFAS 157 establishes a common definition for fair value to be applied with existing generally accepted accounting principles (“GAAP”) requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. The Company adopted SFAS 157 on December 30, 2007 except for those non-recurring measurements for non-financial assets and non-financial liabilities subject to the partial deferral in FASB Statement of Position No. 157-2, “Partial Deferral of the Effective Date of Statement 157,” (“FSP 157-2”) as noted below. The adoption of SFAS 157 did not have an impact on the Company’s financial position or operating results.

     FSP 157-2 deferred the effective date of SFAS 157 for all non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008. The Company is currently assessing the impact of SFAS 157 for non-financial assets and non-financial liabilities on its consolidated statements of financial position and results of operations.

     Fair Value Hierarchy.     SFAS 157 defines the inputs used to measure fair value into the following hierarchy:

     Level 1: Quoted market prices in active markets for identical assets or liabilities.

     Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

     Level 3: Unobservable inputs reflecting the reporting entity’s own assumptions.

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     The Company utilizes the best available information in measuring fair value. The following table sets forth, by level within the fair value hierarchy, the financial assets recorded at fair value on a recurring basis as of March 29, 2008 ($ in millions):

Medco Fair Value Measurements at Reporting Date

	March 29,
Description	2008		Level 1		Level 2		Level 3
Fair value of interest rate swap agreements	$	6.6	$	—	$	6.6	$	—
Available-for-sale investments		5.9		1.9		4.0		—
Money market mutual funds		396.0		396.0		—		—

     Available-for-sale securities classified as Level 1 are measured using quoted market prices for identical assets while the securities classified as Level 2 are measured through comparable assets observed in the markets. The Company’s interest rate swap agreements are valued using observable market inputs, and therefore are classified within Level 2. 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 balance sheet at the principal amounts deposited, which equals the asset values quoted by the money market fund custodians.

3. STOCK-BASED COMPENSATION

     On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”), which requires the measurement and recognition of compensation expense for all stock-based compensation awards made to employees and directors, including employee stock options and employee stock purchase plans. SFAS 123R requires companies to estimate the fair value of option awards on the date of grant using an option-pricing model. The portion of the value that is ultimately expected to vest is recognized as expense over the requisite service period.

     Stock Option Plans.     The Company grants options to employees and directors to purchase shares of Medco common stock at the fair market value on the date of grant. The options generally vest over three years (director options vest in one year) and expire within 10 years from the date of the grant. The fair value of options granted is estimated on the date of grant using the Black-Scholes option-pricing model.

     Summarized information related to stock options held by the Company’s employees and directors is as follows:

						Weighted
						Average		Aggregate
	Number of			Weighted		Remaining		Intrinsic
	Shares			Average		Contractual		Value
	(in thousands)			Exercise Price		Term		(in millions)
Outstanding at December 29, 2007		26,314.2		$	24.64
Granted		4,686.2			50.35
Exercised		(979.1	)		19.25
Forfeited		(226.6	)		30.42
Outstanding at March 29, 2008		29,794.7		$	28.82		7.35	$	442.8
Exercisable at March 29, 2008		16,882.7		$	21.26		6.39	$	378.6

     As of March 29, 2008 there was $135.1 million of total unrecognized compensation cost related to stock options granted. That cost is expected to be recognized over a weighted average period of 2.3 years.

     Restricted Stock Units and Restricted Stock Plans.     The Company grants restricted stock units to employees and directors and had previously granted shares of restricted stock to a limited number of employees. Restricted stock units and restricted stock generally vest after three years. The fair value of the restricted stock units and restricted shares is determined by the product of the number of shares granted and the grant-date market price of the Company’s common

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stock. The fair value of the restricted stock units and restricted shares is expensed on a straight-line basis over the requisite service period.

     Upon vesting, certain employees and directors may defer conversion of the restricted stock units to common stock. Restricted stock units granted to directors are required to be deferred until their service on the Board of Directors ends. Summarized information related to restricted stock units and restricted stock held by the Company’s employees and directors is as follows:

				Aggregate
	Number of			Intrinsic
	Shares			Value
Restricted Stock Units	(in thousands)			(in millions)
Outstanding at December 29, 2007		6,334.1
Granted		1,336.7
Converted		(1,626.6	)
Forfeited		(51.6	)
Outstanding at March 29, 2008		5,992.6		$	261.8
Vested and deferred at March 29, 2008		629.6		$	27.5

			Aggregate
	Number of		Intrinsic
	Shares		Value
Restricted Stock	(in thousands)		(in millions)
Outstanding at December 29, 2007		79.8
Granted		—
Converted		—
Forfeited		—
Outstanding at March 29, 2008		79.8	$	3.5

     The weighted average grant-date fair value of restricted stock units granted during the quarter ended March 29, 2008 was $50.35. As of March 29, 2008, there was $138.1 million of total unrecognized compensation cost related to nonvested restricted stock units and restricted stock grants. This cost is expected to be recognized over a weighted average period of 2.3 years.

4. ACQUISITION OF POLYMEDICA CORPORATION (“POLYMEDICA”)

     The operating results of PolyMedica, which was acquired on October 31, 2007, are included in the accompanying unaudited interim condensed consolidated financial statements. The unaudited pro forma results of operations of the Company and PolyMedica for the quarter ended March 31, 2007 as if the PolyMedica acquisition had occurred at the beginning of fiscal 2007 were as follows ($ in millions, except for per share amounts):

	Quarter Ended
	March 31,
	2007
Pro forma total net revenues	$	11,308.9
Pro forma net income	$	269.5
Pro forma basic earnings per common share	$	0.47
Pro forma diluted earnings per common share	$	0.46

     The pro forma financial information above is not necessarily indicative of what the Company’s consolidated results of operations actually would have been if the PolyMedica acquisition had been completed at the beginning of fiscal 2007. In addition, the pro forma information above does not attempt to project the Company’s future results of operations.

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5. EARNINGS PER SHARE (“EPS”)

     The following is a reconciliation of the number of weighted average shares used in the basic and diluted EPS calculations (amounts in millions):

	Quarters Ended
	March 29,		March 31,
	2008		2007
Weighted average shares outstanding		526.9		573.5
Dilutive common stock equivalents:
Outstanding stock options, restricted stock units and restricted stock		10.9		8.8
Weighted average shares outstanding assuming dilution		537.8		582.3

     SFAS No. 128, “Earnings per Share,” (“SFAS 128”) requires that stock options and restricted stock units granted by the Company be treated as potential common shares outstanding in computing diluted earnings per share. Under the treasury stock method on a grant by grant basis, the amount the employee or director must pay for exercising the award, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefit that would be recorded in additional paid-in capital when the award becomes deductible, are assumed to be used to repurchase shares at the average market price during the period. For the quarters ended March 29, 2008 and March 31, 2007, there were outstanding options to purchase 5.5 million and 11.4 million shares of Medco stock, respectively, which were not dilutive to the EPS calculations when applying the SFAS 128 treasury stock method. These outstanding options may be dilutive to future EPS calculations. The decrease in the weighted average shares outstanding and diluted weighted average shares outstanding for the quarter ended March 29, 2008 compared to the same period in 2007 results from the repurchase of 132.4 million shares of stock in connection with the Company’s share repurchase program since its inception in 2005 through the first quarter of 2008, compared to an equivalent amount of 81.3 million shares purchased inception-to-date as of the first quarter of 2007. The Company repurchased approximately 21.0 million shares of stock in the first quarter of 2008. The decrease in shares outstanding was partially offset by the issuance of stock under employee stock plans and the dilutive effect of outstanding stock options. In accordance with SFAS 128, weighted average treasury shares are not considered part of the basic or diluted shares outstanding.

6. ACCOUNTS RECEIVABLE

     The Company separately reports accounts receivable due from manufacturers and accounts receivable due from clients. Client accounts receivable are presented net of allowance for doubtful accounts and include a reduction for rebates and guarantees payable to clients when such are settled on a net basis in the form of an invoice credit. As of March 29, 2008 and December 29, 2007, identified net specialty pharmacy accounts receivable, primarily due from payors and patients, amounted to $475.1 million and $457.2 million, respectively.

     The Company’s allowance for doubtful accounts as of March 29, 2008 and December 29, 2007 of $127.4 million and $130.0 million, respectively, includes $75.5 million and $70.8 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. The Company’s allowance for doubtful accounts as of March 29, 2008 and December 29, 2007 also includes $29.2 million and $30.3 million, respectively, related to PolyMedica for diabetic supplies dispensed and reimbursed by insurance companies and government agencies. In addition, the Company’s allowance for doubtful accounts also reflects amounts associated with member premiums for the Company’s Medicare Part D product offering. See Note 10, “Segment Reporting,” 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.

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7. GOODWILL AND INTANGIBLE ASSETS, NET

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

	March 29, 2008						December 29, 2007
	Gross						Gross
	Carrying		Accumulated				Carrying		Accumulated
	Value		Amortization		Net		Value		Amortization		Net
Goodwill:
PBM(1)	$	5,131.5	$	813.4	$	4,318.1	$	5,131.6	$	813.4	$	4,318.2
Specialty Pharmacy(2)		1,915.9		—		1,915.9		1,912.0		—		1,912.0
Total(3)	$	7,047.4	$	813.4	$	6,234.0	$	7,043.6	$	813.4	$	6,230.2
Intangible assets:
PBM(1)	$	3,714.6	$	1,638.5	$	2,076.1	$	3,714.2	$	1,580.0	$	2,134.2
Specialty Pharmacy(2)		861.4		101.7		759.7		861.5		90.7		770.8
Total	$	4,576.0	$	1,740.2	$	2,835.8	$	4,575.7	$	1,670.7	$	2,905.0

(1)	Principally comprised of the push-down of the excess of acquisition costs over the fair value of the Company’s net assets from the acquisition of the Company by Merck & Co., Inc. (“Merck”) in 1993, and the recorded value of Medco’s client relationships at the time of acquisition and, to a lesser extent, the Company’s acquisitions of PolyMedica in 2007, and ProVantage Health Services, Inc. in 2000.
(2)	Represents the Specialty Pharmacy segment, primarily reflecting the portion of the excess of the purchase price paid by the Company to acquire Accredo Health, Incorporated (“Accredo”) in 2005 over tangible net assets acquired, and to a significantly lesser extent, a portion of the excess of the purchase price paid by the Company to acquire Critical Care Systems, Inc. (“Critical Care”) in 2007, and Pediatric Services of America, Inc. in 2005.
(3)	The change in goodwill for the quarter ended March 29, 2008 primarily represents a final purchase price cash settlement with Critical Care.

     Aggregate intangible asset amortization expense is estimated to be as follows ($ in millions):

Fiscal Years Ending December
2008 (remaining)	$	209.1
2009		263.2
2010		244.1
2011		233.0
2012		228.4
Total	$	1,177.8

     The weighted average useful life of intangible assets subject to amortization is 22 years in total. The weighted average useful life is approximately 22 years for the PBM client relationships and approximately 21 years for the Specialty-acquired intangible assets. The Liberty trade name acquired intangible asset of $392 million has an indefinite life.

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8. DEBT

     The Company’s debt consists of the following ($ in millions):

	March 29,		December 29,
	2008		2007
Short-term debt:
Accounts receivable financing facility	$	600.0	$	600.0
Total short-term debt		600.0		600.0
Long-term debt:
Senior unsecured revolving credit facility		600.0		1,400.0
Senior unsecured term loan		1,000.0		1,000.0
7.25% senior notes due 2013, net of unamortized discount		497.5		497.4
6.125% senior notes due 2013, net of unamortized discount		298.3		—
7.125% senior notes due 2018, net of unamortized discount		1,187.5		—
Fair value of interest rate swap agreements		6.6		(3.0	)
Total long-term debt		3,589.9		2,894.4
Total debt	$	4,189.9	$	3,494.4

     Senior Notes.     On March 18, 2008, the Company completed an underwritten public offering of $300 million aggregate principal amount of 5-year senior notes at a price to the public of 99.425 percent of par value, and $1.2 billion aggregate principal amount of 10-year senior notes at a price to the public of 98.956 percent. The 5-year senior notes bear interest at a rate of 6.125% per annum, with an effective interest rate of 6.261%, and mature on March 15, 2013. The 10-year senior notes bear interest at a rate of 7.125% per annum, with an effective interest rate of 7.274%, and mature on March 15, 2018. Medco may redeem all or part of these notes at any time or from time to time at its option at a redemption price equal to the greater of (i) 100% of the principal amount of the notes being redeemed plus accrued and unpaid interest to the redemption date or (ii) a “make-whole” amount based on the yield of a comparable U.S. Treasury security plus 50 basis points. The Company will pay interest on both series of senior notes semi-annually on March 15 and September 15 of each year, beginning September 15, 2008. The Company used the net proceeds from the sale of these senior notes to repay borrowings under its revolving credit facility used to fund the acquisition of PolyMedica, which was described in Note 3, “Acquisitions of Businesses,” to the Company’s audited financial statements included in Part II, Item 8 of Medco’s Annual Report on Form 10-K for the fiscal year ended December 29, 2007. The estimated aggregate fair value of the 6.125% senior notes equaled $302.7 million at March 29, 2008. The estimated aggregate fair value of the 7.125% senior notes equaled $1,237.2 million at March 29, 2008. The fair values are based on observable market inputs.

     In August 2003, in connection with Medco’s spin-off, the Company completed an underwritten public offering of $500 million aggregate principal amount of 10-year senior notes at a price to the public of 99.195 percent of par value. The senior notes bear interest at a rate of 7.25% per annum, with an effective interest rate of 7.365%, and mature on August 15, 2013. Medco may redeem all or part of these notes at any time or from time to time at its option at a redemption price equal to the greater of (i) 100% of the principal amount of the notes being redeemed, or (ii) the sum of the present values of 107.25% of the principal amount of the notes being redeemed, plus all scheduled payments of interest on the notes discounted to the redemption date at a semi-annual equivalent yield to a comparable treasury issue for such redemption date plus 50 basis points. The estimated aggregate fair value of the 7.25% senior notes equaled $522.2 million at March 29, 2008. The fair value is based on observable market inputs.

     Swap Agreements.    On December 12, 2007, the Company entered into forward-starting interest rate swap agreements in contemplation of the issuance of long-term fixed-rate financing. These cash flow hedges were entered into to manage the Company’s exposure to changes in benchmark interest rates and mitigate the impact of fluctuations in the interest rates prior to the issuance of the long-term financing. The cash flow hedges entered into were for a notional amount of $500 million on the then-current 10-year treasury interest rate, and for a notional amount of $250 million on the then-current 30-year treasury interest rate, both with a settlement date of March 31, 2008. At the time of purchase, the cash flow hedges were anticipated to be effective in offsetting the changes in the expected future interest rate payments on the proposed debt offering attributable to fluctuations in the treasury benchmark interest rate.

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     In the first quarter of 2008, the Company determined to issue 5-year senior notes and 10-year senior notes on March 18, 2008 as noted above. As a result, a portion of the $250 million notional amount 30-year treasury interest rate cash flow hedge was deemed an ineffective hedge and was recorded as a component of interest and other (income) expense, net, in the accompanying unaudited interim condensed consolidated statement of income. The cash flow hedges were settled on March 17, 2008 for approximately $45.4 million and included an ineffective portion that resulted in an increase of $9.8 million to interest and other (income) expense, net, for the quarter ended March 29, 2008. The effective portion was recorded in accumulated other comprehensive income and is reclassified to interest expense over the ten-year period in which the Company hedged its exposure to variability in future cash flows.

     The Company entered into five interest rate swap agreements in 2004. These swap agreements, in effect, converted $200 million of the $500 million of 7.25% senior notes to variable interest rates. The swaps have been designated as fair value hedges and have an expiration date of August 15, 2013, consistent with the maturity date of the senior notes. The fair value of the derivatives outstanding, which is based upon quoted market prices that reflect the present values of the difference between estimated future fixed rate payments and future variable rate receipts, represented a net receivable of $6.6 million as of March 29, 2008, which is reported in other noncurrent assets, and a net payable of $3.0 million as of December 29, 2007, which was recorded in other noncurrent liabilities, with an offsetting amount recorded in long-term debt, net. These are the amounts that the Company would have received from third parties as of March 29, 2008 or would have had to pay to third parties as of December 29, 2007 if the derivative contracts had been settled. Under the terms of these swap agreements, the Company receives a fixed rate of interest of 7.25% on $200 million and pays variable interest rates based on the six-month London Interbank Offered Rate (“LIBOR”) plus a weighted average spread of 3.05%. The payment dates under the agreements coincide with the interest payment dates on the hedged debt instruments, and the difference between the amounts paid and received is included in interest and other (income) expense, net.

     Five-Year Credit Facilities.    On April 30, 2007, the Company entered into a senior unsecured credit agreement, which is available for working capital requirements, to fund the Company’s share repurchase program, acquisitions, and capital expenditures, and for general corporate purposes. The facilities consist of a $1 billion, 5-year senior unsecured term loan and a $2 billion, 5-year senior unsecured revolving credit facility. The term loan matures on April 30, 2012, at which time the entire facility is required to be repaid. At the Company’s current debt ratings, the credit facilities bear interest at LIBOR plus a 0.45 percent margin, with a 10 basis point commitment fee due on the unused portion of the revolving credit facility.

     During the first quarter of 2008, the Company’s aggregate borrowings under the revolving credit facility decreased by approximately $800 million after applying the proceeds of the senior notes offering in March 2008 described above. As of March 29, 2008, the Company had $600 million outstanding and had $1.387 billion available for borrowing, after giving effect to $13 million in issued letters of credit, under its revolving credit facility.

     Accounts Receivable Financing Facility.    Through a wholly-owned subsidiary, the Company has a $600 million, 364-day renewable accounts receivable financing facility that is collateralized by the Company’s pharmaceutical manufacturer rebate accounts receivable. At March 29, 2008, there was $600 million outstanding with no additional amounts available for borrowing under the facility. The Company pays interest on amounts borrowed under the agreement based on the funding rates of the bank-related commercial paper programs that provide the financing, plus an applicable margin determined by the Company’s credit rating.

     364-day Credit Facility.     On March 18, 2008, the Company terminated the $800 million senior unsecured 364-day revolving credit agreement (the “364-Day Credit Agreement”) entered into on November 30, 2007, which provided for up to $800 million in revolving loans during the availability period, effective beginning on January 2, 2008. Interest was set at LIBOR plus a 0.55 percent margin, with a 10 basis point commitment fee due on the unused portion of the facility. No amounts were drawn by the Company under the 364-Day Credit Agreement at any time. In addition, the Company did not pay any early termination penalties.

     Covenants.    The various series of senior notes discussed above are subject to customary affirmative and negative covenants, including limitations on sale/leaseback transactions; limitations on liens; and limitations on mergers and similar transactions. The 6.125% senior notes and the 7.125% senior notes are also subject to a covenant with respect to certain change of control triggering events, as well as an interest rate adjustment for a downgrade in the ratings to below

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investment grade on the senior notes. In addition, the senior unsecured credit facilities and the accounts receivable financing facility are subject to covenants, including, among other items, maximum leverage ratios. The Company was in compliance with all covenants at March 29, 2008.

     Aggregate Maturities and Interest Expense.The aggregate maturities of long-term debt are as follows ($ in millions):

Fiscal Years Ending December
2008	$	—
2009		—
2010		—
2011		—
Thereafter		3,600.0
Total	$	3,600.0

     Interest expense on total debt was $50.6 million and $22.8 million for the first quarters ended March 29, 2008 and March 31, 2007, respectively.

9. PENSION AND OTHER POSTRETIREMENT BENEFITS

     Net Pension and Postretirement Benefit Cost.The Company has various plans covering the majority of its employees. The Company uses its fiscal year-end date as the measurement date for most of its plans. The net cost for the Company’s pension plans consisted of the following components ($ in millions):

	Quarters Ended
	March 29,			March 31,
	2008			2007
Service cost	$	5.7		$	4.4
Interest cost		2.3			1.7
Expected return on plan assets		(3.2	)		(2.4	)
Net amortization of actuarial losses		—			0.1
Net pension cost	$	4.8		$	3.8

     The increase in the net pension cost for the quarter ended March 29, 2008 compared to the same period last year is primarily due to additional employees participating in the cash balance retirement plan, as well as a plan amendment from graduated seven-year vesting to three-year cliff vesting, which became effective January 1, 2008.

     The Company maintains an unfunded postretirement healthcare benefit plan covering the majority of its employees. The net credit for these postretirement benefits consisted of the following components ($ in millions):

	Quarters Ended
	March 29,			March 31,
	2008			2007
Service cost	$	0.2		$	0.2
Interest cost		0.2			0.2
Amortization of prior service credit		(1.1	)		(1.1	)
Net amortization of actuarial losses		0.2			0.2
Net postretirement benefit credit	$	(0.5	)	$	(0.5	)

     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. In the third quarter of 2006, there was a change in assumption regarding retiree participation based on recent plan experience under the amended plan design. The activity for all periods presented reflects that change in assumption.

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10. SEGMENT REPORTING

     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 network of contractually affiliated retail pharmacies or the Company’s mail-order pharmacies. The PBM segment also includes the operating results of PolyMedica, a provider of diabetes testing supplies and related products to patients with diabetes, commencing October 31, 2007, the date of the acquisition. The Specialty Pharmacy segment, which was formed upon the Accredo acquisition and is also comprised of specialty pharmacy activity previously included within Medco’s PBM business, includes the sale of higher-margin specialty pharmacy products and services for the treatment of chronic and complex (potentially life-threatening) diseases. The Specialty Pharmacy segment also includes the operating results of Critical Care, a provider of specialty infusion services, commencing November 14, 2007, the date of acquisition.

     The Company defines the Specialty Pharmacy segment based on a product set and associated services, broadly characterized to include drugs that are high-cost, usually developed by biotechnology companies and often injectable, and which 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 than is required in the traditional PBM business model. In addition, specialty pharmacy products and services are often covered through medical benefit programs with the primary payors being insurance companies and government programs, along with patients, as well as PBM clients as payors.

     Selected Segment Income and Asset Information.Total net revenues and operating income are measures used by the chief operating decision maker to assess the performance of each of the Company’s operating segments. The following tables present selected financial information about the Company’s reportable segments, including a reconciliation of operating income to income before provision for income taxes ($ in millions):

	Quarter Ended March 29, 2008						Quarter Ended March 31, 2007
			Specialty						Specialty
	PBM(1)		Pharmacy(2)		Total		PBM		Pharmacy		Total
Product net revenues	$	10,932.4	$	1,874.5	$	12,806.9	$	9,591.3	$	1,435.0	$	11,026.3
Service revenues		140.9		15.1		156.0		118.6		14.7		133.3
Total net revenues		11,073.3		1,889.6		12,962.9		9,709.9		1,449.7		11,159.6
Total cost of revenues		10,318.2		1,744.5		12,062.7		9,052.3		1,333.6		10,385.9
Selling, general and administrative expenses		258.0		70.4		328.4		195.4		53.0		248.4
Amortization of intangibles		58.5		11.0		69.5		45.0		9.6		54.6
Operating income	$	438.6	$	63.7	$	502.3	$	417.2	$	53.5	$	470.7
Reconciling item to income before provision for income taxes:
Interest and other (income) expense, net						54.3						14.9
Income before provision for income taxes					$	448.0					$	455.8
Capital expenditures	$	32.7	$	6.4	$	39.1	$	20.0	$	5.0	$	25.0

Identifiable Assets	As of March 29, 2008						As of December 29, 2007
			Specialty						Specialty
	PBM		Pharmacy		Total		PBM		Pharmacy		Total
Total identifiable assets	$	12,525.3	$	3,709.2	$	16,234.5	$	12,597.7	$	3,620.2	$	16,217.9

(1)	Includes PolyMedica’s operating results commencing October 31, 2007, the date of acquisition.
(2)	Includes Critical Care’s operating results commencing November 14, 2007, the date of acquisition.

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11. 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 most significant of these 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 lawsuits 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 legal proceedings and government investigations would not likely be covered by insurance.

     In accordance with SFAS No. 5, “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 can 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 two sealedqui tammatters. The 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 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 twoqui tammatters 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. These twoqui tammatters were not considered in the Company’s settlement with the Department of Justice discussed in Note 4, “Legal Settlements Charge,” to the audited consolidated financial statements included in Part II, Item 8 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2007.

     ERISA and Similar Litigation.In December 1997, a lawsuit captionedGruer 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 and the Company. The suit alleges that the Company should be treated as a “fiduciary” under the provisions of ERISA (the Employee Retirement Income Security Act of 1974) and that the Company had breached fiduciary obligations under ERISA in a variety of ways. After theGruercase 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 theGruerseries of lawsuits on a class action basis for $42.5 million, and agreed to certain business practice changes, to avoid the significant cost and distraction of protracted litigation. In September 2003, the Company paid $38.3 million to an escrow account, representing the Company’s portion, or 90%, of the proposed settlement. The release of claims under the settlement applies to plans for which the Company administered a pharmacy benefit at any time between December 17, 1994 and the date of final approval. It does not involve the release of any potential antitrust claims. In May 2004, the U.S. District Court granted final approval to the settlement and a final judgment was entered in June 2004.

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     Various appeals were taken and in October 2007, the U.S. Court of Appeals for the Second Circuit overruled all but one objection to the settlement that had been the subject of the appeals. The appeals court vacated the lower court’s approval of the settlement in one respect, and remanded the case to the District Court for further proceedings relating to the manner in which the settlement funds should be allocated between self-funded and insured plans. Since that time, the settlement has been revised to allocate a greater percentage of the settlement funds to self-funded plans, and a hearing on whether the revised settlement should be approved is scheduled to take place in May 2008. The plaintiff in one of theGruerseries of cases discussed above,Blumenthal v. Merck-Medco Managed Care, L.L.C., et al.,has 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 theGruersettlement discussed above and, accordingly, seven of these actions had been dismissed pursuant to the final judgment discussed above. The plaintiff in another action,Betty Jo Jones v. Merck-Medco Managed Care, L.L.C., et al., has filed a Second Amended Complaint, in which she seeks to represent a class of all participants and beneficiaries of ERISA plans that required such participants to pay a percentage co-payment on prescription drugs. The effect of the release under theGruersettlement discussed above on theJonesaction has not yet been litigated. In addition to these cases, a proposed class action complaint against Merck and the Company has been filed in the U.S. District Court for the Northern District of California by trustees of another benefit plan, the United Food and Commercial Workers Local Union No. 1529 and Employers Health and Welfare Plan Trust. This plan has elected to opt out of theGruersettlement. TheUnited Food and Commercial Workers Local Union No. 1529 and Employers Health and Welfare Plan Trust v. Medco Health Solutions, Inc. and Merck & Co., Inc. action has been transferred and consolidated in the U.S. District Court for the Southern District of New York by order of the Judicial Panel on Multidistrict Litigation.

     In September 2002, a lawsuit captionedMiles 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. TheMilescase was removed to the U.S. District Court for the Southern District of California and was later transferred to the U.S. District Court for the Southern District of New York and consolidated with the ERISA cases pending against Merck and the Company in that court.

     The Company does not believe that it is a fiduciary under ERISA (except in those instances in which it has expressly contracted to act as a fiduciary for limited purposes), and believes that its business practices comply with all applicable laws and regulations.

     Antitrust and Related Litigation.In August 2003, a lawsuit captionedBrady 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 captionedNorth 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

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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 captionedMike’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 theAlameda Drug Companyaction 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, theBradyplaintiffs filed a petition to transfer and consolidate various antitrust actions against PBMs, includingNorth Jackson, Brady,andMike’s Medical Centerbefore a single federal judge. The motion was granted on August 24, 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 asIn 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 captionedAlameda 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 complaint also copies verbatim many of the allegations in the amended complaint-in-intervention filed by the U.S. Attorney for the Eastern District of Pennsylvania, discussed in Note 4, “Legal Settlements Charge,” included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 29, 2007. The plaintiffs further allege that, as a result of these alleged practices, the Company has been able to increase its market share and artificially reduce the level of reimbursement to the retail pharmacy class members, and that the prices of prescription drugs from Merck and other pharmaceutical manufacturers that do business with the Company had been fixed and raised above competitive levels. The plaintiffs assert claims for violation of California antitrust law and California law prohibiting unfair business practices. The plaintiffs demand, among other things, compensatory damages, restitution, disgorgement of unlawfully obtained profits and injunctive relief. In the complaint, the plaintiff further alleges, among other things, that the Company acts as a purchasing agent for its plan sponsor customers, resulting in a system that serves to suppress competition.

     In February 2006, a lawsuit captionedChelsea Family Pharmacy, PLLC v. Medco Health Solutions, Inc.,was filed in the U.S. District Court for the Northern District of Oklahoma. The plaintiff, which seeks to represent a class of Oklahoma pharmacies that had contracted with the Company within three years prior to the filing of the complaint, alleges, among other things, that the Company has contracted with retail pharmacies at rates that are less than the prevailing rates paid by ordinary consumers and has denied consumers their choice of pharmacy by placing restrictions on the plaintiff’s ability to dispense pharmaceutical goods and services. The plaintiff asserts that the Company’s activities violate the Oklahoma Third Party Prescription Act, and seeks, among other things, compensatory damages, attorneys’ fees and injunctive relief. On September 21, 2007, the Magistrate Judge recommended that the District Court deny Medco’s motion to stay the action pending arbitration. On October 4, 2007, Medco filed an objection to the Magistrate’s Report and Recommendation. That motion is pending.

     Contract Litigation.In July 2003, a lawsuit captionedGroup Hospitalization and Medical Services v. Merck-Medco Managed Care, L.L.C., et al.was filed against the Company in the Superior Court of New Jersey. In this action, the Company’s former client, CareFirst Blue Cross Blue Shield, asserts claims for violation of fiduciary duty under state law; breach of contract; negligent misrepresentation; unjust enrichment; violations of certain District of Columbia laws regarding consumer protection and restraint of trade; and violation of a New Jersey law prohibiting racketeering. The plaintiff demands compensatory damages, punitive damages, treble damages for certain claims and restitution. Following a summary judgment hearing in this matter on November 30, 2007, the judge dismissed the fiduciary duty, consumer fraud, and racketeering claims. On December 21, 2007, the Company and CareFirst Blue Cross Blue Shield agreed in

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principle to settle this matter for an immaterial amount and subsequently, the parties formally settled this matter and the judge has dismissed the complaint with prejudice.

     On December 27, 2007, IMS Health Incorporated filed a demand for arbitration against the Company. In this action, IMS Health Incorporated is alleging that the Company violated the terms of a cross-licensing data agreement by charging a third-party a lower price for data and subsequently not adjusting the price charged to IMS Health Incorporated to be equal to what was being charged to the third party. IMS Health Incorporated is seeking a declaratory judgment to enforce the disputed terms of the agreement and damages based on the price differential.

     Bankruptcy Preference Litigation.On November 4, 2004, a preference action captionedBerman v. Paid Prescriptions, LLC (In re HNRC Dissolution Co.)was filed against the Company in the United States Bankruptcy Court for the Eastern District of Kentucky, Ashland Division. The lawsuit seeks to recover payments made by the debtor (a former client of the Company) prior to the filing of the bankruptcy petition. The Company was never properly served with the complaint, and first learned of this matter in the fourth quarter of 2007 after the Trustee of the bankruptcy estate obtained a default judgment against the Company. The Company has filed a motion to vacate the default judgment. This motion is pending before the bankruptcy court.

     Accredo.Accredo, a former Accredo officer and a former Accredo officer who is a current Medco director are defendants in a securities class action lawsuit filed in the United States District Court for the Western District of Tennessee. Plaintiffs in the securities class action lawsuit allege that the actions and omissions of the current Medco director and former Accredo officer relating to a prior acquisition by Accredo constitute violations of various sections of the Securities Exchange Act of 1934. Summary judgment motions will be filed in the summer of 2008 and trial is currently scheduled to commence in October 2008.

     Certain former officers and former directors of Accredo are defendants in a stockholders derivative suit based on the same underlying claims filed in the Circuit Court of Shelby County, Tennessee. Plaintiffs in the derivative suit allege that the former officers and former directors have breached their fiduciary duty to Accredo and also allege other violations. Pending court approval, the derivative case has been settled in principle for an immaterial amount, which is entirely covered by insurance.

     PolyMedica Shareholder Litigation.In August 2007, a putative stockholder class action lawsuit related to the merger was filed by purported stockholders of PolyMedica in the Superior Court of Massachusetts for Middlesex County against, amongst others, the Company and its affiliate, MACQ Corp. The lawsuit captioned,Groen v. PolyMedica Corp. et al.,alleges, among other things, that the price agreed to in the merger agreement was inadequate and unfair to the PolyMedica stockholders and that the defendants breached their duties to the stockholders and/or aided breaches of duty by other defendants in negotiating and approving the merger agreement. Shortly thereafter, two virtually identical lawsuits (only one of which named the Company as a defendant) were filed in the same court. The complaints allege claims for breach of fiduciary duty and seek injunctive, declaratory and other equitable relief.

     On September 28, 2007, the parties to these actions reached an agreement in principle to settle the actions for an immaterial amount. As part of the settlement, the defendants, while denying all allegations of wrongdoing, agreed, among other things, to make certain disclosures and to pay certain fees and costs associated with the litigation. The settlement is subject to court approval.

Other Matters

     The Company entered into an indemnification and insurance matters agreement with Merck in connection with the spin-off. To the extent that the Company is required to indemnify Merck for liabilities arising out of a lawsuit, an adverse outcome with respect to Merck could result in the Company making indemnification payments in amounts that could be material, in addition to any damages that the Company is required to pay.

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Purchase Obligations

     The Company has entered into agreements with certain biopharmaceutical manufacturers and a brand-name pharmaceutical manufacturer that contain minimum purchasing volume commitments. As of March 29, 2008, these purchase obligations amounted to $123.6 million for the remainder of 2008, the majority of which is associated with Accredo’s specialty pharmacy business. There are no such commitments beyond 2008.

     PolyMedica has entered into purchase commitments for advertising spots and other media to obtain favorable advertising rates. As of March 29, 2008, these commitments amounted to $6.2 million through 2010, of which $5.4 is committed for the remainder of 2008.

12. RECENT ACCOUNTING PRONOUNCEMENTS

     In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No 133” (“SFAS 161”). SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative instruments. The standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, and the Company is evaluating the impact that such adoption will have on its financial statements.

     In December 2007, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 07-1, “Accounting for Collaborative Arrangements,” (“EITF 07-1”), which defines collaborative arrangements and establishes reporting and disclosure requirements for transactions between participants in a collaborative arrangement and between participants in the arrangements and third parties. EITF 07-1 is effective for periods beginning after December 15, 2008 and applies to arrangements in existence as of the effective date. The Company’s adoption of EITF 07-01 in 2009 is not expected to have a material impact on its consolidated financial statements.

     In December 2007, the FASB issued SFAS No. 141 (R), “Business Combinations” (“SFAS 141(R)”) and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). The standards are intended to improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. SFAS 141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS 141(R) is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited.

     SFAS 160 is designed to improve the relevance, comparability, and transparency of financial information provided to investors by requiring all entities to report noncontrolling (minority) interests in subsidiaries in the same way—as equity in the consolidated financial statements. Moreover, SFAS 160 eliminates the diversity that currently exists in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. In addition, SFAS 160 shall be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements shall be applied retrospectively for all periods presented. The Company’s adoption of SFAS 160 in 2009 is not expected to have a material impact on its consolidated financial statements.

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13. SUBSEQUENT EVENT

Acquisition of a Majority Interest in Europa Apotheek Venlo B.V.

     On April 28, 2008, the Company completed the acquisition of a majority interest in Europa Apotheek Venlo B.V. (“Europa Apotheek”), a privately held company based in the Netherlands, which provides clinical health care and mail-order pharmacy services in Germany. In this transaction Medco acquired a majority equity interest in Europa Apotheek for approximately $120 million, with additional future consideration for achieving performance targets. This acquisition is a logical extension of the Company’s international strategy to leverage the Company’s proven proprietary technologies and partnering to deliver customized solutions to the challenges of managing health care costs and improving clinical care abroad.

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 could result in significantly decreased revenues and could harm our profitability;

• If we do not continue to earn and retain purchase discounts and rebates from manufacturers at current levels, our gross margins may decline;

• Our acquisition activity has increased recently 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;

• If we fail to comply with complex and rapidly evolving laws and regulations, we could suffer penalties, or be required to pay substantial damages or make significant changes to our operations;

• 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 to execute our Medicare Part D prescription drug benefits strategy could adversely impact our business and financial results;

• 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;

• We are subject to corporate integrity agreements and noncompliance may impede our ability to conduct business with the federal government;

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• Legislative or regulatory initiatives that restrict or prohibit the PBM industry’s ability to use patient identifiable medical information could limit our ability to use information that is critical to the operation of our business;

• Our specialty pharmacy business is highly dependent on our relationships with a limited number of biopharmaceutical suppliers and the loss of any of these relationships could significantly impact our ability to sustain or increase our revenues;

• 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, Medicare Part D offerings and certain revenues from diabetes testing supplies expose us to increased credit risk;

• Changes in industry pricing benchmarks could adversely affect our financial performance;

• The terms and covenants relating to our existing indebtedness could adversely impact our financial performance;

• Prescription volumes may decline, and our net revenues and profitability may be negatively impacted, if products are withdrawn from the market, if prescription drugs transition to over-the-counter products, or if increased safety risk profiles of specific drugs result in utilization decreases;

• We may be subject to liability claims for damages and other expenses that are not covered by insurance;

• The success of our business depends on maintaining a well-secured pharmacy operation and technology infrastructure and failure to execute could adversely impact our business;

• We could 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;

• Changes in reimbursement rates, including competitive bidding for durable medical equipment suppliers, could negatively affect our PolyMedica diabetes testing supplies revenues and profits under our Liberty brand; 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 and other documents filed from time to time with the Securities and Exchange Commission.

Overview

     We are the nation’s leading pharmacy benefit manager based on net revenues. We provide sophisticated traditional and specialty prescription drug benefit programs and services for our clients and members. Our business model requires collaboration with retail pharmacies, physicians, the Centers for Medicare & Medicaid Services (“CMS”) for Medicare, and particularly in specialty pharmacy, collaboration with state Medicaid agencies, and other payors such as 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 our Specialty Pharmacy segment, Accredo Health Group, which became the nation’s largest specialty pharmacy based on revenues with our 2005 acquisition of Accredo Health, Incorporated (“Accredo”) (the “Accredo acquisition”). In 2007, we introduced the Medco Therapeutic Resource Centers^®, staffed with more than 1,100 pharmacists who are trained and certified in specific complex and chronic conditions and have expertise with the associated medications. The therapeutic resource center for diabetes was augmented with the 2007 acquisition of

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PolyMedica Corporation (“PolyMedica”), through which we became the largest diabetes pharmacy care practice based on covered patients. See Note 3, “Acquisitions of Businesses,” to our audited consolidated financial statements included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 for more information.

     We previously disclosed a two-for-one stock split, which was effected in the form of a 100% stock dividend and distributed on January 24, 2008, to shareholders of record at the close of business on January 10, 2008. All share and per share amounts, including those as of and for the first quarter of 2007, have been adjusted for the increase in issued and outstanding shares after giving effect to the stock split. See Note 1, “Background and Basis of Presentation,” to the audited consolidated financial statements included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 for additional information.

     The complicated environment in which we operate presents us with opportunities, challenges and risks. Our clients and membership are paramount to our success; the retention of existing and winning of new clients and members poses the greatest opportunity, 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 hinge 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, and our ability to continue to provide innovative and competitive clinical and other services to clients and patients, including our active participation in the Medicare Part D benefit and the rapidly growing specialty pharmacy industry.

     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 Medco’s mail-order pharmacy operations, as well as Accredo’s specialty 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; diluted earnings per share; Specialty Pharmacy segment revenue and operating income; Earnings Before Interest Income/Expense, Taxes, Depreciation, and Amortization (“EBITDA”); and EBITDA per adjusted prescription. See “—EBITDA” further below for a definition and calculation of EBITDA and EBITDA per adjusted prescription. We believe these measures highlight key business trends and are important in evaluating our overall performance.

Financial Performance Summary for the Quarter Ended March 29, 2008

     Our diluted earnings per share increased 6.4% to $0.50 for the first quarter of 2008 from $0.47 per share for the first quarter of 2007. Our net income decreased 1.7% to $270.2 million in the first quarter of 2008 compared to $274.8 million in the first quarter of 2007, which included the benefit from the short-term availability of genericPlavix^®. The diluted earnings per share and net income activity reflects higher generic dispensing rates, mail-order penetration and manufacturer rebate retention rates, as well as a decrease in the diluted weighted average shares outstanding. These are partially offset by the aforementionedPlavixbenefit in the first quarter of 2007, as well as higher start-up costs from significant new client installations, and higher client price discounts reflecting an increased level of first-quarter client renewals in 2008 compared to the first quarter of 2007. In addition, the first quarter of 2008 includes the operating results of PolyMedica and Critical Care Systems, Inc. (“Critical Care”) commencing October 31, 2007 and November 14, 2007, the dates of acquisition, respectively.

     The diluted weighted average shares outstanding were 537.8 million for the first quarter of 2008, compared to 582.3 million for the first quarter of 2007, representing a decrease of 7.6%. This decrease results from our share repurchase program which commenced in 2005.

     Total net revenues increased 16.2% to $12,962.9 million for the first quarter of 2008, compared to the same period last year. Product net revenues increased 16.1% to $12,806.9 million, which reflects higher total volume driven by new business, as well as price inflation on brand-name drugs, partially offset by a greater representation of lower cost generic drugs and higher client price discounts. Additionally, our service revenues increased 17.0% to $156.0 million, which is

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primarily attributable to higher client and other service revenues, reflecting higher revenues for services associated with Medicare Part D-related product offerings, clinical programs, and nursing services, in addition to higher claims processing administrative fees.

     Total prescription volume, adjusted for the difference in days supply between mail and retail, increased 9.1% to 206.7 million for the first quarter of 2008, substantially the result of higher volumes from new clients. The adjusted mail-order penetration rate increased to 38.4% for the first quarter of 2008, compared to 36.9% for the first quarter of 2007, and results from a large mail-order only client commencing in 2008.

     Our overall generic dispensing rate increased to 63.3% for the first quarter of 2008, compared to 58.2% for the first quarter of 2007. This increase reflects the introduction of new generic products during this period, the effect of client plan design changes promoting the use of lower-cost and more steeply discounted generics, and our programs designed to encourage generic utilization. The higher generic dispensing rate, which contributes to lower costs for clients and members, resulted in a reduction of approximately $750 million in net revenues for the first quarter of 2008.

     Our overall gross margin of 6.9% for the first quarter of 2008 was consistent with the first quarter of 2007, primarily reflecting our increased generic dispensing rate, mail-order volume and rebate retention rates, offset by the aforementionedPlavixbenefit in the first quarter of 2007, as well as new client start-up costs and client price discounts.

     Selling, general and administrative (“SG&A”) expenses of $328.4 million for the first quarter of 2008 increased from the first quarter of 2007 by $80.0 million, or 32.2%, reflecting the addition of PolyMedica and Critical Care SG&A expenses, as well as higher employee-related costs associated with business growth across the Company, including client and product support activities.

     Amortization of intangible assets of $69.5 million for the first quarter of 2008 increased $14.9 million from the first quarter of 2007 as a result of the PolyMedica and Critical Care acquisitions.

     Interest and other (income) expense, net, of $54.3 million for the first quarter of 2008 increased $39.4 million compared to the first quarter of 2007, primarily attributable to higher interest expense reflecting increased borrowings to fund our acquisitions, share repurchase program, general corporate activities, working capital requirements, and capital expenditures, as well as a charge for the ineffective portion of the forward-starting interest rate swap agreements associated with our March 2008 issuance of senior notes,which is described further below under “—Liquidity and Capital Resources—Swap Agreements.”

     Our effective tax rate (defined as the percentage relationship of provision for income taxes to income before provision for income taxes) was 39.7% for the first quarter of 2008, consistent with the first quarter of 2007.

Key Financial Statement Components

     Consolidated Statements of Income

     Our net revenues are comprised primarily of product net revenues and are derived 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. 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. Our product net revenues also include revenues from the sale of diabetic supplies dispensed by PolyMedica.

     In addition, our product net revenues include premiums associated with our Medicare Part D Prescription Drug Program (“PDP”) risk-based product offering. This product involves prescription dispensing for members covered under the CMS-sponsored Medicare Part D benefit. Since 2006, two of our insurance company subsidiaries have been operating under contracts with CMS to offer a number of Medicare Part D PDP products. The products involve underwriting the benefit and charging member premiums for prescription dispensing covered under the CMS-approved Medicare Part D benefit. We provide a Medicare drug benefit that represents either (i) the minimum, standard level of benefits mandated

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by statute, or (ii) enhanced coverage, on behalf of certain clients, which exceeds the standard drug benefit in exchange for additional premiums.

     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 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 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 by members based on prescription orders by those members, some of which are subsidized by CMS in cases of low-income membership. The subsidy amounts received in advance are recorded in accrued expenses and other current liabilities on the consolidated balance sheets. At the end of the contract term and based on actual annual drug costs incurred, subsidies are reconciled with actual costs and residual subsidy advance receipts are payable to CMS. The cost share is treated consistently as other co-payments derived from providing PBM services, as a component of product net revenues in the consolidated statements of income where the requirements of Emerging Issues Task Force (“EITF”) No. 99-19, “Reporting Gross Revenue as a Principal vs. Net as an Agent,” 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, Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007. In the first quarters of 2008 and 2007, premium revenues for our PDP product, which exclude member cost share, were $81 million and $77 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. As a CMS-approved PDP, our policies and practices associated with executing the program are subject to audit, and if material contractual or regulatory non-compliance was to be identified, applicable sanctions and/or monetary penalties 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 and other non-product-related revenues, sales of prescription services to pharmaceutical manufacturers and data to other parties, and performance-oriented fees paid by specialty pharmacy manufacturers.

     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 network of retail pharmacies are comprised of the contractual cost of drugs dispensed by, and professional fees paid to, retail pharmacies in the networks, including the associated member co-payments. Our cost of product net revenues relating to drugs dispensed by our mail-order pharmacies consists primarily of the cost of inventory dispensed and our costs incurred to process and dispense the prescriptions, including the associated fixed asset depreciation. The operating costs of our call center pharmacies are also included in cost of product net revenues. In addition, cost of product net revenues includes a credit for

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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 Part D PDP product offering 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 $4,050 for coverage year 2008 and $3,850 for coverage year 2007. 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 recorded in accrued expenses and other current liabilities on the consolidated balance sheets. At the end of the contract term and based on actual annual drug costs incurred, residual subsidy advance receipts are payable to CMS. Cost of service revenues consist principally of labor and operating costs for delivery of services provided, as well as costs associated with member communication materials.

     SG&A expenses reflect the costs of operations dedicated to executive management, the generation of new sales, maintenance of existing client relationships, management of clinical programs, enhancement of technology capabilities, direction of pharmacy operations, and performance of reimbursement activities, in addition to finance, legal and other staff activities, and the effect of certain legal settlements. SG&A also includes advertising expenses associated with PolyMedica, which are expensed as incurred.

     Interest and other (income) expense, net, primarily includes interest expense on our senior unsecured credit facilities, accounts receivable financing facility, senior notes, and, in the first quarter of 2008, a loss on the ineffective portion of the settled forward-starting interest rate swap agreements. Interest and other (income) expense, net, also includes interest income or interest expense on interest rate swap agreements on $200 million of the 7.25% senior notes. This net expense amount is partially offset by interest income generated by cash and cash equivalent investments and short- and long-term investments in marketable securities.

     For further details, see our critical accounting policies included in “—Use of Estimates and Critical Accounting Policies and Estimates” and Note 2, “Summary of Significant Accounting Policies,” to our audited consolidated financial statements included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007.

     Consolidated Balance Sheets

     Our primary assets include cash and cash equivalents, short- and long-term investments, manufacturer accounts receivable, client accounts receivable, inventories, fixed assets, deferred tax assets, goodwill and intangibles. 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 investments include U.S. government securities that have average maturities of less than one year and that are held to satisfy statutory capital requirements for our insurance subsidiaries. We have no exposure to or investments in any instruments associated with the sub-prime market.

     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 such 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 include premiums receivable from CMS for our Medicare Part D PDP product offering and premiums from members. Additionally, we have receivables from Medicare and Medicaid for a portion of our specialty pharmacy business, and diabetic supplies dispensed by PolyMedica.

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     Inventories reflect the cost of prescription products held for dispensing by our mail-order pharmacies and are recorded on a first-in, first-out basis, net of allowances for losses. Deferred tax assets primarily represent temporary differences between the financial statement basis and the tax basis of certain accrued expenses, stock-based compensation, and client rebate pass-back liabilities. Income taxes receivable represents amounts due from the IRS and state and local 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. 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 push-down of goodwill and intangibles from our acquisition by Merck in 1993, the value of the Liberty trade name, customer relationships and goodwill recorded upon our acquisition in 2007 of PolyMedica and, for the Specialty Pharmacy segment, goodwill and intangible assets recorded primarily from our acquisition of Accredo in 2005.

     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, cost share, and catastrophic reinsurance payments received in advance from CMS for our Medicare Part D PDP product offering. This includes published amounts due to CMS associated with the 2006 plan year reconciliation process. Our debt is primarily comprised of a senior unsecured term loan facility, senior notes and an accounts receivable financing facility. In addition, we have a net deferred tax liability primarily associated with our recorded intangible assets. We do not have any off-balance sheet arrangements, other than purchase commitments and lease obligations. See “— Contractual Obligations” below.

     Our stockholders’ equity includes an offset for treasury stock purchases under our share repurchase program. The accumulated other comprehensive income component of stockholders’ equity includes the net gains and losses and prior service costs and credits related to our pension and other postretirement benefit plans in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of Financial Accounting Standards Board (“FASB”) Statements No. 87, 88, 106, and 132(R),” and unrealized investment gains and losses, as well as unrealized losses on cash flow hedges associated with our senior notes.

     Consolidated Statements of Cash Flows

     An important element of our operating cash flows is the timing of billing cycles, which are 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. We also generate operating cash flows associated with our Medicare Part D PDP product offering, including premiums, cost share, and various subsidies received in advance from CMS. In addition, our operating cash flows include tax benefits associated with employee stock plans other than the benefits of realized tax deductions in excess of tax benefits on 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 mail-order inventory purchases, which are paid in accordance with payment terms offered by our suppliers to take advantage of appropriate discounts, payments to retail pharmacies, rebate and guarantee payments to clients, employee payroll and

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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 and proceeds from securities and other investments, which relate to investment activities of our insurance companies. Acquisitions will also generally result in cash outflows from investing activities. Our financing cash flows primarily include share repurchases, proceeds from debt, interest and principal payments on our outstanding debt, proceeds from employee stock plans, and the benefits of realized tax deductions in excess of tax benefits on compensation expense.

Client-Related Information

     Revenues from UnitedHealth Group Incorporated (“UnitedHealth Group”), currently our largest client, amounted to approximately $2,800 million, or 21%, of our net revenues in the first quarter of 2008, and approximately $2,500 million, or 22%, of our net revenues in the first quarter of 2007. The UnitedHealth Group account has much lower mail-order penetration and, because of its size, much steeper pricing than the average client, and consequently generates lower profitability than typical client accounts. On April 22, 2008, the Company issued a press release announcing that it has reached agreement with UnitedHealth Group to provide pharmacy benefit services through December 31, 2012 under a new agreement which includes terms that provide better alignment between the parties. None of our other clients individually represented more than 10% of our net revenues in the first quarter of 2008 or 2007.

Segment Discussion

     We have two reportable segments, PBM and Specialty Pharmacy. The PBM segment involves sales of traditional prescription drugs and supplies to our clients and members, either through our network of contractually affiliated retail pharmacies or our mail-order pharmacies. The PBM segment also includes the operating results of PolyMedica, a provider of diabetes testing supplies and related products to patients with diabetes, commencing October 31, 2007, the date of the acquisition. The Specialty Pharmacy segment, which was formed upon the Accredo acquisition and is also comprised of specialty pharmacy activity previously included within Medco’s PBM business, includes the sale of higher-margin specialty pharmacy products and services for the treatment of chronic and complex (potentially life-threatening) diseases. The Specialty Pharmacy segment also includes the operating results of Critical Care, a provider of specialty infusion services, commencing November 14, 2007, the date of acquisition.

     We define the Specialty Pharmacy segment based on a product set and associated services, broadly characterized to include drugs that are high-cost, usually developed by biotechnology companies and often injectable or infusible, and which 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 than is required in the traditional PBM business model, including in-home nursing services and administration. In addition, specialty pharmacy products and services are often covered through medical benefit programs with the primary payors being insurance companies and government programs, along with patients, as well as PBM clients as payors.

     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. Currently, both the PBM and the Specialty Pharmacy segments operate in one geographic region, which includes the United States and Puerto Rico.

     As a result of the nature of our integrated PBM services and contracts, the chief operating decision maker views Medco’s PBM operations as a single segment for purposes of making decisions about resource allocations and in assessing performance.

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Consolidated Results of Operations

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

	Quarter								Quarter
	Ended								Ended
	March 29,			Increase					March 31,
	2008(1)			(Decrease)					2007
Net Revenues
Retail product(2)	$	7,415.6		$	703.3		10.5	%	$	6,712.3
Mail-order product		5,391.3			1,077.3		25.0	%		4,314.0
Total product(2)	$	12,806.9		$	1,780.6		16.1	%	$	11,026.3
Client and other service		114.8			18.0		18.6	%		96.8
Manufacturer service		41.2			4.7		12.9	%		36.5
Total service	$	156.0		$	22.7		17.0	%	$	133.3
Total net revenues(2)	$	12,962.9		$	1,803.3		16.2	%	$	11,159.6
Cost of Revenues
Product(2)	$	12,016.8		$	1,666.9		16.1	%	$	10,349.9
Service		45.9			9.9		27.5	%		36.0
Total cost of revenues(2)	$	12,062.7		$	1,676.8		16.1	%	$	10,385.9
Gross Margin(3)
Product	$	790.1		$	113.7		16.8	%	$	676.4
Product gross margin percentage		6.2	%		0.1	%				6.1	%
Service	$	110.1		$	12.8		13.2	%	$	97.3
Service gross margin percentage		70.6	%		(2.4	)%				73.0	%
Total gross margin	$	900.2		$	126.5		16.4	%	$	773.7
Gross margin percentage		6.9	%		—					6.9	%
Volume Information
Retail prescriptions		127.2			7.7		6.4	%		119.5
Mail-order prescriptions		26.6			3.2		13.7	%		23.4
Total prescriptions		153.8			10.9		7.6	%		142.9
Adjusted prescriptions(4)		206.7			17.2		9.1	%		189.5
Adjusted mail-order penetration(5)		38.4	%		1.5	%				36.9	%
Other volume(6)		1.2			1.2		N/M	*		—
Generic Dispensing Rate Information
Retail generic dispensing rate		65.3	%		5.1	%				60.2	%
Mail-order generic dispensing rate		53.6	%		5.2	%				48.4	%
Overall generic dispensing rate		63.3	%		5.1	%				58.2	%

*	Not meaningful.
(1)	Includes PolyMedica’s and Critical Care’s operating results commencing October 31, 2007 and November 14, 2007, the dates of acquisition, respectively.
(2)	Includes retail co-payments of $2,102 million for the first quarter of 2008 and $1,986 million for the first quarter of 2007.
(3)	Defined as net revenues minus cost of revenues.
(4)	Adjusted prescription volume equals the majority of mail-order prescriptions multiplied by 3, plus retail prescriptions. These mail-order prescriptions are multiplied by 3 to adjust for the fact that they include approximately 3 times the amount of product days supplied compared with retail prescriptions.
(5)	The percentage of adjusted mail-order prescriptions to total adjusted prescriptions.
(6)	Represents over-the-counter drugs, as well as diabetic supplies primarily dispensed by PolyMedica.

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Net Revenues

     Retail.The $703 million increase in retail net revenues for the first quarter of 2008 is attributable to net volume increases of $434 million primarily from new business, and net price increases of $269 million driven by price inflation on brand-name drugs, partially offset by higher client price discounts. The aforementioned net price variance includes the offsetting effect of approximately $510 million for the first quarter from a greater representation of generic drugs in 2008.

     Mail.The $1,077 million increase in mail-order net revenues for the first quarter of 2008 reflects net volume increases of $822 million primarily from new business and incremental volume from PolyMedica, and net price increases of $255 million driven by price inflation on brand-name drugs, partially offset by higher client price discounts. The aforementioned net price variance includes the offsetting effect of approximately $240 million for the first quarter from a greater representation of generic drugs in 2008.

     Our product net revenues include premium revenues for our Medicare Part D PDP risk-based product offering, which exclude member cost share. In the first quarters of 2008 and 2007, premium revenues for our PDP product were $81 million and $77 million, respectively, or less than 1% of total net revenues.

     Our overall generic dispensing rate increased to 63.3% for the first quarter of 2008, compared to 58.2% for the first quarter of 2007. Mail-order and retail generic dispensing rates increased to 53.6% and 65.3%, respectively, for the first quarter of 2008, compared to 48.4% and 60.2% for the first quarter of 2007, respectively. These increases reflect the introduction of new generic products during these periods, the effect of client plan design changes promoting the use of lower-cost and more steeply discounted generics, and our programs designed to encourage generic utilization.

     Service revenues increased $23 million in the first quarter of 2008 as a result of higher client and other service revenues of $18 million and higher manufacturer service revenues of $5 million. The higher client and other service revenues reflect higher revenues for services associated with Medicare Part D-related product offerings, clinical programs, and nursing services, in addition to higher claims processing administrative fees. The higher manufacturer revenues result from higher administrative fees earned primarily from higher volumes.

Gross Margin

     Our product gross margin percentage was 6.2% for the first quarter of 2008 compared to 6.1% for the first quarter of 2007. The rate of change in cost of product net revenues was consistent with the rate of change in product net revenues, reflecting the greater representation of lower-cost generic products, as well as higher mail-order volumes, favorable retail pharmacy reimbursement rates, and increased brand-name pharmaceutical rebates. These items are offset by price inflation on brand-name drugs, the first-quarter 2007 benefit from the short-term availability of genericPlavix, and new client start-up costs. Also contributing as an offset are higher client price discounts, which include an increased level of first-quarter client renewals in 2008 compared to the first quarter of 2007 and the effect of 2008 new clients.

     Rebates from brand-name pharmaceutical manufacturers, which are reflected as a reduction in cost of product net revenues, totaled $1,053 million in the first quarter of 2008, and $919 million in the first quarter of 2007, with formulary rebates representing 50.2% and 49.0% of total rebates, respectively. The increase in rebates earned reflects improved formulary management and patient compliance, as well as favorable pharmaceutical manufacturer rebate contract revisions, and decreased rebates as a result of brand-name drugs that have lost patent protection. We retained approximately $211 million, or 20.0%, of total rebates in the first quarter of 2008, compared to $168 million, or 18.3%, in the first quarter of 2007, reflecting the current mix of client rebate sharing arrangements.

     Service gross margin of $110 million for the first quarter of 2008 increased $13 million compared to $97 million for the first quarter of 2007. This reflects the increase in service revenues of $23 million driven by the aforementioned client and other service revenue increases, offset by increases in cost of service revenues of $10 million reflecting higher labor and other costs associated with client programs including Medicare Part D and the aforementioned nursing services.

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     The following table presents additional selected consolidated comparative results of operations ($ in millions):

	Quarter							Quarter
	Ended							Ended
	March 29,		Increase					March 31,
	2008(1)		(Decrease)					2007
Gross margin(2)	$	900.2	$	126.5		16.4	%	$	773.7
Selling, general and administrative expenses		328.4		80.0		32.2	%		248.4
Amortization of intangibles		69.5		14.9		27.3	%		54.6
Interest and other (income) expense, net		54.3		39.4		264.4	%		14.9
Income before provision for income taxes		448.0		(7.8	)	(1.7	)%		455.8
Provision for income taxes		177.8		(3.2	)	(1.8	)%		181.0
Net income	$	270.2	$	(4.6	)	(1.7	)%	$	274.8

(1)	Includes PolyMedica’s and Critical Care’s operating results commencing October 31, 2007 and November 14, 2007, the dates of acquisition, respectively.
(2)	Defined as net revenues minus cost of revenues.

Selling, General and Administrative Expenses

     SG&A expenses for the first quarter of 2008 were $328 million and increased from the first quarter of 2007 by $80 million, or 32.2%. This primarily reflects PolyMedica SG&A expenses of $46 million, as well as higher employee-related costs of $19 million associated with business growth across the Company, including client and product support activities. Also contributing to the increase are Critical Care SG&A expenses of $14 million.

Amortization of Intangibles

     Amortization of intangible assets was $70 million for the first quarter of 2008 compared to $55 million for the first quarter of 2007. The increase reflects the additional intangible amortization associated with the PolyMedica and Critical Care acquisitions.

Interest and Other (Income) Expense, Net

     Interest and other (income) expense, net, increased $39.4 million for the first quarter of 2008, compared to the same period last year. The variance results from higher interest expense of $27.8 million, lower interest income of $1.8 million, and other expense of $9.8 million from a charge for the ineffective portion of the forward-starting interest rate swap agreements associated with our March 2008 issuance of senior notes described further below under “—Liquidity and Capital Resources—Swap Agreements.” The interest expense variance reflects increased borrowings to fund our acquisitions, share repurchase program, general corporate activities, working capital requirements, and capital expenditures, partially offset by lower interest rates on floating rate debt. The interest income variance reflects lower interest rates.

     The weighted average interest rate on our indebtedness was approximately 5.2% for the first quarter of 2008, compared to 6.9% for the first quarter of 2007, and reflects variability in floating interest rates on the senior unsecured credit facilities and the accounts receivable financing facility.

Provision for Income Taxes

     Our effective tax rate (defined as the percentage relationship of provision for income taxes to income before provision for income taxes) was 39.7% in the first quarter of 2008, consistent with the first quarter of 2007.

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Net Income and Earnings per Share

     Net income as a percentage of net revenues decreased to 2.1% in the first quarter of 2008, from 2.5% in the first quarter of 2007, as a result of the aforementioned factors. Diluted earnings per share increased 6.4% to $0.50 for the first quarter of 2008, from $0.47 for the first quarter of 2007.

     The diluted weighted average shares outstanding were 537.8 million for the first quarter of 2008, compared to 582.3 million for the first quarter of 2007, representing a decrease of 7.6%. This decreases results from the repurchase of approximately 132.4 million shares of stock in connection with our share repurchase program since its inception in 2005 through the end of the first quarter of 2008, compared to an equivalent amount of 81.3 million shares repurchased inception-to-date through the end of the first quarter of 2007. There were approximately 21.0 million shares repurchased in the first quarter of 2008, compared to 23.2 million shares repurchased in the first quarter of 2007. The effect of these repurchases was partially offset by the dilutive effect of stock options.

Segment Results of Operations

PBM Segment

     The PBM segment involves sales of traditional prescription drugs and supplies to our clients and members, either through our network of contractually affiliated retail pharmacies or our mail-order pharmacies. The following table presents selected PBM segment comparative results of operations ($ in millions):

	Quarter							Quarter
	Ended							Ended
	March 29,			Increase				March 31,
	2008(1)			(Decrease)				2007
Product net revenues	$	10,932.4		$	1,341.1	14.0	%	$	9,591.3
Total service revenues		140.9			22.3	18.8	%		118.6
Total net revenues		11,073.3			1,363.4	14.0	%		9,709.9
Total cost of revenues		10,318.2			1,265.9	14.0	%		9,052.3
Total gross margin(2)	$	755.1		$	97.5	14.8	%	$	657.6
Gross margin percentage		6.8	%		—				6.8	%
Selling, general and administrative expenses		258.0			62.6	32.0	%		195.4
Amortization of intangibles		58.5			13.5	30.0	%		45.0
Operating income	$	438.6		$	21.4	5.1	%	$	417.2

(1)	Includes PolyMedica’s operating results commencing October 31, 2007, the date of acquisition.
(2)	Defined as net revenues minus cost of revenues.

     PBM total net revenues of $11,073 million for the first quarter of 2008 increased $1,363 million, compared to the first-quarter 2007 revenues of $9,710 million. The increase primarily reflects higher total volume driven by new business and incremental volume from PolyMedica, as well as price inflation on brand-name drugs, partially offset by a greater representation of lower cost generic drugs and higher client price discounts.

     Gross margins were 6.8% of net revenues for the first quarter of 2008, consistent with the first quarter of 2007, primarily driven by the increased generic dispensing rates, higher mail-order penetration reflecting a large mail-order only client commencing in 2008, and higher rebate retention rates, offset by the aforementionedPlavixbenefit in the first quarter of 2007, as well as new client start-up costs and higher client price discounts.

     SG&A expenses for the first quarter of 2008 were $258 million and increased from the first quarter of 2007 by $63 million. This primarily reflects SG&A expenses associated with PolyMedica, as well as higher employee-related costs associated with business growth across the Company. Amortization of intangible assets was $59 million for the first

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quarter of 2008, an increase of $14 million from the first quarter of 2007, reflecting the additional intangible amortization associated with the PolyMedica acquisition.

     Operating income of $439 million for the first quarter of 2008 increased $21 million, or 5.1%, compared to the first quarter of 2007. The increased operating income results from the aforementioned factors. For additional information on the PBM segment, see Note 10, “Segment Reporting,” to the unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

Specialty Pharmacy Segment

     The Specialty Pharmacy segment is also comprised of specialty pharmacy activity previously included within Medco’s PBM business, includes the sale of higher-margin specialty pharmacy products and services for the treatment of chronic and complex (potentially life-threatening) diseases. The following table presents selected Specialty Pharmacy segment comparative results of operations ($ in millions):

	Quarter								Quarter
	Ended								Ended
	March 29,			Increase					March 31,
	2008(1)			(Decrease)					2007
Product net revenues	$	1,874.5		$	439.5		30.6	%	$	1,435.0
Total service revenues		15.1			0.4		2.7	%		14.7
Total net revenues		1,889.6			439.9		30.3	%		1,449.7
Total cost of revenues		1,744.5			410.9		30.8	%		1,333.6
Total gross margin(2)	$	145.1		$	29.0		25.0	%	$	116.1
Gross margin percentage		7.7	%		(0.3	)%				8.0	%
Selling, general and administrative expenses		70.4			17.4		32.8	%		53.0
Amortization of intangibles		11.0			1.4		14.6	%		9.6
Operating income	$	63.7		$	10.2		19.1	%	$	53.5

(1)	Includes Critical Care’s operating results, which commenced November 14, 2007, the date of acquisition.
(2)	Defined as net revenues minus cost of revenues.

     Specialty Pharmacy total net revenues of $1,890 million for the first quarter of 2008 increased $440 million compared to the first-quarter 2007 revenues of $1,450 million. The increase primarily results from higher mail-order revenues reflecting new clients, as well as incremental revenues resulting from the Critical Care acquisition.

     Gross margins were 7.7% of net revenues for the first quarter of 2008, compared to 8.0% for the first quarter of 2007. The decreased gross margin primarily results from new client mix and start-up costs, lower brand-name manufacturer purchase discounts, as well as lower margin associated with the timing of inventory purchases, partially offset by the higher margins associated with the Critical Care product line.

     SG&A expenses for the first quarter of 2008 were $70 million, and increased from the first quarter of 2007 by $17 million. This increase primarily reflects the aforementioned SG&A expenses associated with Critical Care of $14 million, as well as higher employee-related costs. Amortization of intangible assets was $11 million for the first quarter of 2008, an increase of $1 million from the first quarter of 2007, reflecting the additional intangible amortization resulting from the Critical Care acquisition.

     Operating income of $64 million for the first quarter of 2008 increased $10 million compared to the first-quarter 2007 operating income of $54 million. The increased operating income results from the aforementioned factors. For additional information on the Specialty Pharmacy segment, see Note 10, “Segment Reporting,” to the unaudited interim condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

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Liquidity and Capital Resources

Cash Flows

     The following table presents selected data from our unaudited interim condensed consolidated statements of cash flows ($ in millions):

	Quarter						Quarter
	Ended						Ended
	March 29,						March 31,
	2008(1)			Variance			2007
Net cash provided by operating activities	$	165.5		$	65.0		$	100.5
Net cash used by investing activities		(45.6	)		(17.3	)		(28.3	)
Net cash used by financing activities		(353.4	)		54.2			(407.6	)
Net decrease in cash and cash equivalents		(233.5	)		101.9			(335.4	)
Cash and cash equivalents at beginning of period		774.1			(44.4	)		818.5
Cash and cash equivalents at end of period	$	540.6		$	57.5		$	483.1

⁽¹⁾ Includes PolyMedica’s and Critical Care’s operating results commencing October 31, 2007 and November 14, 2007, the dates of acquisition, respectively.

     Operating Activities.Net cash provided by operating activities of $166 million for the first quarter of 2008 reflects net income of $270 million, with adjustments for depreciation and amortization of $110 million. Additionally, there were net cash inflows of $390 million for client rebates and guarantees payable reflecting increased client rebates passed back to clients and payment timing, and net cash inflows of $49 million from accrued expenses and other current and noncurrent liabilities, primarily due to the timing of income tax payments. These cash inflows were partially offset by cash outflows of $365 million resulting from a decrease in claims and other accounts payable due the timing of payment cycles. In addition, there were net cash outflows of $302 million associated with increases in manufacturer and client accounts receivable reflecting business growth.

     The $65 million increase in net cash provided by operating activities in the first quarter of 2008 compared to the first quarter of 2007 is primarily due to an increase in cash flows of $194 million from claims and other accounts payable, reflecting higher retail volumes, partially offset by a decrease in cash flows of $139 million from manufacturer accounts receivable, net, reflecting business growth.

     Investing Activities.The net cash used by investing activities of $46 million is primarily attributable to capital expenditures of $39 million associated with capitalized software development in connection with client-related programs and our Medicare Part D PDP product offering, and technology and pharmacy operations hardware investments, including those associated with the construction of our third automated dispensing pharmacy, which is expected to be operational in 2009. The $17 million increase in net cash used by investing activities in the first quarter of 2008 compared to the first quarter of 2007 is primarily due to an increase in capital expenditures.

     Financing Activities.The net cash used by financing activities of $353 million in the first quarter of 2008 primarily results from $1 billion in share repurchases and repayments on long-term debt of $1.2 billion, partially offset by proceeds from long-term debt of $1.9 billion, comprised of $1.5 billion from our underwritten public offering of senior notes discussed below, and a $0.4 billion draw down under our 5-year senior unsecured revolving credit facility. Net cash used by financing activities also includes a $45.4 million settlement of a cash flow hedge that we entered into in December 2007 described below, as well as $24 million of excess tax benefits from stock-based compensation arrangements. The decrease in net cash used by financing activities of $54 million in the first quarter of 2008 compared to the first quarter of 2007 primarily results from an increase in proceeds from debt of $1.9 billion, partially offset by an increase in repayments on debt of $1.2 billion, a $275 million decrease in proceeds under the accounts receivable financing facility, an increase in share repurchases of $219 million, a decrease in net proceeds from employee stock plans of $98 million, as well as the $45.4 million settlement of the cash flow hedge.

     On March 18, 2008, we completed an underwritten public offering of $300 million aggregate principal amount of 5-year senior notes at a price to the public of 99.425 percent of par value, and $1.2 billion aggregate principal amount of 10-

32

year senior notes at a price to the public of 98.956 percent. The 5-year senior notes bear interest at a rate of 6.125% per annum, with an effective interest rate of 6.261%, and mature on March 15, 2013. The 10-year senior notes bear interest at a rate of 7.125% per annum, with an effective interest rate of 7.274%, and mature on March 15, 2018. Medco may redeem all or part of these notes at any time or from time to time at its option at a redemption price equal to the greater of (i) 100% of the principal amount of the notes being redeemed plus accrued and unpaid interest to the redemption date or (ii) a “make-whole” amount based on the yield of a comparable U.S. Treasury security plus 50 basis points. We will pay interest on both series of senior notes semi-annually on March 15 and September 15 of each year, beginning September 15, 2008. We used the net proceeds from the sale of these senior notes to repay borrowings under our revolving credit facility used to fund the acquisition of PolyMedica, which was described in Note 3, “Acquisitions of Businesses,” to our audited financial statements included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007.

     Total cash and short-term investments as of March 29, 2008 were $611 million, including $541 million in cash and cash equivalents. Total cash and short-term investments as of December 29, 2007 were $844 million, including $774 million in cash and cash equivalents. The decrease of $233 million in cash and short-term investments for the first quarter of 2008 primarily reflects the use of cash associated with share repurchase activity and repayments on debt, partially offset by proceeds from debt and cash flows from operations.

Financing Facilities

Five-Year Credit Facilities

     We have a senior unsecured credit facility consisting of a $1 billion, 5-year senior unsecured term loan and a $2 billion, 5-year senior unsecured revolving credit facility. The term loan matures on April 30, 2012, at which time the entire facility is required to be repaid. At our current debt ratings, the credit facilities bear interest at London Interbank Offered Rate (“LIBOR”) plus a 0.45 percent margin, with a 10 basis point commitment fee due on the unused portion of the revolving credit facility.

     During the first quarter of 2008, our aggregate borrowings under the revolving credit facility decreased by approximately $800 million after applying the proceeds of the senior notes offering in March 2008 described above. As of March 29, 2008, we had $600 million outstanding and had $1.387 billion available for borrowing, after giving effect to $13 million in issued letters of credit, under our revolving credit facility.

Accounts Receivable Financing Facility

     Through a wholly-owned subsidiary, we have a $600 million, 364-day renewable accounts receivable financing facility that is collateralized by our pharmaceutical manufacturer rebate accounts receivable. At March 29, 2008, there was $600 million outstanding with no additional amounts available for borrowing under the facility. We pay interest on amounts borrowed under the agreement based on the funding rates of the bank-related commercial paper programs that provide the financing, plus an applicable margin determined by our credit rating.

364-day Credit Facility

     On March 18, 2008, we terminated the $800 million senior unsecured 364-day revolving credit agreement (the “364-Day Credit Agreement”) entered into on November 30, 2007, which provided for up to $800 million in revolving loans during the availability period, effective beginning on January 2, 2008. No amounts were drawn by us under the 364-Day Credit Agreement at any time. In addition, we did not pay any early termination penalties.

Credit Lines

     We have access to uncommitted credit lines that we utilize from time to time to meet daily working capital needs and to take advantage of lower interest rates. These credit lines are supplemental, typically utilized for overnight borrowings, and not considered replacements to our committed credit facilities. There were no amounts outstanding under these credit lines as of March 29, 2008.

Interest Rates

     The estimated weighted average annual interest rate on our indebtedness was approximately 5.2% and 6.9% for the quarters ended March 29, 2008 and March 31, 2007, respectively. Several factors could change the weighted average annual interest rate, including but not limited to a change in our debt ratings, reference rates used under our bank credit facility, swap agreements and the mix of our debt, including the effect of our March 2008 issuance of senior notes.

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Swap Agreements

     On December 12, 2007, we entered into forward-starting interest rate swap agreements in contemplation of the issuance of long-term fixed-rate financing. These cash flow hedges were entered into to manage our exposure to changes in benchmark interest rates and mitigate the impact of fluctuations in the interest rates prior to the issuance of the long-term financing. The cash flow hedges entered into were for a notional amount of $500 million on the then-current 10-year treasury interest rate, and for a notional amount of $250 million on the then-current 30-year treasury interest rate, both with a settlement date of March 31, 2008. At the time of purchase, the cash flow hedges were anticipated to be effective in offsetting the changes in the expected future interest rate payments on the proposed debt offering attributable to fluctuations in the treasury benchmark interest rate. During the first quarter of 2008, the fair value of these cash flow hedges changed from a liability of $7.9 million to a liability of $45.4 million due to a decrease in interest rates.

     In the first quarter of 2008, we determined to issue 5-year senior notes and 10-year senior notes on March 18, 2008 as noted above. As a result, a portion of the $250 million notional amount 30-year treasury interest rate cash flow hedge was deemed an ineffective hedge and was recorded as a component of interest and other (income) expense, net, in the accompanying unaudited interim condensed consolidated statement of income. The cash flow hedges were settled on March 17, 2008 for $45.4 million and included an ineffective portion that resulted in an increase of $9.8 million to interest and other (income) expense, net, for the quarter ended March 29, 2008. The effective portion was recorded in accumulated other comprehensive income and is reclassified to interest expense over the ten-year period in which we hedged our exposure to variability in future cash flows.

     In 2004, we entered into five interest rate swap agreements on $200 million of the $500 million in 7.25% senior notes. These swap agreements were entered into as an effective hedge to (i) convert a portion of the senior note fixed rate debt into floating rate debt; (ii) maintain a capital structure containing appropriate amounts of fixed and floating rate debt; and (iii) lower the interest expense on these notes in the near term. We do not expect our cash flows to be affected to any significant degree by a sudden change in market interest rates.

Covenants

     The various series of senior notes discussed above are subject to customary affirmative and negative covenants, including limitations on sale/leaseback transactions; limitations on liens; and limitations on mergers and similar transactions. The 6.125% senior notes and the 7.125% senior notes are also subject to a covenant with respect to certain change of control triggering events, as well as an interest rate adjustment for a downgrade in the ratings to below investment grade on the senior notes. In addition, the senior unsecured credit facilities and the accounts receivable financing facility are subject to covenants, including, among other items, maximum leverage ratios. We were in compliance with all covenants at March 29, 2008.

Debt Ratings

     Medco’s debt ratings, all of which represent investment grade, reflect the following as of the filing date of this Quarterly Report on Form 10-Q: Moody’s Investors Service, Baa3; Fitch Ratings, BBB; Standard & Poor’s, BBB.

EBITDA

     We calculate and use EBITDA and EBITDA per adjusted prescription as indicators of our ability to generate cash from our reported operating results. These measurements are used in concert with net income and cash flows from operations, which measure actual cash generated in the period. In addition, we believe that EBITDA and EBITDA per adjusted prescription are supplemental measurement tools used by analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. EBITDA does not represent funds available for our discretionary use and is not intended to represent or to be used as a substitute for net income or cash flows from operations data as measured under U.S. generally accepted accounting principles. The items excluded from EBITDA, but included in the calculation of reported net income, are significant components of the consolidated statements of income and must be considered in performing a comprehensive assessment of overall financial

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performance. EBITDA, and the associated year-to-year trends, should not be considered in isolation. Our calculation of EBITDA may not be consistent with calculations of EBITDA used by other companies.

     EBITDA per adjusted prescription is calculated by dividing EBITDA by the adjusted prescription volume for the period. This measure is used as an indicator of EBITDA performance on a per-unit basis, providing insight into the cash-generating potential of each prescription. EBITDA, and as a result, EBITDA per adjusted prescription, is affected by the changes in prescription volumes between retail and mail order, the relative representation of brand-name, generic and specialty drugs, as well as the level of efficiency in the business. Adjusted prescription volume equals the majority of mail-order prescriptions multiplied by 3, plus retail prescriptions. These mail-order prescriptions are multiplied by 3 to adjust for the fact that they include approximately 3 times the amount of product days supplied compared with retail prescriptions.

     The following table reconciles our reported net income to EBITDA and presents EBITDA per adjusted prescription for each of the respective periods (in millions, except for EBITDA per adjusted prescription data):

	Quarters Ended
	March 29,			March 31,
	2008(1)			2007
Net income	$	270.2		$	274.8
Add:
Interest and other (income) expense, net		54.3	(2)		14.9
Provision for income taxes		177.8			181.0
Depreciation expense		40.1			41.5
Amortization expense		69.5			54.6
EBITDA	$	611.9		$	566.8
Adjusted prescriptions(3)		206.7			189.5
EBITDA per adjusted prescription	$	2.96		$	2.99

(1)	Includes PolyMedica’s and Critical Care’s operating results commencing October 31, 2007 and November 14, 2007, the dates of acquisition, respectively.
(2)	Includes a $9.8 million charge for the ineffective portion of the forward-starting interest rate swap agreements associated with the March 2008 issuance of senior notes as discussed above in “—Liquidity and Capital Resources—Swap Agreements.”
(3)	Adjusted prescription volume equals the majority of mail-order prescriptions multiplied by 3, plus retail prescriptions. These mail-order prescriptions are multiplied by 3 to adjust for the fact that they include approximately 3 times the amount of product days supplied compared with retail prescriptions.

     For the first quarter of 2008 compared to the first quarter of 2007, EBITDA increased by 8.0%, compared to decreases in EBITDA per adjusted prescription of 1.0% and net income of 1.7%. The decline in EBITDA per adjusted prescription and net income reflects the aforementionedPlavix benefit in the first quarter of 2007, as well as new client start-up costs and the increase in adjusted prescriptions. The higher rate of increase for EBITDA compared with net income primarily reflects the aforementioned higher level of interest and other (income) expense, net, as well as higher intangible amortization expense.

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Commitments

Contractual Obligations

     The following table presents our contractual obligations as of March 29, 2008, as well as our long-term debt obligations ($ in millions):

Payments Due By Period

			Remainder
	Total		of 2008		2009-2010		2011-2012		Thereafter
Long-term debt obligations(1)	$	3,600.0	$	—	$	—	$	1,600.0	$	2,000.0
Interest expense on long-term debt obligations(2)		1,374.0		144.7		385.8		353.0		490.5
Operating lease obligations(3)		123.6		30.3		61.7		22.4		9.2
Purchase commitments(4)		129.8		129.0		0.8		—		—
Other(5)		10.0		—		10.0		—		—
Total	$	5,237.4	$	304.0	$	458.3	$	1,975.4	$	2,499.7

(1)	Long-term debt obligations exclude $16.7 million in total unamortized discounts on our 7.25%, 6.125% and 7.125% senior notes and the fair value of interest rate swap agreements of $(6.6) million on $200 million of the 7.25% senior notes.
(2)	The variable component of interest expense for the senior unsecured credit facility is based on the first-quarter 2008 LIBOR. The LIBOR fluctuates and may result in differences in the presented interest expense on long-term debt obligations.
(3)	Reflects contractual operating lease commitments to lease pharmacy and call center pharmacy facilities, offices and warehouse space throughout the United States, as well as pill dispensing and counting devices and other operating equipment for use in our mail-order pharmacies and computer equipment for use in our data centers.
(4)	Primarily represents contractual commitments to purchase inventory from certain biopharmaceutical manufacturers and a brand-name pharmaceutical manufacturer. As of March 29, 2008, these purchase obligations amounted to $123.6 million for the remainder of 2008, the majority of which is associated with Accredo’s specialty pharmacy business. In addition, PolyMedica has entered into purchase commitments for advertising spots and other media to obtain favorable advertising rates. As of March 29, 2008, these commitments amounted to $6.2 million through 2010, of which $5.4 is committed for the remainder of 2008.
(5)	As part of the PolyMedica acquisition, we assumed a $10 million note payable associated with a previous acquisition, which is included in other noncurrent liabilities in the consolidated balance sheet.

     We have a minimum pension funding requirement of $18.4 million under the Internal Revenue Code (“IRC”) during 2008.

     We also have outstanding debt associated with our 364-day renewable accounts receivable financing facility amounting to $600 million at March 29, 2008. This is classified as short-term debt on our consolidated balance sheet. We may incur additional indebtedness by drawing down additional amounts under our senior unsecured revolving credit facility or by obtaining financing through other sources.

     As of March 29, 2008, we had letters of credit outstanding of approximately $14.3 million, of which approximately $13.3 million were issued under our senior unsecured revolving credit facility.

     As of March 29, 2008, we have liabilities for income tax contingencies of $106.8 million, for which the majority of the associated statutes of limitations are scheduled to expire by the end of 2012.

     Off-Balance Sheet Arrangements

     We have no off-balance sheet arrangements, other than purchase commitments and lease obligations. See “—Contractual Obligations” above.

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Share Repurchase Program

     We currently have a $5.5 billion share repurchase plan which expires on December 31, 2008. The original share repurchase plan, which was approved in August 2005, authorized share repurchases of $500 million. The plan was increased in $1 billion increments in December 2005 and November 2006, and was increased by $3 billion in February 2007. During the first quarter of 2008, we repurchased approximately 21.0 million shares at a cost of $1 billion. Inception-to-date repurchases through March 29, 2008 under this program total approximately 132.4 million shares at a cost of approximately $4.5 billion and at an average per-share price of $34.10. Our Board of Directors periodically reviews the program and approves the associated trading parameters. We may incur debt through borrowings under our revolving credit facility or otherwise in order to fund repurchases under our share repurchase plan. For more information, see Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds,” included in Part II of this Quarterly Report on Form 10-Q.

Looking Forward

     We believe that our operating cash flows will continue to be positive and adequate to fund our ongoing operations, our debt service requirements and capital investments in 2008 and in the foreseeable future. However, we may incur additional indebtedness by drawing down additional amounts under our senior unsecured revolving credit facility, or by obtaining financing through other sources, in order to, for example, fund strategic investments.

     It is anticipated that our 2008 capital expenditures, for items such as capitalized software development for strategic initiatives and infrastructure enhancements, will be approximately $285 million. The increase over 2007 capital expenditures is primarily associated with the construction of our third automated dispensing pharmacy in Indiana, which is expected to be operational in 2009.

     We have no plans to pay cash dividends in the foreseeable future.

Recently Adopted Financial Accounting Standard

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 does not require any new fair value measurements. SFAS 157 establishes a common definition for fair value to be applied with existing generally accepted accounting principles (“GAAP”) requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. We adopted SFAS 157 on December 30, 2007 except for those non-recurring measurements for non-financial assets and non-financial liabilities subject to the partial deferral in FASB Statement of Position No. 157-2, “Partial Deferral of the Effective Date of Statement 157,” (“FSP 157-2”) as noted below. The adoption of SFAS 157 did not have an impact on our financial position or operating results.

     FSP 157-2 deferred the effective date of SFAS 157 for all non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008. We are currently assessing the impact of SFAS 157 for non-financial assets and non-financial liabilities on our consolidated statements of financial position and results of operations.

     Fair Value Hierarchy.SFAS 157 defines the inputs used to measure fair value into the following hierarchy:

Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3: Unobservable inputs reflecting the reporting entity’s own assumptions.

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     We utilize the best available information in measuring fair value. The following table sets forth, by level within the fair value hierarchy, the financial assets recorded at fair value on a recurring basis as of March 29, 2008 ($ in millions):

Medco Fair Value Measurements at Reporting Date

	March 29,
Description	2008		Level 1		Level 2		Level 3
Fair value of interest rate swap agreements	$	6.6	$	—	$	6.6	$	—
Available-for-sale investments		5.9		1.9		4.0		—
Money market mutual funds		396.0		396.0		—		—

     Available-for-sale securities classified as Level 1 are measured using quoted market prices for identical assets while the securities classified as Level 2 are measured through comparable assets observed in the markets. Our interest rate swap agreements are valued using observable market inputs, and therefore are classified within Level 2. Our money market mutual funds are invested in funds that seek to preserve principal, are highly liquid, and therefore are recorded on the balance sheet at the principal amounts deposited, which equals the asset values quoted by the money market fund custodians.

Recent Accounting Pronouncements

     In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No 133” (“SFAS 161”). SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative instruments. The standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, and we are evaluating the impact that such adoption will have on our financial statements.

     In December 2007, the FASB ratified EITF Issue No. 07-1, “Accounting for Collaborative Arrangements,” (“EITF 07-1”), which defines collaborative arrangements and establishes reporting and disclosure requirements for transactions between participants in a collaborative arrangement and between participants in the arrangements and third parties. EITF 07-1 is effective for periods beginning after December 15, 2008 and applies to arrangements in existence as of the effective date. Our adoption of EITF 07-01 in 2009 is not expected to have a material impact on our consolidated financial statements.

     In December 2007, the FASB issued SFAS No. 141 (R), “Business Combinations” (“SFAS 141(R)”) and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). The standards are intended to improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. SFAS 141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS 141(R) is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited.

     SFAS 160 is designed to improve the relevance, comparability, and transparency of financial information provided to investors by requiring all entities to report noncontrolling (minority) interests in subsidiaries in the same way—as equity in the consolidated financial statements. Moreover, SFAS 160 eliminates the diversity that currently exists in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.

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Earlier adoption is prohibited. In addition, SFAS 160 shall be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements shall be applied retrospectively for all periods presented. Our adoption of SFAS 160 in 2009 is not expected to have a material impact on our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We have floating rate debt with our credit facilities and investments in marketable securities that are subject to interest rate volatility, which is our principal market risk. In addition, we have interest rate swap agreements on $200 million of the $500 million in 7.25% senior notes. As a result of these interest rate swap agreements, the $200 million of senior notes is subject to interest rate volatility. A 25 basis point change in the weighted average annual interest rate relating to the credit facilities’ balances outstanding and interest rate swap agreements as of March 29, 2008, which are subject to variable interest rates based on LIBOR, and the accounts receivable financing facility, which is subject to the commercial paper rate, would yield a change of approximately $6.0 million in annual interest expense. We do not expect our cash flows to be affected to any significant degree by a sudden change in market interest rates.

     We have operated our business within the United States and Puerto Rico and have executed all transactions in U.S. dollars and, therefore, we have had no foreign exchange risk. However, as a result of our recently announced acquisition of a majority interest in Europa Apotheek Venlo B.V., we will be subject to foreign exchange risk in the future, which is not expected to have a material impact on our financial statements.

Item 4. Controls and Procedures

     The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are effective as of March 29, 2008. There have been no changes in internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     In the ordinary course of business, the Company is involved in litigation, claims, government inquiries, investigations, charges and proceedings, including, but not limited to, those relating to regulatory, commercial, employment, employee benefits and securities matters. Descriptions of certain legal proceedings to which the Company is a party are contained in Note 11, “Commitments and Contingencies—Legal Proceedings,” to the unaudited interim condensed consolidated financial statements included in Part I of this Quarterly Report on Form 10-Q and are incorporated by reference herein. Such descriptions include the following recent developments:

     Bankruptcy Preference Litigation.     On November 4, 2004, a preference action captionedBerman v. Paid Prescriptions, LLC (In re HNRC Dissolution Co.)was filed against the Company in the United States Bankruptcy Court for the Eastern District of Kentucky, Ashland Division. The lawsuit seeks to recover payments made by the debtor (a former client of the Company) prior to the filing of the bankruptcy petition. The Company was never properly served with the complaint, and first learned of this matter in the fourth quarter of 2007 after the Trustee of the bankruptcy estate obtained a default judgment against the Company. The Company has filed a motion to vacate the default judgment. This motion is pending before the bankruptcy court.

     Contract Litigation.    On December 21, 2007, the Company and CareFirst Blue Cross Blue Shield agreed in principle to settle the matter discussed in Note 11, “Commitments and Contingencies—Legal Proceedings,” to the accompanying unaudited interim condensed consolidated financial statements for an immaterial amount and subsequently, the parties formally settled this matter and the judge has dismissed the complaint with prejudice.

     Accredo.     Summary judgment motions in the Accredo-related securities class action lawsuit will be filed in the summer of 2008 and trial is scheduled to commence in October 2008.

     Pending court approval, the Accredo derivative case has been settled in principle for an immaterial amount, which is entirely covered by insurance.

Item 1A. Risk Factors

     Reference is made to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007. There have been no material changes with regard to the risk factors disclosed in such Form 10-K other than as set forth below.

Changes in reimbursement rates, including competitive bidding for durable medical equipment suppliers, could negatively affect our PolyMedica diabetes testing supplies revenues and profits under our Liberty brand.

     The majority of our revenues under our Liberty brand depend on the continued availability of reimbursement by government and private insurance plans. Any reduction in Medicare or other government program or private plan reimbursements currently available for our products would reduce our revenues. Without a corresponding reduction in the cost of such products, our profits would also be reduced. Additionally, our profits could be affected by the imposition of more stringent regulatory requirements for Medicare or other government program reimbursement or adjustments to previously reimbursed amounts.

     The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (P.L. 108-173) (the “Act”) provides for a phased-in program for competitive bidding of certain durable medical equipment items. Phase 1 of the program is being conducted in 10 Competitive Bid Areas (“CBAs”), and the diabetes testing supply product category was included in Phase 1 of the program. Phase 1 bidding (which goes into effect on July 1, 2008) resulted in an approximately 43% decrease in reimbursement for mail-order diabetes testing supplies. Only winning mail-order diabetes testing supply bidders will be allowed to provide competitively bid items through the mail to patients whose primary residence is in a competitively bid area. Liberty did not receive an offer to contract as a mail-order provider. CMS intends to expand the entire competitive bidding program and may specifically implement a national or regional mail-order program for diabetes

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testing supplies in 2010, which could affect a substantial portion of Liberty’s diabetes patient base. The competitive bidding program could cause our operating results to be negatively affected through a combination of lower reimbursement rates for competitively bid items and/or our failure to secure status as a contracted supplier.

     The Act provides CMS additional authority, beginning in 2009, to use pricing information it gathers during the initial competitive bidding phases for the purposes of establishing reimbursement rates in geographic areas not subject to competitive bidding. CMS intends to issue further guidance on whether and then how it intends to use this authority through the formal rule-making process. Our operating results could be negatively affected if CMS uses this authority to impose lower reimbursement rates in geographic areas that would otherwise have been excluded from the impact of competitive bidding.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     We currently have a $5.5 billion share repurchase plan which expires on December 31, 2008. The original share repurchase plan, which was approved in August 2005, authorized share repurchases of $500 million. The plan was increased in $1 billion increments in December 2005 and November 2006, and was increased by $3 billion in February 2007. The Company’s Board of Directors periodically reviews the program and approves the associated trading parameters.

     The following is a summary of the Company’s share repurchase activity for the three months ended March 29, 2008:

Issuer Purchases of Equity Securities

					Total number of		Approximate
					shares purchased		dollar value of
					as part of a		shares
					publicly		that may yet be
	Total number of		Average		announced		purchased under
	shares		price paid		program since		the program(3)
Fiscal Period	purchased		per share(1)		inception(2)		(in thousands)
Balances at December 29, 2007						111,400,964	$	1,984,670
Fiscal January 2008		5,273,200	$	51.80		5,273,200	$	1,711,495
Fiscal February 2008		8,220,621	$	49.00		8,220,621	$	1,308,670
Fiscal March 2008		7,555,620	$	42.99		7,555,620	$	983,864
First quarter 2008 totals		21,049,441	$	47.55		21,049,441

(1)	Dollar amounts include transaction costs. The total average price paid per share in the table above represents the average price paid per share for repurchases initiated during the three months ended March 29, 2008. The average price paid per share for repurchases initiated since inception is $34.10.
(2)	The Company repurchased all of the above-referenced shares of its common stock through its publicly announced share repurchase program.
(3)	These amounts reflect the remaining authorized repurchases based on the increase in the authorized repurchases.

Item 3. Defaults Upon Senior Securities

     Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

     Not applicable.

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Item 5. Other Information

     Rule 10b5-1 Sales Plans.Medco’s comprehensive compliance program includes a broad policy against insider trading. The procedures promulgated under that policy include regularly scheduled blackout periods that apply to over 600 employees. Executive officers are prohibited from trading during the period that begins on the first day of the last month of the fiscal period and ends on the third trading day after the release of earnings. In addition, executive officers are required to pre-clear all of their trades. Medco’s executive officers are also subject to share ownership guidelines and retention requirements. The ownership targets are based on a multiple of salary (5, 3 or 1.5 times salary), but are expressed as a number of shares. The targets are determined using base salary and the closing price of our stock on the date of our Annual Meeting of Shareholders. For the first quarter of 2008, the number of shares required to be held was calculated using a $38.87 stock price, the closing price of our stock on the date of the 2007 Annual Meeting of Shareholders.

     To facilitate compliance with the ownership guidelines and retention requirements, Medco’s Board of Directors authorized the use of prearranged trading plans under Rule 10b5-1 of the Exchange Act. Rule 10b5-1 permits insiders to adopt predetermined plans for selling specified amounts of stock or exercising stock options under specified conditions and at specified times. Executive officers may only enter into a trading plan during an open trading window and they must not possess material nonpublic information regarding the company at the time they adopt the plan. Using trading plans, insiders can diversify their investment portfolios while avoiding concerns about transactions occurring at a time when they might possess material nonpublic information. Under Medco’s policy, sales instructions made pursuant to a written trading plan may be executed during a blackout period. In addition, the use of trading plans provides Medco with a greater ability to monitor trading and compliance with its stock ownership guidelines.

     All trading plans adopted by Medco executives are reviewed and approved by the Office of the General Counsel. For ease of administration, executives have been permitted to add new orders to existing plans rather than requiring the adoption of a new plan. Once modified, a plan cannot be changed for at least 90 days. Both new plans and modifications are subject to a mandatory “waiting period” designed to safeguard the plans from manipulation or market timing.

     The following table, which we are providing on a voluntary basis, sets forth the Rule 10b5-1 sales plans entered into by our executive officers in effect as of April 29, 2008⁽¹⁾:

	Number of			Number of
	Shares to be			Shares Sold		Projected
	Sold Under the			Under the		Beneficial
Name and Position	Plan(2)		Timing of Sales Under the Plan	Plan(3)		Ownership(4)
John Driscoll President, New Markets		27,934	Option exercise in tranches of 18,934 and 1,000 shares shall be triggered if stock reaches specific prices; sale of 8,000 previously acquired shares shall trigger if stock reaches specified price.		0		41,874
Kenneth O. Klepper President and Chief Operating Officer		53,334	Sale of 11,000 previously acquired shares if stock reaches a specified price and sales related to exercise of 53,334 options shall trigger if stock reaches specified price.		11,000		214,044
Thomas M. Moriarty General Counsel, Secretary and Senior Vice President, Pharmaceutical Contracting		20,958	Option exercise in tranches of 6,628; 7,200 and 7,130 shares shall be triggered if stock reaches specific prices; sale of 8,120 previously acquired shares shall trigger if stock reaches specified price.		8,120		5,680
David B. Snow, Jr. Chairman and Chief Executive Officer		200,000	Sale of 200,000 previously acquired shares if stock reaches a specified price.		0		978,812

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(1)	This table does not include any trading plans entered into by any executive officer that have expired by their terms or have been fully executed through April 29, 2008. No plans entered into by executive officers have been voluntarily terminated.
(2)	This column reflects the number of shares remaining to be sold as of April 29, 2008.
(3)	This column reflects the number of shares sold under the plan through April 29, 2008.
(4)	This column reflects an estimate of the number of shares each identified executive officer will beneficially own following the sale of all shares under the Rule 10b5-1 sales plans currently in effect. This information reflects the beneficial ownership of our common stock as of April 29, 2008, and includes shares of our common stock subject to options or restricted stock units that were then vested or exercisable and unvested options and restricted stock units that are included in a current trading plan for sales periods that begin after the applicable vesting date. Options cannot be exercised and restricted stock units cannot be converted prior to vesting. The estimates reflect option exercises and sales under the plan, but do not reflect any changes to beneficial ownership that may have occurred since April 29, 2008 outside of the plan.

Item 6. Exhibits

Number		Description	Method of Filing
	3.1	Second Amended and Restated Articles of Incorporation of Medco Health Solutions, Inc., as further amended (incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-3 filed March 12, 2008).	Incorporated by reference.
	3.2	Third Amended and Restated Bylaws of Medco Health Solutions, Inc. (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed February 5, 2008).	Incorporated by reference.
	31.1	Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed with this document.
	31.2	Certification of Chief Financial Officer pursuant Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed with this document.
	32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed with this document.
	32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed with this document.

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Signatures

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

	MEDCO HEALTH SOLUTIONS, INC. (Registrant)
Date: April 29, 2008	By:	/s/ David B. Snow, Jr.
	Name:	David B. Snow, Jr.
	Title:	Chairman and Chief Executive Officer
Date: April 29, 2008	By:	/s/ Richard J. Rubino, C.P.A.
	Name:	Richard J. Rubino, C.P.A.
	Title:	Senior Vice President, Finance and Chief Financial Officer

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Index to Exhibits

Number		Description
	3.1	Second Amended and Restated Articles of Incorporation of Medco Health Solutions, Inc., as further amended (incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-3 filed March 12, 2008).
	3.2	Third Amended and Restated Bylaws of Medco Health Solutions, Inc. (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed February 5, 2008).
	31.1	Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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