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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K/A(Amendment No. 2)

|     |  |                                                                                                                              
|---- |  | -----------------------------------------------------------------------------------------------------------------------------
|[X]  |  | Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended March 31, 2001
|    
|    
|    
|    
|[  ] |  | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934                                     

Commission File Number: 0-21447

AdvancePCS(Exact name of registrant as specified in its charter)

|                                                                                     |  |                                                
|------------------------------------------------------------------------------------ |  | -----------------------------------------------
|Delaware
(State or other jurisdiction of incorporation of organization)              |  | 75-2493381
(I.R.S. employer Identification No.)
|                                                                                    
|5215 North OConnor, Suite 1600, Irving, TX
(Address of principal executive offices) |  | 75039
(Zip Code)                               

Registrants telephone number, including area code: (469) 420-6000

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

|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange
on which registered
|                    |  |                                          
|None                |  | None                                     

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

Class A common stock, $0.01 par value
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

Yes [X]          No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [  ]

The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the closing sale price of the Class A common stock
on May 31, 2001 as reported on the Nasdaq National Market, was approximately
$1,901,655,943.

As of May 31, 2001, registrant had (1) 32,498,906 shares of Class A common
stock, $.01 par value, outstanding, (2) 4,207,300 shares of Class B-1 common
stock, $.01 par value, outstanding and (3) 100 shares of Class B-2 common stock,
$01 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for registrants 2001 annual meeting of
stockholders are incorporated by reference in Part III.



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|------------------------------------------------- | ---------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|EXPLANATORY NOTE                                 
|SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
|PART I                                           
|                                                  | ITEM 1.  BUSINESS                                                                             
|                                                  | ITEM 2.  PROPERTIES                                                                           
|                                                  | ITEM 3.  LEGAL PROCEEDINGS AND GOVERNMENT INVESTIGATIONS                                      
|PART II                                          
|                                                  | ITEM 6.  SELECTED HISTORICAL FINANCIAL AND OPERATING DATA                                     
|                                                  | ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                  | ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|                                                  | ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|PART III                                         
|                                                  | ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|PART IV                                          
|                                                  | ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                    
|SIGNATURES                                       



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AdvancePCS

Table of Contents

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|EXPLANATORY NOTE                                  |  |                                                                                       | 2 |     
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|Item 1.                                           |  | BUSINESS                                                                              |   |      | 3  | 
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|Item 2.                                           |  | PROPERTIES                                                                            |   |      | 25 | 
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|Item 3.                                           |  | LEGAL PROCEEDINGS AND GOVERNMENT INVESTIGATIONS                                       |   |      | 26 | 
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|PART II                                          
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|Item 6.                                           |  | SELECTED HISTORICAL FINANCIAL AND OPERATING DATA                                      |   |      | 27 | 
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|Item 7.                                           |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |      | 29 | 
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|Item 7A.                                          |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |   |      | 37 | 
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|Item 8.                                           |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                           |   |      | 37 | 
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|PART III                                         
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|Item 13.                                          |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                        |   |      | 38 | 
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|PART IV                                          
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|Item 14.                                          |  | EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                      |   |      | 38 | 
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|                                                  |  | SIGNATURES                                                                            |   |      | 39 | 

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EXPLANATORY NOTE

This Amendment No. 2
to AdvancePCS's Annual Report on Form 10-K for the year ended
March 31, 2001 filed with Securities and Exchange Commission on
June 29, 2001 and as amended on July 30, 2001, is being
filed to amend and restate the information required by Part I, Items
1, 2 and 3, Part II, Items 6, 7, 7a and 8, Part III, Item 13 and Part
IV, Item 14 to address certain comments received by the Securities
and Exchange Commission based on a review of a Registration Statement
on Form S-3 filed with the Securities and Exchange Commission on
September 20, 2001.




SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This
Form 10-K/A, along with the previously filed Annual Report on
Form 10-K, as amended, includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. We have based these forward-looking statements on our
current expectations and projections about future events. Statements that are
predictive in nature, that depend upon or refer to future events or conditions
or that include words such as expects, anticipates, intends, plans,
believes, estimates, thinks, and similar expressions are forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors that may cause our actual results and performance to be
materially different from any future results or performance expressed or
implied by these forward-looking statements. These factors include, among other
things, those matters discussed under the caption Risk Factors, as well as
the following:



| |  | general economic and business conditions;                                                                     
|- |  | --------------------------------------------------------------------------------------------------------------
| 
| |  | demographic changes;                                                                                          
| 
| |  | new governmental regulations and changes in, or the failure to comply with existing, governmental regulations;
| 
| |  | legislative proposals that impact our industry or the way we do business;                                     
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| |  | changes in our industry;                                                                                      
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| |  | changes in Medicare and Medicaid payment levels;                                                              
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| |  | liability and other claims asserted against us;                                                               
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| |  | integration of PCS and realization of synergies;                                                              
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| |  | competition; and                                                                                              
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| |  | our ability to attract and retain qualified personnel.                                                        

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

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PART I




ITEM 1. BUSINESS

The following description of our business should be read in conjunction
with the information included elsewhere in this Form 10-K/A or
in the previously filed Annual Report on Form 10-K, as amended, for
the year ended March 31, 2001. This description
contains forward-looking statements that involve risks and uncertainties. Our
actual results could differ significantly from the results discussed in the
forward-looking statements as a result of the factors set forth in Risk
Factors and elsewhere in this Form 10-K/A. References in
this Form 10-K/A to
we, our, or us refer to AdvancePCS.

Overview

We are a leading provider of health improvement services in the United
States. As the largest pharmacy benefit management company, or PBM, based on
number of lives covered, we currently serve more than 75 million health plan
members and manage more than $21 billion in prescription drug spending on an
annualized basis on behalf of our health plan sponsors. In addition, we offer a
wide range of other health improvement products and services, such as
prescription discount cards for the uninsured and under-insured, web-based
programs, disease management, clinical trials and outcomes studies. Our mission
is to improve the quality of care delivered to health plan members while
helping health plan sponsors reduce overall costs.

We generate revenues by providing our health improvement services to two
primary customer groups: health plan sponsors and pharmaceutical manufacturers.
We serve a broad range of health plan sponsors, including BlueCross BlueShield
plans and other managed care organizations, employer groups, third-party
administrators of health plans, insurance companies, government agencies and
labor union-based trusts. We work closely with pharmaceutical manufacturers to
negotiate lower drug costs for our health plan sponsors. We also provide
pharmaceutical manufacturers with clinical trial, research and information
management services.

In October 2000, we became the largest PBM, based on number of lives
covered, through our acquisition of PCS Holding Corporation or PCS. In
addition, in July 2000, we acquired First Florida International Holdings Inc.
and its affiliated companies, collectively known as FFI, which provide
prescription discount programs, or consumer cards, to the uninsured and
under-insured. We believe these acquisitions significantly enhance our
competitive position in the industry and provide substantial opportunities to
generate operational efficiencies and continued growth.

Industry Background

The U.S. Health Care Financing Administration, or HCFA, estimates that
total U.S. health care expenditures were $1.2 trillion in 1999 and projects
this spending to grow by 6.5 percent annually from 2000 through 2008, or an
average of 1.6 percentage points above the growth rate of gross domestic
product during the same period. Based on these projections, HCFA estimates that
U.S. health care expenditures will total $2.2 trillion and reach 16.2 percent
of gross domestic product by 2008.

HCFA estimates that total prescription drug spending in the United States
was approximately $100 billion in 1999 and projects this spending to remain the
fastest growing component of health care costs, increasing by between nine and
twelve percent annually from 2000 through 2008. We believe factors contributing
to this trend include:



| |  |  | higher drug utilization due to the growing use of pharmaceuticals as
a first line of attack in disease treatment, increasing availability of
pharmacy benefits to health plan members, an aging population and
increasing direct-to-consumer advertising by pharmaceutical
manufacturers;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | an expected increase in new drug introductions, primarily due to
increases in research and development spending by pharmaceutical
companies, as well as more rapid drug approval by the U.S. Food and Drug
Administration or FDA; and                                                    
|
| |  |  | high costs for newly-developed, more effective drug therapies.                                                                                                                                                                                                                           

PBMs were first formed during the 1970s to provide health plan sponsors
with a more efficient and less costly means of managing their members
prescription drug benefit, particularly the processing of pharmaceutical
claims. In recent years, managed care has evolved from a short-term,
cost-driven model to a long-term, medical outcomes-based model, where the
overall cost and quality of patient care are both key considerations of the
health plan sponsor. While PBMs continue to process hundreds of millions of
pharmaceutical claims per year, PBMs have also developed additional services,
including mail-order pharmacies in the 1980s and point-of-sale claims
processing, formulary development and other clinical services in the 1990s. By
designing and implementing effective pharmacy benefit plans and formularies,
PBMs gained the ability to

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influence the choice of pharmaceuticals used by a health plans members.
PBMs use their formulary influence and increased purchasing power to negotiate
both rebates from pharmaceutical manufacturers and discounts from retail
pharmacies in order to generate savings for health plan sponsors.

Over the past few years, the PBM industry has undergone significant
consolidation. We believe such consolidation has principally been driven by the
significant benefits of size and scale, including:



| |  |  | cost-saving opportunities to leverage a fixed-cost infrastructure
over greater prescription claim volume, resulting in greater pricing
flexibility; and                  
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | increased negotiating leverage with pharmaceutical manufacturers and
retail pharmacies, resulting in greater ability to obtain lower drug
costs for health plan sponsors.

We believe PBMs that effectively capture these benefits will be better
positioned to strengthen their relationships with plan members, physicians and
health plan sponsors and improve their competitive position.

Several legislative proposals are under consideration in Congress to
provide Medicare recipients with outpatient drug benefits through the use of
PBMs. Medicare, the primary health insurer for more than 35 million Americans
over the age of 65, does not currently offer an outpatient prescription drug
benefit. The terms of the current proposals vary, and there can be no assurance
of actual implementation of such a benefit. Depending on the approval and final
design of a Medicare drug benefit, PBMs could play a significant role in its
administration.

Our Competitive Advantages

We are the largest PBM in the industry

As the largest PBM based on number of lives covered, we currently serve
more than 75 million members enrolled with our health plan sponsors. We operate
through a network of approximately 56,000 retail pharmacies and, on an
annualized basis, we estimate that we manage more than 500 million pharmacy
claims representing more than $21 billion in prescription drug spending. Our
large member base gives us significant leverage when negotiating rebates and
discounts from pharmaceutical companies and retail pharmacies. In addition, we
believe that our mail service pharmacies are of sufficient scale and capacity
to effectively compete on large contracts. As the industry leader based on
number of lives covered, we intend to position ourselves as the first choice of
health plan sponsors who need a PBM with scale and scope to help effectively
manage their growing prescription drug costs.

We maintain an independent status

We benefit from our independent status, as we are not controlled by a
pharmaceutical manufacturer, retail pharmacy or health plan sponsor. We believe
this independence is valued by health plan sponsors for the inherent choice and
impartiality we are able to provide.

We offer a wide range of health improvement products and services

We believe we have one of the widest ranges of health improvement products
and services in the industry. We provide a broad range of PBM products and
services complemented by consumer and information products and technology
solutions. Our PBM products and services include data, clinical and mail order
services. Our data service operations process prescription claims through our
retail pharmacy network. Our clinical services perform formulary design and
compliance services as well as provide proprietary decision support tools, and
our mail order services process prescription orders through our mail
pharmacies.

We also offer consumer cards for uninsured and under-insured consumers, as
well as web-based products and services such as online pharmacy services and
web site development services for health plan sponsors. In addition, we offer a
wide range of other health improvement products and services that utilize our
data management and predictive modeling capabilities, such as disease
management, clinical trials and outcome studies. Our acquisition of PCS has
given us the opportunity to combine these products and services with our PBM
services for a comprehensive health improvement product offering.

We have a diverse client base with substantial penetration across all key client segments

Historically, we have had strong client relationships with BlueCross
BlueShield companies and other managed care organizations. While PCS has served
managed care plans, it has traditionally focused on and developed expertise in
serving
4Table of Contentsself-insured employers, insurance carriers and government plans. As a
result of our combination, we now have a diverse client base and substantial
market penetration among each of these major target client groups.We have a focused and experienced management team with an established track
record in growing our business and integrating acquisitionsOur management team, including our founder and chief executive officer,
David D. Halbert, has consistently delivered strong operating and financial
results through internal growth and the acquisition and successful integration
of several companies. During the last six fiscal years, we have grown
significantly, with total revenues increasing from approximately $64.4 million
in fiscal year 1995 to approximately $7.0 billion in fiscal year 2001 and
EBITDA increasing from approximately $1.8 million in fiscal year 1995 to
approximately $149.6 million in fiscal year 2001.With the addition of the PCS management, our combined senior management
team of 11 officers has an aggregate of 161 years of experience in the health
care industry. We have successfully completed most of the steps in integrating
PCS that are necessary for us to operate as a single, combined company. In
addition, we have successfully integrated the following four acquisitions in
the past three years:
        
        Innovative Medical Research, Inc., which conducts clinical trials and
survey research for the pharmaceutical and managed care industries, in
1998;
        
        Baumel-Eisner Neuromedical Institute, Inc., which conducts
neurological and psychiatric clinical trials of investigational new
drugs on behalf of the pharmaceutical industry, in 1998;
        
        Foundation Health Pharmaceutical Services, the pharmacy benefit
operations of Foundation Health Systems, Inc., now known as Health Net,
in 1999; and
        
        First Florida International (FFI) in 2000.In connection with our acquisition of Foundation Health Pharmaceutical
Services, we added more than 12 million covered lives to our base of 15 million
covered lives.StrategyOur mission is to improve the quality of care delivered to health plan
members while helping health plan sponsors reduce overall costs. In order to
accomplish this mission, we plan to:Continue to gain efficiencies from our acquisition of PCSThrough the acquisition of PCS, we have created significant cost saving
opportunities and increased negotiating leverage with pharmaceutical
manufacturers and retail pharmacies. During the two-year period following the
acquisition of PCS, we expect to realize significant synergies from the
integration of PCS. This integration involves the renegotiation of existing
contracts with pharmaceutical manufacturers and retail pharmacy chains and the
consolidation of some operations to maximize the efficiency of our combined
infrastructure. In particular, we plan to consolidate our Richardson, Texas
mail pharmacy, call center operations, internet/e-business efforts, enterprise
infrastructure, data warehouse efforts and duplicative information systems.Increase sales penetration to existing customersOne of our primary growth strategies is to increase sales penetration of
our health improvement services within our existing customer base. While we and
PCS have each historically offered traditional PBM services, we developed a
different array of disease management, clinical and research products. With the
addition of the complementary product lines and customer groups of PCS, we now
offer more comprehensive product solutions, which we intend to cross-sell into
our respective customer bases. For example, the customers in the employer group
segment, where PCS has traditionally had a strong presence, are increasingly
interested in our disease management programs. Similarly, PCS offered certain
clinical programs and services that we had not previously provided to our
customers.Beyond combining existing services, we also plan to increase sales to our
existing customers by expanding our disease management services and developing
additional clinical research capabilities. For example, we currently offer six
disease management programs, and during the past 12 months have performed 50
outcomes research programs covering a broad range of disease states. We are
also developing a physician education program for osteoporosis. We expect to
develop additional disease management, outcomes research and physician
education programs tailored to our customers requests.5Table of ContentsIncrease our mail service penetrationWe believe that our mail services reduce costs to health plan sponsors
through volume purchasing, increased generic dispensing and higher rebates
through greater formulary compliance. Historically, neither we nor PCS promoted
our mail pharmacies aggressively. We did not have the scale to operate mail
pharmacy services efficiently. PCS did not begin offering mail service until
late 1996, and, due to a change in ownership, PCS was not able to expand its
capacity to meet demand. However, with our combination, we see a significant
opportunity to profitably expand penetration of our mail order business, which
provides lower costs for our health plan sponsors.We plan to increase the percentage of the prescriptions filled by our mail
pharmacies by aggressively promoting our mail services to the members of our
health plan sponsors. We estimate that we manage more than 500 million pharmacy
claims on an annualized basis, and of these less than 10% of the prescriptions
for these claims are filled by our mail pharmacies. We believe that our primary
competitors are filling a significantly greater proportion of their members
prescriptions through mail service.Increase our core health plan sponsor customer baseThe number of members served by our programs has increased from an
estimated 5.2 million at March 31, 1995 to more than 75 million at March 31,
2001. We plan to continue to grow our customer base by marketing our scale and
comprehensive service offerings to a broader range of health plan sponsors. We
believe that our increased size and ability to negotiate higher rebates and
discounts make us more attractive to large accounts. Since the announcement of
the PCS transaction, we have entered into multi-year contracts with three new
large accounts representing an aggregate of approximately two million members
and have signed multi-year contract renewals with several existing customers,
including Blue Cross & Blue Shield Association Federal Employee Program, or
FEP, Humana, Inc. and Tufts Health Plan, which together represent approximately
95 million members. Also, we announced on June 21, 2001 that we have signed an
agreement to provide services to more than 3 million members of Health Care
Service Corp. This multi-year contract includes 2 million new lives with Blue
Cross and Blue Shield of Illinois as well as renewals with current clients Blue
Cross and Blue Shield of Texas and New Mexico.As part of our strategy to expand our customer base, we have reorganized
our sales force into teams focused on each customer segment. Through this
reorganization, our sales force will be able to focus on the specific
characteristics and needs of our current and prospective customers in each
segment.Further develop web-based capabilities and pursue new technology initiativesOur health plan sponsors are increasingly interested in the convenience of
technology-enabled, pharmacy-related products and services for their members.
We provide our clients with comprehensive web-based solutions, which include
web-enabled PBM functions, such as online refills and online prescription drug
history, web-based content, and web site development services for health plan
sponsors. We plan to expand our current web-based product offerings, which
would include developing new initiatives to offer broader medical content to
health plan sponsors and to empower consumers by involving them more directly
in their medical care. We are also currently working with health plan sponsors
to develop web-enabled pharmacy services on their respective web sites for
members.In addition, we intend to continue to explore and implement new
technologies to enable us to more effectively deliver our products and
services. For example, we are currently participating in pilot programs that
support the development of emerging technology solutions using handheld devices
that provide enhanced point-of-care prescribing capabilities to physicians.
These devices provide timely information, such as patient histories, formulary
checks and drug utilization reviews, to physicians at the point-of-care to
allow for electronic transmittal of prescriptions. Further, we are a founding
partner in a venture, RxHub, that will develop an electronic exchange to enable
physicians who use electronic prescribing technology to link to pharmacies,
PBMs and health plan sponsors that their patients use. As a result, we expect
improved formulary compliance, better outcomes and lower costs for us and our
health plan sponsors.Pursue strategic acquisitions and alliancesWe plan to continue our strategy of selectively pursuing acquisitions and
alliances that are consistent with our corporate mission. In particular, we
seek opportunities to:
        
        increase the size of our core PBM business;
        
        expand our product offerings for health plan sponsors and pharmaceutical manufacturers; and6Table of Contents
        
        enhance our current health improvement programs.Recent AnnouncementsOn June 18, 2001 we announced the launch of AdvancePCS SpecialtyRx. We
expect this specialty pharmacy business to further our goal of improving
overall health care for patients using injectable and other expensive,
high-technology drugs, while controlling the costs incurred by medical plan
sponsors to provide these therapies. Specialty pharmacy services focus on
pharmaceutical products that generally are biotechnological in nature and are
given by injection. These services are traditionally used by small patient
populations with chronic, often complex, diseases requiring challenging
regimens and a high level of clinical expertise. Costs for individual therapies
average approximately $18,000 annually, but can range up to $200,000 annually.We have taken three important steps to form AdvancePCS SpecialtyRx. First,
we have entered into a definitive agreement to acquire TheraCom Inc., or
TheraCom, a specialty pharmacy provider based in Bethesda, Maryland. Secondly,
we have signed a definitive agreement to establish a joint venture with
Priority Healthcare Corp., a national specialty pharmacy and distribution
company located in Lake Mary, Florida. Thirdly, we have hired an experienced
team to build and manage AdvancePCS SpecialtyRx. Michael Ellis, senior vice
president, specialty pharmacy, who has 19 years of experience in pharmaceutical
services, will lead this team. These announcements position us to immediately
offer clients a single-sourced solution to their complex and growing specialty
pharmacy needs.TheraCom is a focused specialty pharmacy company that provides customized
services around complex and emerging biotechnology therapies and the
significant patient management needs associated with those therapies.
TheraCom, is a specialty pharmacy company with substantial experience providing
distribution and related services to the biotechnology industry, including
product coverage advocacy, insurance verification, reimbursement processing,
pharmacist counseling and intervention, clinical and dosage monitoring,
adherence counseling, nurse training, and in-home nursing coordination.
TheraCom also provides Internet, direct marketing, advertising and product
launch support services. TheraCom is a licensed pharmacy offering national
coverage, as well as a licensed wholesaler for distribution orders. We plan to
maintain TheraCom and its 87 employees at its present location. TheraCom
management, including founders Robert Dresing, chairman, and Mark Hansan,
president and chief executive officer, will continue to direct its operations.
The TheraCom transaction will be accounted for under purchase accounting rules.AdvancePriority SpecialtyRx, the joint venture between AdvancePCS and
Priority Healthcare Corp. will provide our customers with comprehensive,
quality specialty pharmacy services. We will have a 51 percent ownership share
in the joint venture, and Priority Healthcare Corp. will have a 49 percent
interest. Priority Healthcare Corp. is a national specialty pharmacy and
distributor that provides biopharmaceuticals, complex therapies and related
disease treatment programs and services.Health Improvement Products and ServicesPBM ServicesWe offer a broad range of data, clinical and mail services to our
customers through our PBM operations. We provide value by improving the level
of care and lowering the costs associated with a pharmacy benefit plan.Data Services.Through our data services operations, we processed more
than 436 million prescription claims for health plan sponsors on a pro forma
basis in the last 12 months. We administer a network of more than 56,000 retail
pharmacies that has agreed to provide prescription drugs to individual members
of our health plan sponsors at pre-negotiated prices. The retail pharmacies in
our network are linked to us through our online, real-time claims processing
systems that are designed to significantly reduce the cost of processing
prescriptions for those pharmacies linked to these systems. When a member of
one of our health plan sponsors presents a prescription or health plan
identification card to a retail pharmacist in our network, our online system
provides the pharmacist with the following information:
        
        verification of whether the individual is eligible for benefits;
        
        the prescription benefits the individuals health plan has selected,
including whether the drug to be dispensed is included on the health
plans formulary, and the individuals co-payment obligation;
        
        the amount the pharmacy can expect to receive as payment for its
services; and7Table of Contents
        
        an alert message to warn the pharmacist of possible interactions,
including drug-drug, drug-food, drug-age and drug-pregnancy
interactions.On behalf of health plan sponsors, we aggregate all pharmacy benefit claims on
a system-wide basis and facilitate payments to retail pharmacies.Mail Services.We believe that our mail pharmacies reduce costs to health
plan sponsors through volume purchasing, increased generic dispensing and
higher rebates through greater formulary compliance. Mail service is ideal for
maintenance medications because of the convenience of home delivery and
improved patient compliance through methods such as refill reminders. Our mail
pharmacies currently dispense more than nine million prescriptions on an
annualized basis, typically in the form of a three-month supply of medications
for chronic conditions. Our mail service operations are highly automated,
featuring bar code and scanning technology to route and track orders,
computerized dispensing of many medications and computer-generated mailing
labels and invoices. To enhance accurate dispensing of prescriptions, our mail
service system is equipped with automated quality control features, and a
registered pharmacist inspects each prescription.Our mail pharmacy operations are located in Fort Worth, Texas and
Birmingham, Alabama. We have consolidated our Richardson, Texas mail pharmacy
operations into our larger facilities in Fort Worth, Texas and Birmingham,
Alabama. We believe that this consolidation will enhance the operating
efficiencies of our mail pharmacy business.While the vast majority of our prescriptions are currently submitted
through the mail, we will continue to promote our web-based capabilities to
further reduce the costs associated with prescription refills. For additional
information on our web-based capabilities, see  Web-based Health Improvement
Products and Services below.Clinical and Other Services.Our clinical services professionals work
closely with health plan sponsors to design and administer pharmacy benefit
plans that, through the use of formularies and other techniques, promote
clinically appropriate drug usage while reducing drug costs. Our formulary
development process begins with a panel of independent physicians and
pharmacists who perform a clinical review of available drugs for inclusion in
the formulary based on safety and efficacy. After the clinical review has been
performed, we negotiate rebates and discounts with pharmaceutical manufacturers
to obtain the most cost effective formulary for our health plan sponsors.We encourage formulary compliance through programs that operate at the
patient, prescribing physician and pharmacist levels. We help design tiered
co-payment plans, which require a health plan member to pay higher amounts for
non-preferred drugs. We attempt to influence physician prescribing patterns by
analyzing physicians prescribing behavior relative to physician peer groups
and notifying them when their practices differ from peer group norms and
medical best practices. We provide face-to-face consultations between our
clinical pharmacists and high-prescribing physicians in an effort to align
prescribing practices in targeted categories and diseases that are in the best
interests of health plan sponsors and members. We also provide our own
educational materials to physicians, pharmacists and health plan sponsors.
Through the retail pharmacies, we offer a voluntary therapeutic interchange
program that encourages pharmacists to consult with patients and physicians
regarding therapeutically equivalent, cost-effective drug alternatives. Our
programs support cost effective, clinically appropriate drug management and
help to ensure that members receive appropriate drug therapies.In addition, we have developed consulting products and services to assist
health plan sponsors in designing programs that manage prescription drug costs
effectively while maintaining high physician and member satisfaction. Such
programs include restrictive formularies, three-tiered co-payments and prior
authorization features. We have developed a proprietary decision support system
that offers virtually unlimited querying capability of pharmacy, medical and
laboratory data, sophisticated outcomes analyses, detailed physician and
pharmacy provider profiling, utilization trending and formulary and rebate
analysis. This system allows health plan sponsors to study the effectiveness of
specific drugs, identify and address areas for improvement and develop new
programs.Consumer Card ServicesAccording to the U.S. Census Bureau, in 1999 approximately 43 million
Americans had no health insurance coverage. We estimate that approximately 17
million more Americans do not have outpatient prescription drug coverage
included with their health insurance. Additionally, millions of Americans with
outpatient drug coverage have inadequate benefits. We provide services to make
prescription drugs more affordable for groups and individuals who have limited
or no prescription drug insurance coverage. Through our consumer card services,
participants receive a discount on covered prescription drugs at the point of
sale, thereby reducing their prescription drug costs. We are able to achieve
our goal of providing prescription drugs to consumers at reduced prices by
negotiating rebates on prescription drugs from pharmaceutical manufacturers and
discounts from retail pharmacies based on our size and ability to influence
market share. In order to maximize the cost savings to participants, we also
provide messages to pharmacies participating in the programs to inform them of
clinically appropriate alternative drugs that may have a lower, out-of-pocket
cost for the patient. We also intend to expand a patient
8Table of Contentsletter program informing participants of preferred drugs available at
discounts through the program and encouraging them to bring the preferred drug
to the attention of their physician to determine whether or not they are a
candidate for the more cost effective treatment option. In addition to cost
savings, patients benefit by participating in our drug program by allowing us
to capture the patients drug history and to identify and alert the dispensing
pharmacist to any potential drug interactions.We currently have four consumer card programs. Three of our programs have
more than 40,000 participating retail pharmacies nationwide and include a mail
service option to provide additional savings to participants. Currently, we
market our programs under MatureRx(R), femScript(R), and AvidaRx(TM), which we
acquired through our acquisition of FFI, as well as provide private label
consumer card programs for customers. MatureRx is designed to meet the needs of
senior citizens who are beneficiaries of Medicare, which does not currently
cover the cost of prescription drugs, by reducing their costs for prescription
drugs. femScript is designed to help women obtain prescription coverage for
oral contraceptives and estrogen replacement therapies. AvidaRx and the
AdvancePCS private label consumer card programs offer savings on preferred
products to participants. The AdvancePCS private label consumer card program
offers savings on a broad range of products to participants through more than
47,000 participating retail pharmacies nationwide.Web-based Health Improvement Products and ServicesWe believe that our web-based offerings are the most comprehensive in the
industry. Through these offerings we intend to both increase member
satisfaction with our PBM services and enhance our operating efficiency. We
also aim to facilitate the member retention and growth goals of our health plan
sponsors by providing such plans with leading e-health web site development
services and access to our e-health portals.PBM Services.Our online pharmacy services allow us to both reduce costs
and improve service. When visiting our web sites, members of our health plan
sponsors can place orders for prescriptions, check order status, locate network
pharmacies, review formulary information and save processing and customer
service costs. We believe a key differentiating characteristic of our online
PBM services is the ability of patients to access online a confidential and
complete history of all prescriptions dispensed to them. In addition, we
continue to work with our health plan sponsors to develop interfaces that
enable them to seamlessly link into our PBM services through their own web
sites.Client Services.In response to client demand for their own e-health
solutions, we provide web development services for health plan sponsors, an
e-health portal and an online drugstore. We develop e-health web portals for
our clients by either co-branding our own e-health portal or creating a
completely customized private-label web site on their behalf. Our web
development services are provided in conjunction with Consumer Health
Interactive, Inc., or CHI, of which we currently own approximately 19 percent.
CHI assisted us in the development of our own e-health portal,
BuildingBetterHealth.com,which provides consumers a comprehensive source of
health, wellness and medical information, including access to medical and drug
encyclopedias, an extensive medical library, medication guides, diet and
nutritional resources, information about diseases, pregnancy, child and elder
care, current news articles about health care developments, and related
content. In addition, our online drugstore, AdvanceRx.comoffers consumers the
further convenience of shopping for other drugstore products while filling
their prescriptions online or visiting BuildingBetterHealth.comor one of the
other web sites that we developed for health plan sponsors. AdvanceRx.com
offers over-the-counter products, health and beauty products, vitamins and
nutritional supplements, medical supplies and similar products, covering over
10,000 different SKUs.Disease Management and Other Health Improvement ProgramsDisease Management.We help health plan sponsors manage the cost and
treatment of specific chronic diseases by improving medical outcomes and
lowering the cost of health care delivery. Our programs are designed to support
the quality initiatives and third party accreditation requirements, such as
those of the National Committee on Quality Assurance, of our health plan
sponsors. These programs monitor the contracted population and intervene when
individuals demonstrate symptoms of a specific disease or high risk
indications.Our disease management programs are executed by a dedicated team of
clinicians and managed care professionals and typically have five principal
elements:
        
        Data integration.We compile and analyze medical, laboratory,
pharmacy and other relevant data for a particular group of health plan
members.
        
        Case finding.We identify patients from the group who have the
specific disease and stratify them for targeted interventions.
        
        Treatment assessment.We compare treatment received by identified
patients with nationally accepted treatment guidelines. We also assess
physician knowledge of clinical guidelines for targeted interventions.9Table of Contents
        
        Targeted interventions.We intervene with identified patients by
educating them about their disease and providing self-management tools.
We also provide physicians with treatment guidelines, patient profiles
and patient management tools.
        
        Outcomes analysis.We measure the results of the intervention by
tracking the identified patients medical outcomes and monitoring
ongoing compliance with their treatment programs.We have designed disease management programs for cardiovascular secondary
risk reduction, asthma, diabetes, heart failure, depression and hypertension.
We have approximately 15 million eligible members who are enrolled in health
plans currently under contract for one or more of our programs. We believe our
disease management programs are supported by our ability to assess quality of
life, quality of care and overall satisfaction with the disease management
programs. We also assess the economic benefit of the programs to our health
plan sponsors.The Center for Work and Health.In the first quarter of fiscal year 2001,
we developed the Center for Work and Health to focus specifically on employer
group clients and the impact that illnesses have on losses in productive hours
of work. In this regard, the Center for Work and Health views health care
dollars as an investment in human capital that needs to be effectively managed
to improve the quality of life of employees and to reduce lost productive hours
and absenteeism due to illness. The Center for Work and Health focuses on
health problems that both have a substantial impact on productivity and can be
improved, such as arthritis pain, back pain, musculoskeletal pain, depression,
diabetes, gastrointestinal disorders, allergic rhinitis, migraines and numerous
other conditions. Many of these conditions are common in working populations
and are under-diagnosed, not adequately managed and under-treated. Strategies
that facilitate effective care are likely to improve outcomes and, as a result,
reduce lost hours of productivity. We believe these results are particularly
valuable to our employer group clients, who are responsible for the cost of
medical care and benefit economically from a reduction in lost productivity.The Center for Healthier Aging and Patient Safety.In the third quarter of
fiscal year 2000, we developed the Center for Healthier Aging and Patient
Safety to encourage better health for elderly and the chronically ill through
preventative and interventional programs designed to promote the appropriate
use of pharmacy therapy and reduce overall health care costs for these
patients. Through focused data analysis, we work to assure that medications
provide their intended advantages with minimal unintended adverse effects. We
also work with pharmaceutical manufacturers to evaluate appropriate medications
and medication information for elderly patients and their physicians. As a
result, we believe that our emphasis on effective care for the elderly will
increase our visibility in the marketplace and position us to take advantage of
any future Medicare drug benefit opportunities.Clinical trialsThrough our clinical research operations, we assist pharmaceutical
manufacturers in conducting clinical trials for both new drugs and new uses for
existing drugs. Our current clinical trial initiatives are focused on
Alzheimers disease and other neurological disorders, psychological conditions
and pain relief. We provide key functions in the clinical trials process,
including:
        
        recruiting patients and physicians to participate in trials;
        
        administering the trials as designed by the pharmaceutical manufacturers; and
        
        measuring the patients results.The large size and breadth of our PBM population enhances our clinical
trial recruitment and execution capabilities. Our patient enrollment methods
are designed to reduce drug development time, which permits sponsors of
clinical trials to introduce their products into the market faster and to
maximize the economic return for such products. We use a call center and
medically appropriate surveys to identify patients eligible to participate in
our clinical trials. We believe that the combination of our clinical trials
expertise with the largest PBM membership base allows us to more thoroughly and
accurately evaluate the clinical benefits and predict the impact of new
pharmaceutical products and services on health care expenditures and patient
care management.Outcomes studiesWe provide pharmaceutical manufacturers an established vehicle for
conducting studies that can document a drugs economic and clinical benefits in
a real world environment. In addition, our surveying capabilities permit us to
evaluate the effectiveness of disease management strategies. We perform outcome
studies on a broad range of conditions including chronic pain, dementia, asthma
and diabetes.
10Table of ContentsOur outcomes studies services include conducting studies to further the
understanding of the characteristics of diseases and to develop simple-to-use
tools, such as questionnaires and decision trees, for diagnosing diseases. In
addition, we develop measurements for monitoring patient medical outcomes and
determine how to best influence the health status of individuals. We also
evaluate the direct and indirect costs of health care, as well as conduct
surveys to evaluate physician knowledge and behavior in order to develop
individualized educational materials for each physician.ClientsWe generate a significant portion of our revenues from contracts with
health plan sponsors. One of our clients, Foundation Health Systems, Inc., now
known as Health Net, accounted for approximately 14 percent of our revenues in
fiscal year 2001. However, on a pro forma basis giving effect to our
acquisition of PCS, Health Net accounted for approximately eight percent of
revenues in fiscal year 2001. FEP accounted for 11% of our revenues for the
year ended March 31, 2001. On a pro forma basis giving effect to our
acquisition of PCS, government contracts, including state and federal,
represented approximately 12 percent of our client base in fiscal year 2001.
These arrangements are typically acquired through a competitive bidding process
and may be terminated on short notice by the government. No other client
accounted for more than 10 percent of our revenues in this period.Historically, we have had strong client relationships with BlueCross
BlueShield companies and other managed care organizations. While PCS has served
managed care plans, it has traditionally focused on and developed expertise in
serving self-insured employers, insurance carriers and government plans. As a
result of our combination, we now have a diverse client base and substantial
market penetration among all major target client groups.Sales, Marketing and ServiceAs of March 31, 2001, we had a staff of more than 530 sales and support
people. Our sales force is supplemented by client service representatives in
more than 30 offices throughout the United States. As part of our strategy to
expand our client base, we have reorganized our sales force into teams focused
on each client segment. Through this reorganization, our sales force will be
able to focus on the specific characteristics and needs of our current and
prospective clients in each segment.The sales process for health plan sponsors usually lasts a minimum of six
to nine months and sometimes can extend for a year or longer. We initiate the
sales process with large health plan sponsors at our most senior levels. A
staff of sales representatives uses a team approach to work with a number of
senior level individuals within a health plan sponsor. In this manner, we are
able to work with health plan sponsors at multiple levels within their
organizations, and our health plan sponsors have multiple contacts within our
organization.Once we have contracted with a health plan sponsor for our services, we
commit to provide it with the highest level of support. For example, our
benefits design group works with our health plan sponsors to design the
pharmacy benefits that they will provide to the individuals in their plans.
Each client is supported by a multi-functional team led by a senior-level
account manager who coordinates with designated resources across our company.
The account management teams are organized by market segment to enhance their
understanding of the needs and complexities of our clients.In addition, we commit to our health plan sponsors that the individuals
enrolled in their plans will receive high quality member service. To fulfill
this promise, we manage three advanced call centers staffed with over 1000
member service representatives who are available to answer incoming calls 24
hours a day, seven days a week. For the year ended March 31, 2001, our call
centers received approximately 269,000 calls per week, on average.SuppliersIn an effort to continue to gain efficiencies from our acquisition of PCS
we recently entered into a three-year agreement with a wholesale
distributor, Bergen Brunswig Drug Company, to
be our primary supplier of pharmaceuticals to our mail pharmacies. We believe
our supplier arrangements are more than adequate, and we maintain strong
relationships with back-up wholesalers and suppliers. In addition, we believe
alternative suppliers can be utilized without any disruptions. If a
drug is not in our inventory, we can generally obtain it from either
a primary or secondary supplier within one or two business days. We believe it
would be relatively easy to switch from one supplier to another. Other than
with respect to our mail pharmacies, we do not purchase products for retail
pharmacies or otherwise supply products to them. Retail pharmacies typically
have their own arrangements with wholesale distributors or pharmaceutical
manufacturers.11Table of ContentsInformation SystemsInformation technology systems are a critical part of our business. We
maintain a number of separate, proprietary systems that are designed to
efficiently support our specific departments, yet are compatible for electronic
data interchange. Our information technology systems are highly scalable and
run on a variety of platforms. We have an experienced systems staff of more
than 700 employees. We maintain extensive preventative measures to protect
against disaster, including redundancy in all aspects of processing,
telecommunications and power sources.As part of our integration efforts with PCS, we have moved our Richardson,
Texas data center into our Scottsdale, Arizona data center. Although we
combined physical locations, we will continue to maintain our separate data
processing platforms in order to avoid client disruptions associated with
conversion. The Scottsdale, Arizona data center has received ISO 9002
certification from the International Organization for Standardization, the
worlds foremost quality standards organization, and has also received an
exceptional audit grade from registrars with the professional services firm,
Deloitte & Touche LLP.We are continuing to make significant progress in efforts to integrate
other technology that we acquired in connection with the PCS acquisition. We
have successfully integrated many of our administrative technologies such as
voice-mail, e-mail and telephony systems. We are making significant progress in
our efforts to integrate our accounting and payroll/benefit systems. We have
successfully created an interface to all of our call centers and our mail
service pharmacies so clients can be supported by any combination of these
facilities. By combining our technologies, we expect to achieve significant
synergies in our various operations to eliminate many redundant systems and to
redeploy key personnel to focus on our most critical needs.CompetitionWe compete with a number of national companies, including Merck-Medco
Managed Care, LLC, a subsidiary of Merck & Co., Inc., a pharmaceutical
manufacturer, Express Scripts, Inc. and Caremark Rx, Inc. In addition, we
compete with a number of local and regional PBMs and mail order pharmacies,
some of which may be owned by health plans or retail pharmacy chains. These
competitors may possess purchasing and other advantages over us that could
allow them to price competing services more aggressively than we can because of
their market position, affiliations and other aspects of their businesses.We believe that the primary competitive factors in the PBM industry
include:
        
        the size and financial strength of the company;
        
        independence from pharmaceutical manufacturers, retail pharmacies and health plan sponsors;
        
        the ability to reduce health plan sponsor costs by negotiating
favorable rebates and volume discounts from pharmaceutical
manufacturers;
        
        the quality, scope and costs of programs offered; and
        
        the ability to use clinical strategies to improve patient outcomes and reduce costs.Government RegulationVarious aspects of our business are governed by federal and state laws and
regulations and compliance is a significant operational requirement for us. We
believe that we are in substantial compliance with all existing legal
requirements material to the operation of our business. However, the
application of complex standards to the detailed operation of our business
always creates areas of uncertainty. Moreover, regulation of the field is in a
state of flux. Numerous health care laws and regulations have been proposed at
the state and federal level, many of which could affect our business. We cannot
predict what additional federal or state legislation or regulatory initiatives
may be enacted in the future regarding health care or the business of PBMs, or
how existing laws may be interpreted. It is possible that federal or state
governments might impose additional restrictions or adopt interpretations of
existing laws that could have a material adverse affect on our business,
profitability or growth prospects.Among the federal and state laws and regulations that affect aspects of
the PBM business are the following:12Table of ContentsFDA Regulation.The U.S. Food and Drug Administration, or FDA, generally
has authority under the Federal Food, Drug and Cosmetic Act, or FDCA, to
regulate drug promotional materials that are disseminated by or on behalf of
a
 pharmaceutical manufacturer. In January 1998, the FDA issued a Draft
Guidance for Industry regarding the regulation of activities of pharmacy
benefit managers that are directly or indirectly controlled by pharmaceutical
manufacturers. In that draft guidance, the FDA purported to have the authority
to hold pharmaceutical manufacturers responsible for the promotional activities
of PBMs, depending upon the nature and extent of the relationship between the
pharmaceutical manufacturer and the PBM. We and many other companies and
associations commented to the FDA in writing regarding its authority to
regulate the communications of PBMs that are not owned by pharmaceutical
manufacturers. In the fall of 1998, the FDA withdrew the guidance and stated
that it would reconsider the basis for its issuance. To date, the FDA has not
taken any further action on the issue. Although it appears that the FDA has
changed its position regarding regulation of communications by PBMs, there is
no assurance that it will not re-examine the issue and seek to assert the
authority to regulate the communications of such PBMs.The FDA also regulates the conduct of clinical trials for drugs. In
general, the sponsor of the drug product that is being studied, or the
manufacturer that will have the right to market the drug product if it is
approved by the FDA, has the responsibility to comply with the laws and
regulations that apply to the conduct of the clinical trials. However, in
providing services related to the conduct of clinical trials, we may assume
some or all of the sponsors or clinical investigators obligations related to
the study of the drug. In October 1998, the FDA announced that the agency would
give Institutional Review Boards or IRBs, the independent bodies that oversee
the conduct of clinical investigations, increased access to information
pointing to violative or potentially violative conduct on the part of the
physicians conducting the clinical trials, or clinical investigators.
Recently, public concern over the conduct of clinical trials for drugs has
grown, and scrutiny of the authority and the role of IRBs, as well as the
oversight of clinical trials for drugs has increased. New regulations or
standards may be enacted that would increase the regulatory compliance burden
on those involved in clinical investigations.We believe that we meet all of our regulatory responsibilities with regard
to our involvement in clinical trials. However, the interpretation of the laws
and regulations relating to the conduct of clinical trials is complex and
sometimes subjective. We cannot assure you that the FDA will not at some point
consider our compliance efforts to be inadequate and initiate administrative
enforcement actions against us. If we fail to successfully defend against an
administrative enforcement action, it could result in an administrative order
suspending, restricting or eliminating our ability to participate in the
clinical trial process, which would materially limit our business operations.
Moreover, some violations of the FDCA are punishable by civil and criminal
penalties against both the violating company and responsible individuals. If
warranted by the facts, we and our employees involved in the trials could face
civil and criminal penalties, which include fines and imprisonment.Regulation of Confidentiality of Patient Identifiable Information.
Government regulation of the use of patient identifiable information has grown
substantially over the past several years, and is likely to increase further in
the future. Many states have recently enacted laws dealing with the use and
disclosure of health information, and this is expected to be an area of
significant activity in many states this year again. The proposals vary widely,
some relating to only certain types of information, others to only certain
uses, and yet others to only certain types of entities. Texas, California and
New York are some of the larger states that focused on health information
privacy this year. Numerous proposals have been circulated at the state and
federal level and there is no assurance that these proposals, if adopted, will
not have a material adverse effect on our business, profitability and growth
prospects. The programs that we offer our health plan customers are
information-based, utilizing aggregated and anonymous data, as well as
patient-specific information, depending upon the needs of the customer.
Government restrictions on the use of patient identifiable information could
adversely affect our ability to promote formulary compliance and to conduct
health improvement programs and outcomes studies, as well as our business
growth strategy based on these programs.In the absence of comprehensive federal privacy legislation, in December
2000, the Department of Health and Human Services, or HHS, issued final
regulations regarding the privacy of individually identifiable health
information pursuant to the Health Insurance Portability and Accountability Act
of 1996, or HIPAA. This final privacy rule applies to both electronic and paper
records and imposes extensive requirements on the way in which health care
providers, health plans and their business associates use and disclose
protected information. This final rule gives patients significant rights to
understand and control how their protected health information is used and
disclosed. Direct providers, such as pharmacies, are required to obtain patient
consents for treatment, payment and health care operations. For all uses or
disclosures of protected information that do not involve treatment, payment or
health care operations, the rule requires that all covered entities obtain a
valid patient authorization. In most cases, use or disclosure of protected
health information must be limited to the minimum amount necessary to achieve
the purpose of the use or disclosure. Organizations subject to the rule will
have approximately two years to comply with these provisions. Sanctions for
failing to comply with standards issued pursuant to HIPAA include criminal
penalties and civil sanctions. Additional guidelines on the application of the
final privacy rule are expected to be released in the near future, and these
could impact the manner in which we use or disclose protected health
information.In addition, in August 1998, HHS issued proposed regulations pursuant to
HIPAA that govern the security of individually-identifiable health information.
A final security rule has not yet been published but, once issued, it is likely
to13Table of Contentsimpose additional administrative burdens on health care providers, health
plans and their business associates, relating to the storage, utilization and
transmission of health information.Due to the complex and controversial nature of the HIPAA regulations, they
may be subject to court challenge, as well as further legislative and
regulatory actions that could alter their effect. However, as currently
written, they will likely increase our burden of regulatory compliance with
respect to our health improvement programs and other information-based
products, and may reduce the amount of information we may use if patients do
not consent to its use. There can be no assurance that the restrictions and
duties imposed will not have a material adverse effect on our business,
profitability or growth prospects.Even without new legislation and beyond the final federal regulations,
individual health plan sponsors could prohibit us from including their
patients medical information in our various databases of medical data. They
could also prohibit us from offering services that involve the compilation of
such information.Anti-Kickback Laws.Subject to certain exceptions, federal law prohibits
the payment, offer, receipt or solicitation of any remuneration that is
knowingly and willfully intended to induce the referral of Medicare, Medicaid
or other federal health care program beneficiaries for the purchase, lease,
ordering or recommendation of the purchase, lease or ordering of items or
services reimbursable under federal health care programs. Several states also
have similar laws, known as all payor statutes, which apply anti-kickback
prohibitions beyond services for which federal health care program payments may
be made. Sanctions for violating these federal and state anti-kickback laws may
include criminal and civil sanctions and exclusion from participation in
federal health care programs. State anti-kickback laws vary, and have rarely
been interpreted by courts. However, in several cases, courts have ruled that
contracts that violate anti-kickback laws are void as a matter of public
policy.The federal anti-kickback statute has been interpreted broadly by courts,
by the Office of Inspector General, or OIG, and within administrative
tribunals. Courts have ruled that a violation of the statute may occur even if
only one of the purposes of a payment arrangement is to induce patient
referrals or purchases. Among the practices that have been identified by the
OIG as potentially improper under the statute are product conversion programs
in which benefits are given by pharmaceutical manufacturers to pharmacists or
physicians for changing a prescription, or recommending or requesting such a
change, from one drug to another. These laws have been cited as a partial
basis, along with the state consumer protection laws discussed below, for
investigations and multi-state settlements relating to financial incentives
provided by pharmaceutical manufacturers to physicians or pharmacists in
connection with such programs.Because of the federal statutes broad scope, federal regulations
establish some safe harbors from liability. Safe harbors exist for, among
other things, certain properly reported discounts received from vendors,
certain investment interests, certain properly disclosed payments made by
vendors to group purchasing organizations and certain managed care risk-sharing
arrangements. A practice that does not fall within a safe harbor is not
necessarily unlawful, but may be subject to scrutiny and challenge.We believe that we are in compliance with the legal requirements imposed
by these laws and regulations, and we believe that there are material
differences between the drug-switching programs about which the OIG has raised
concerns and the programs we offer to our customers. To date, the government
has not commenced enforcement actions under the anti-kickback statutes against
PBMs with regard to their negotiation of discounts, rebates and administrative
fees from drug manufacturers in connection with drug purchasing and formulary
management programs, or their contractual agreements with pharmacies that
participate in their networks, or their relationships with their health plan
customers. However, in June of 2000, MIM Corporation, a PBM settled a lawsuit
with the federal government and the State of Tennessee asserting that it had
defrauded the Tennessee Medicaid program in managing its prescription drug
benefit by making false claims and diverting payments.In June 1998, the United States Attorneys Office for the Eastern District
of Pennsylvania began an investigation into whether rebates and other payments
made by pharmaceutical manufacturers to PBMs, or payments made by PBMs to
retail pharmacies or others, may violate the anti-kickback laws or other
federal laws. To date, no specific prosecutions or settlements have been made
public. As part of this investigation, prior to our acquisition of PCS, PCS
received a subpoena from the OIG requesting general information about PCSs
programs. AdvancePCS has turned over documents in response to the subpoena.
The United States Attorneys Office has also contacted some of the
pharmaceutical manufacturers with which we have agreements, and has asked these
manufacturers to provide copies of documents relating to their agreements with
us. We believe subpoenas have been issued to other PBMs and pharmaceutical
manufacturers as well. At this time, we are unable to predict whether the
government will commence any action challenging any of our programs and
practices. We believe that our programs, and those programs of PCS prior to the
acquisition are in compliance with the requirements imposed by the
anti-kickback laws and other applicable laws and regulations. Nevertheless, we
could be subject to scrutiny, investigation or challenge under these laws and
regulations as a result of the OIG investigation or otherwise, which could
14Table of Contentshave a material adverse effect on our business, profitability and growth
prospects. For more information regarding the OIG investigation, see  Legal
Proceedings and Government Investigations below.OIG Study.The OIG Office of Evaluation and Inspections, which seeks to
improve the effectiveness and efficiency of the HHSs programs, issued a report
on PBM arrangements on April 15, 1997. The report was based primarily on a
nationwide survey of HMOs that use PBMs, and examined the benefits of, and
concerns raised by, the HMOs relationships with PBMs.The report identified concerns about the potential for bias resulting from
alliances of PBMs and pharmaceutical manufacturers and the lack of oversight by
HMOs regarding the performance of PBMs in delivering quality services to health
plan members. The report recommended that HCFA and state Medicaid programs
should include stronger oversight provisions in their risk contracts with HMOs
by requiring HMOs to review the performance of the PBMs with which they
contract. The report also recommended that HCFA, the FDA and the Health
Resources and Services Administration, working with outside organizations,
should develop quality measures for pharmacy practices that can be used in
managed care settings. We intend to closely monitor these agency actions and
whether these actions would have any impact on our business.Managed Care Reform.Legislation is being debated on both the federal and
state level, and has been enacted in several states, aimed primarily at
improving the quality of care provided to individuals enrolled in managed care
plans. Some of these initiatives would, among other things, require that health
plan members have greater access to drugs not included on a plans formulary
and give health plan members the right to sue their health plans for
malpractice when they have been denied care, and mandate the content of the
appeals or grievance process when a health plan member is denied coverage. The
scope of the managed care reform proposals under consideration by Congress and
state legislatures, and enacted by states, to date vary greatly, and the extent
to which future legislation may be enacted is uncertain. However, these
initiatives could greatly impact the managed care and pharmaceutical industries
and, therefore, could have a material impact on our business.Direct Regulation of PBMs.Several states, including Georgia, New Jersey
and New York, have introduced legislation that would directly regulate PBMs,
but to our knowledge, no state has passed such legislation. Several regulatory
and quasi-regulatory bodies, such as the National Association of Insurance
Commissioners, the National Association of Boards of Pharmacy and the National
Committee on Quality Assurance, are also considering proposals to regulate PBMs
and proposals to increase the regulation of certain PBM activities, such as
formulary and utilization management, and downstream risk assumption. As
discussed below under  Licensure Laws, state licensure of certain
activities, such as utilization review and third party administration, also may
adversely impact our business and operations. While the outcome of these
initiatives is uncertain, any resulting legislation could significantly impact
our business, both directly as a PBM, and indirectly through the impact on the
pharmacy benefit services we are able to deliver on behalf of our health plan
sponsors.ERISA Regulation.We have agreements to provide PBM services to a number
of self-funded corporate health plans. These plans are subject to the Employee
Retirement Income Security Act of 1974, or ERISA, which regulates employee
pension and health benefit plans. We believe that our activities are
sufficiently limited that we do not assume any of the plan fiduciary
responsibilities that would subject us to regulation under ERISA. Our
agreements with our self-funded corporate plan customers state that we are not
the fiduciary of the plan. However, the U.S. Department of Labor, which is the
agency that enforces ERISA, could assert that the fiduciary obligations imposed
by the statute apply to certain aspects of our operations. In past decisions,
the United States Supreme Court and other federal courts have declined to
extend fiduciary status to managed care organizations that contract with ERISA
plans. However, future cases involving PBMs could be decided differently, and
if we were deemed to be a fiduciary, we could potentially be subject to claims
over benefit denials. In addition, we could also be subject to claims for
breaching fiduciary duties in connection with the services we provide to the
plan.In March 1998, Mulder v. PCS Health Systems, Inc.was filed as an alleged
class action lawsuit, contending that we are an ERISA fiduciary and that we
have breached our fiduciary obligations under ERISA in connection with our
development and implementation of formularies, preferred drug listings and
intervention programs. We have denied all allegations of wrongdoing and are
vigorously defending this lawsuit. For information regarding this action, see
" Legal Proceedings and Government Investigations below.ERISA prohibits a party in interest to a plan from engaging in certain
types of transactions with the plan, including purchases, sales, and loans.
Violations are subject to civil and possibly criminal liability. By providing
services to these plans, we are subject to the restrictions on a party in
interest. We believe that we are in compliance with these provisions of ERISA.
However, we can provide no assurance that the government would not challenge
our practices.Consumer Protection Laws.Most states have consumer protection laws,
which have been the basis for investigations and multi-state settlements
relating to financial incentives provided by pharmaceutical manufacturers to
retail pharmacies in connection with drug switching programs. In addition,
under a settlement agreement entered into with 17 states on October
25, 1995,
15Table of ContentsMerck-Medco Managed Care, the PBM subsidiary of pharmaceutical
manufacturer Merck & Co., agreed to require pharmacists affiliated with
Merck-Medco Managed Care mail service pharmacies to disclose to physicians and
patients the financial relationships between Merck & Co., Merck-Medco Managed
Care and the mail service pharmacy when such pharmacists contact physicians
seeking to change a prescription from one drug to another. We believe that our
contractual relationships with pharmaceutical manufacturers and retail
pharmacies do not include the features that were viewed by enforcement
authorities as problematic in these settlement agreements, and that our
business practices are otherwise compliant with consumer protection laws.
However, we could be subject to scrutiny or challenge under one or more of
these laws. Additionally, most states have enacted consumer protection laws
relating to a wide range of managed health care activities, including provider
contracting, member appeals, and access to services and supplies.Network Access Legislation.A significant number of states have adopted
some form of legislation affecting our ability to limit access to retail
pharmacy provider networks or from removing retail pharmacies from a network.
These laws may require us, directly or through our health plan customers, to
admit any retail pharmacy willing to meet the plans price and other terms for
network participation; these laws are sometimes referred to as any willing
provider or freedom of choice laws. To date, we have not been materially
affected by these statutes because we administer a large network of over 56,000
retail pharmacies and will admit any licensed pharmacy that meets our
credentialing criteria, involving such matters as adequate insurance coverage,
minimum hours of operation, and the absence of disciplinary actions by the
relevant state agencies.Formulary Restrictions.A number of states have begun to actively
regulate the management of prescription drug benefits. Texas, California, New
York and New Jersey have taken the lead proposing legislation on a wide range
of issues affecting the delivery of pharmacy benefits. Many smaller states have
followed, although often focusing on particular aspects, such as the
development and use of formularies or pharmacy network issues. For example,
some states have passed laws mandating coverage for off-label uses of drug
products, such as the off-label uses of chemotherapeutic agents where those
uses are recognized in peer-reviewed medical journals or reference compendia.
Other states have begun to enact laws that regulate the development and use of
formularies by insurers, HMOs and other third party payors. These laws have
included requirements on the development, review and update of formularies, the
role and composition of pharmacy and therapeutics committees, the disclosure of
formulary information to health plan members; and a process for allowing
members to obtain non-preferred drugs without additional cost-sharing where
they are medically necessary and the formulary drugs are determined to be
inappropriate. Additionally, the National Association of Insurance
Commissioners is developing a model law on drug formularies, currently known as
the Health Carrier Prescription Benefit Management Model Act, that, if
ultimately enacted throughout the country, may provide more uniformity for
health plans and PBMs. Among other things, the model law would address the
disclosure of formulary information to health plan members, members access to
non-preferred drugs, and availability of an appeals process for members to use
when coverage of a non-preferred drug is denied by the health plan or its
designee. Increasing regulation of formularies by states could significantly
affect our ability to develop and administer formularies on behalf of our
insurer, HMO and other health plan customers.Legislation Imposing Plan Design Restrictions.Some states have
legislation that prohibits a health plan sponsor from implementing certain
restrictive design features. For example, some states prohibit insurers, HMOs
and other health plans from requiring members to use mail pharmacies. Other
restrictions affect the ability to make formulary changes and restrictions.
Among the most aggressive in this regard are Texas and New Jersey, both of
which have recently issued far-reaching regulations limiting formulary
flexibility. In Texas, the new regulations prevent plans from changing their
formularies during the plan year, and in New Jersey, the regulations mandate
coverage of at least two drugs per therapeutic class and limit the difference
in co-payments to 30% for different tiers on a formulary. Other states mandate
coverage of certain benefits or conditions. This legislation does not generally
apply to us, but it may apply to some of our customers such as HMOs and
insurers. If similar legislation were to become widespread and broad in scope,
it could have the effect of limiting the ability of PBMs to achieve economic
benefits through health benefit management services.Licensure Laws.Many states have licensure or registration laws governing
certain types of ancillary health care organizations, including preferred
provider organizations, third party administrators, and companies that provide
utilization review and related services. The scope of these laws differs
significantly from state to state, and the application of these laws to the
activities of pharmacy benefit managers is often unclear. We have registered
under these laws in those states in which we have concluded, after discussion
with the appropriate state agency, that such registration is required. As noted
above under  Direct Regulation of PBMs, some states have introduced
legislation that, if enacted, would subject PBMs to comprehensive regulation.
Such enactments could adversely affect our business and operations.Legislation and Regulation Affecting Drug Prices.The federal Medicaid
rebate statute provides that manufacturers must provide rebates to the program
on all drugs purchased equivalent to the difference between the average price
of the drugs and the best price at which the manufacturer sells the drugs to
wholesalers. In addition, under the Federal Supply Schedule, the government
seeks and obtains favorable pricing based on manufacturers commercial prices
and sales practices. Some manufacturers may see these policies as a
disincentive to offering discounts to private purchasers, including the plans
16Table of Contentsrepresented by AdvancePCS. Some states have adopted legislation or
regulations providing that a pharmacy participating in the states Medicaid
program must give program patients the best price that the pharmacy makes
available to any third party plan. These requirements are sometimes referred to
as most favored nation payment systems. Other states have enacted unitary
pricing legislation, which mandates that all wholesale purchasers of drugs
within the state be given access to the same discounts and incentives. Any such
legislation, if enacted in any state, may adversely affect our ability to
negotiate discounts from network pharmacies or manufacturers. Some
manufacturers may view these Medicaid rebate provisions as a disincentive to
provide discounts, which could adversely affect our ability to control costs.A number of states have also recently introduced broad drug price control
bills that would extend price controls beyond the Medicaid program. Many of
these bills impose maximum drug prices based on the Federal Supply Schedule and
require that manufacturers and/or pharmacies extend this pricing to one or more
segments of the states population, such as to all Medicare beneficiaries. If
enacted, these bills could adversely affect our mail-order pharmacys
reimbursement rates, or otherwise discourage the use of the full range of our
services by current or future clients. A number of states have begun to seek
supplemental rebates from drug manufacturers, beyond those required by the
federal Medicaid statute. Some of those states may utilize the services of
PBMs to negotiate and administer these supplemental rebate programs.In 2000, Congress passed the Medicine Equity and Drug Safety Act of 2000,
directing the FDA to promulgate regulations allowing pharmacists and drug
wholesalers to reimport approved drugs, originally manufactured in the United
States, back into the United States from other countries where the drugs were
sold at a lower price. The purpose of the law was to enable United States
citizens to purchase drugs at prices comparable to lower prices charged for
such medicines in other countries. In December 2000, the Secretary of HHS
notified President Clinton that HHS would not seek the necessary funding to
implement the law, since she believed it was too flawed as written to be
effective. The Secretary of HHS in the Bush Administration has put his review
of this policy on hold, and it will not be implemented this year. Whether and
how the law will ultimately be implemented through regulations is unclear. It
may offer PBMs opportunities to reduce costs, but faces substantial opposition
from the prescription drug industry. The ultimate effect of the legislation on
our business is not known at this point.Recently, the government has increased its attention to how drug
manufacturers develop pricing information, which in turn is used in setting
payments under the Medicare and Medicaid programs. One element common to many
payment formulas, Average Wholesale Price, or AWP, has come under criticism as
not accurately reflecting prices actually charged and paid at the wholesale or
retail level. The Department of Justice is currently conducting, and the House
Commerce Committee has conducted, an investigation into the use of AWP for
federal program reimbursement, and whether it has inflated drug expenditures by
the Medicare and Medicaid programs. In addition, the Clinton administration,
along with many states, proposed changing the basis for calculating
reimbursement of certain drugs by the Medicare and Medicaid programs. Instead
of AWP as historically reported by First DataBank, a company that specializes
in the compilation of drug pricing information, the federal and state
governments proposed to use a different set of pricing data, also compiled by
First DataBank, which generally yielded lower prices for certain drugs. As part
of the 2000 Consolidated Appropriations Act, P.L. 106-554, however, Congress
enjoined reductions in Medicare drugs reimbursed based on the revised data
pending a study by the General Accounting Office, and the HCFA has suspended
the implementation of this data with respect to Medicare pending this study.
These changes and other legislative or regulatory adjustments that may be made
to the program for reimbursement of drugs by Medicare and Medicaid, if
implemented, could affect our ability to negotiate discounts with
pharmaceutical manufacturers. In addition, it may affect our relations with
pharmacies and health plans. In some circumstances, they might also impact the
reimbursement that our mail-order pharmacy receives from managed care
organizations that contract with government health programs to provide
prescription drug benefits or otherwise elect to rely on the revised First
DataBank pricing information. Furthermore, private payors may choose to follow
the governments example, and adopt different drug pricing bases. This could
affect our ability to negotiate with plans, manufacturers and pharmacies
regarding discounts.In January of 2001, Bayer Corporation entered into a $14 million
settlement with the Department of Justice regarding a qui tamsuit that alleged
that Bayer had artificially inflated the average wholesale price that it
reported to government health care programs. In addition, Bayer agreed to
report new pricing information, the average sale price, to government health
care programs, which is calculated differently from the average wholesale
price. To the extent that AdvancePCSs private plan customers opt to rely on
this data, and demand similar calculations from manufacturers, it could impact
our ability to negotiate rebates with manufacturers.Medicare Prescription Drug Benefit.Medicare reimbursement and coverage
of prescription drugs may change significantly in the near future. Medicare
does not currently offer an outpatient prescription drug benefit. Proposals
have been made to reduce Medicare drug reimbursement amounts, although the
prospects for legislation are uncertain. Several legislative proposals are
under consideration in Congress to provide Medicare recipients with outpatient
drug benefits through the use of PBMs. Many states have established or are
considering establishing or expanding state drug assistance
17Table of Contentsprograms that would increase access to drugs by those currently without
coverage. We cannot assess at this stage how such proposals will impact drug
costs or our business.Regulation of Financial Risk Plans.The administration of fee-for-service
prescription drug plans by PBMs generally is not subject to insurance
regulation by the states. However, if a pharmacy benefit manager offers to
provide prescription drug coverage on a capitated basis or otherwise accepts
financial or insurance type risk in providing the benefit, laws in various
states may regulate the plan. These laws may require that the party at risk
establish reserves or otherwise demonstrate financial responsibility. Laws that
may apply in such cases include laws governing the business of insurance, HMOs,
limited prepaid health service plans, preferred provider organizations and
organized delivery systems. Many of these state laws may be preempted in whole
or in part by ERISA, which provides for comprehensive federal regulation of
employee benefit plans. However, the scope of ERISA preemption is uncertain and
is subject to conflicting court rulings. Other state laws may be invalid in
whole or in part as an unconstitutional attempt by a state to regulate
interstate commerce, but the outcome of challenges to these laws on this basis
is uncertain. This issue has received a great deal of attention recently. For
example, the National Community Pharmacists Association has asked the National
Association of Insurance Commissioners to examine whether PBMs should be
subject to state insurance laws. Accordingly, compliance with state laws and
regulations is a significant operational requirement for us, and could limit
our flexibility to adopt alternative and novel fee arrangements with our
customers.Mail Pharmacy Regulation.Our mail pharmacy operation distributes drugs
throughout the United States. Our fulfillment centers are presently located in
Fort Worth, Texas and Birmingham, Alabama. We are in the process of
consolidating our Richardson, Texas mail pharmacy operations into our larger
facilities in Fort Worth, Texas and Birmingham, Alabama. We are licensed by
United States, Texas and Alabama authorities to do business as a pharmacy and
to deliver controlled substances. Many of the states into which we deliver
pharmaceuticals and controlled substances have laws and regulations that
require out-of-state mail service pharmacies to register with that states
board of pharmacy, or similar regulatory body, in order to mail drugs into the
state. We have registered in every state that, to our knowledge, requires such
registration. In addition, some states require out-of-state mail service
pharmacies to have a pharmacist at the mail order location who is licensed in
the state to which the drugs are shipped, as well as meeting other standards.
To the extent that such laws or regulations are applicable to us, we believe
that we are in compliance with them.Other Statutes and Regulations Affecting our Mail Pharmacy Operations.
HCFA requires mail order pharmacies to provide toll-free numbers for patient
counseling of Medicaid recipients residing out of state. However, we do not
currently receive reimbursement from any state Medicaid programs. Congressional
directives to provide useful information on prescription drugs to consumers may
involve participation by mail order pharmacies in disseminating such
information. Federal statutes and regulations govern the labeling, packaging,
advertising and adulteration of prescription drugs and the dispensing of
controlled substances. The Federal Trade Commission requires mail order sellers
of goods generally to engage in truthful advertising, to stock a reasonable
supply of the product to be sold, to fill mail orders within thirty days, and
to provide customers with refunds when appropriate. The United States Postal
Service has statutory authority to restrict the transmission of drugs and
medicines through the mail to a degree that could have an adverse effect on our
mail service operations. The United States Postal Service historically has
exercised this statutory authority only with respect to controlled substances.
Alternative means of delivery are available to us.EmployeesOn March 31, 2001, we had 4,534 employees, including 15 medical doctors
and 442 pharmacists. None of our employees is represented by a labor union. In
the opinion of management, we have good relationships with our employees.InsuranceOur PBM operations, including the dispensing of pharmaceutical products by
our mail service pharmacies, and the services rendered in connection with our
health improvement services, and our non-PBM operations, such as the products
and services provided in connection with our clinical trial services, may
subject us to litigation and liability for damages. We believe that our
insurance protection is adequate for our present business operations, but there
can be no assurance that we will be able to maintain our professional and
general liability insurance coverage in the future or that such insurance
coverage will be available on acceptable terms or be adequate to cover any or
all potential product or professional liability claims. A successful product or
professional liability claim in excess of our insurance coverage, or one for
which an exclusion from coverage applies, could have a material adverse effect
upon our financial position or results of operations.18Table of ContentsRisk FactorsRisks Related to Our BusinessWe may not realize the benefits of integrating with PCS or be successful in
managing our combined company.We acquired PCS on October 2, 2000, which dramatically increased the size
of our company. Unless our management is successful in integrating and managing
the employees and assets acquired in the transaction in a cost-efficient manner
we will not be able to realize the operating efficiencies and other benefits
sought from the transaction. If we fail to successfully integrate our
operations with those of PCS and successfully manage the combined company, our
business, profitability and growth prospects will suffer.We have substantial debt obligations that could restrict our operations.We have substantial indebtedness. To finance our acquisition of PCS, we
entered into an $825 million senior secured credit facility and issued $200
million of senior subordinated notes to the seller, Rite Aid Corporation, or
Rite Aid. We repaid the senior subordinated notes with the proceeds from our
offering of $200 million in 8 1/2% Senior Notes Due 2008 (Senior Notes). As of
March 31, 2001, our outstanding debt was approximately $845 million and our
ratio of debt to total stockholders equity was approximately 2.1 to 1.Our substantial indebtedness could have adverse consequences, including:
        
        increasing our vulnerability to adverse economic and industry
conditions;
        
        limiting our flexibility in planning for, or reacting to, changes in
our business and the industry in which we operate; and
        
        limiting our ability to borrow additional funds.In addition, approximately $645 million of our outstanding debt bears
interest at a variable rate. While we have entered into interest rate
protection agreements with respect to $400 million of this debt, we remain
exposed to interest rate risk with respect to the remaining $245 million of
this debt. Economic conditions could result in higher interest rates, which
could increase debt service requirements on variable rate debt.Our debt service requirements will require the use of a substantial
portion of our operating cash flow to pay interest on our debt instead of other
corporate purposes. If our cash flow and capital resources are insufficient to
fund our debt obligations, we may be forced to sell assets, seek additional
equity or debt capital or restructure our debt. We cannot assure you that our
cash flow and capital resources will be sufficient for payment of interest on
and principal of our debt in the future, or that any such alternative measures
would be successful or would permit us to meet scheduled debt service
obligations. Any failure to meet our debt obligations could harm our business,
profitability and growth prospects.Any failure to meet our debt obligations could harm our business, financial
condition and results of operations.If our cash flow and capital resources are insufficient to fund our debt
obligations, we may be forced to sell assets, seek additional equity or debt
capital or restructure our debt. In addition, any failure to make scheduled
payments of interest and principal on our outstanding indebtedness would likely
result in a reduction of our credit rating, which could harm our ability to
incur additional indebtedness on acceptable terms. Although we have
not defaulted on, or failed to meet, any of our debt obligations, we cannot assure you that
our cash flow and capital resources will be sufficient for payment of interest
on and principal of our debt in the future or that any such alternative
measures would be successful or would permit us to meet scheduled debt service
obligations.Restrictive financing covenants limit the discretion of our management.Our credit facility and certain agreements governing our debt contain a
number of covenants that limit the discretion of our management with respect to
certain business matters. Our credit facility covenants, among other things,
restrict our ability to:
        
        incur additional indebtedness;
        
        issue preferred stock;19Table of Contents
        
        declare or pay dividends and other distributions;
        
        create liens;
        
        make capital expenditures;
        
        make certain investments or acquisitions;
        
        enter into mergers or consolidations;
        
        make sales of assets; and
        
        engage in certain transactions with affiliates.The Senior Notes indenture contains, similar restrictive covenants. In
addition, under our credit facility, we are required to satisfy a minimum fixed
charge coverage ratio, a maximum total leverage ratio and a minimum interest
coverage ratio. A breach of any agreements governing our debt would permit the
acceleration of the related debt, which could harm our business, profitability
and growth prospects. These restrictions may place us at a disadvantage
compared to our competitors that have fewer restrictive covenants and are not
required to operate under such restrictions.Competition in our industry is intense and could reduce or eliminate our
profitability.The PBM industry is very competitive. If we do not compete effectively,
our business, profitability and growth prospects could suffer. Our competitors
include profitable and well-established companies that have significant
financial, marketing and other resources. Some of our competitors in the PBM
business are owned by profitable and well-established pharmaceutical
manufacturers or national retail pharmacy chains, which may give them
purchasing power and other advantages over us by virtue of their ownership
structure, and enable them to succeed in taking away some of our customers.Competitive pressures
have historically contributed to a decrease in our margins. Our
margins were 5.4% in the year ended March 31, 1999, 4.1% in the year
ended March 31, 2000 and 3.3% in the year ended March 31, 2001. Our gross margins may continue to decline as we attract and renew
larger customers who typically have greater bargaining power than smaller
customers and may require us to sell our services at decreased prices. We
cannot be sure that we will continue to remain competitive, nor can we be sure
that we will be able to successfully market our PBM services to customers at
our current levels of profitability.If we lose key health plan sponsors, our business, profitability and growth
prospects could suffer.We depend on a limited number of large health plan sponsors for a
significant portion of our consolidated revenues. Five customers generated
approximately 39% of the claims we processed in fiscal year 2001 and
approximately 36% on a pro forma basis giving effect to our acquisition of PCS.
During this period, Foundation Health Systems, Inc., now known as Health Net,
generated approximately 12% of the claims we processed and approximately 8% on
a pro forma basis. Our business, profitability and growth prospects could
suffer if we were to lose one or more of our significant health plan sponsors.Our contracts with health plan sponsors typically provide for multi-year
terms, with automatic 12-month renewals unless either party terminates the
contract by giving written notice before the automatic renewal date. Most of
these contracts are also terminable by either party without cause with 30 to
180 days notice. Many of our health plan sponsors put their contracts out for
competitive bidding prior to expiration. We could lose health plan sponsors if
they cancel their agreements with us, if we fail to win a competitive bid at
the time of contract renewal, if the financial condition of any of our health
plan sponsors deteriorates or if our health plan sponsors are acquired by, or
acquire, companies with which we do not have contracts. Over the past several
years, insurance companies, health maintenance organizations, or HMOs, and
managed care companies have experienced significant consolidation. Our health
plan sponsors have been, and may continue to be, subject to consolidation
pressures.If we lose relationships with one or more key pharmaceutical manufacturers or
if the payments we receive from pharmaceutical manufacturers decline, our
business, profitability and growth prospects could suffer.We have contractual relationships with numerous pharmaceutical
manufacturers that pay us rebate payments on behalf of our health plan sponsors
based on use of selected drugs by their health plan members, as well as fees
for other programs and services. We believe our business, profitability and
growth prospects could suffer if:
        
        we lose relationships with one or more key pharmaceutical manufacturers;20Table of Contents
        
        rebates decline due to the failure of our health plan sponsors to meet market share or other thresholds;
        
        legal restrictions are imposed on the ability of pharmaceutical
manufacturers to offer formulary rebates or purchase our programs or
services; or
        
        pharmaceutical manufacturers choose not to offer formulary rebates or
purchase our programs or services.Over the next few years, as patents expire covering many brand name drugs
that currently have substantial market share, generic products will be
introduced that may substantially reduce the market share of the brand name
drugs. Historically, manufacturers of generic drugs have not offered formulary
rebates on their drugs. If the use of newly-approved, brand name drugs added to
formularies, which are the lists of preferred prescription drugs covered by a
health plan, does not offset any decline in use of brand name drugs whose
patents expire, our pricing could be altered.If we lose pharmacy network affiliations, our business, profitability and
growth prospects could suffer.Our contracts with retail pharmacies, which are non-exclusive, are
generally terminable by either party on short notice. If one or more of the top
pharmacy chains elects to terminate its relationship with us or if we are only
able to continue our relationship on terms less favorable to us, our members
access to retail pharmacies and our business could suffer. In addition, some
large retail pharmacy chains either own or have strategic alliances with PBMs
or could attempt to acquire or enter into these kinds of relationships with
PBMs in the future. Ownership of, or alliances with, PBMs by retail pharmacy
chains could have material adverse effects on our relationships with these
retail pharmacy chains and on our business, profitability and growth prospects.Failure to continue to develop or acquire new products, services and
technologies could adversely affect our business, profitability and growth
prospects.We and our competitors continually develop new products and services to
assist our customers in managing their pharmacy benefit. If we are unsuccessful
in continuing to develop innovative products and services, our ability to
attract new customers and retain existing customers may suffer. If our product
development strategies are not successful, our business, profitability and
growth prospects could suffer. Historically, we have experienced expense
increases when developing new products. We anticipate that we will need to
expend significant resources to develop or acquire new products and services in
the future, which may adversely impact our profitability.If we are unable to manage potential problems and risks related to future
acquisitions and alliances, our business, profitability and growth prospects
could suffer.Part of our growth strategy includes acquisitions and alliances involving
complementary products, services, technologies and businesses. For
example, on October 2, 2000, we acquired PCS, which dramatically increased
the size of our company. If we are unable
to overcome the potential problems and inherent risks related to such acquisitions
and alliances, our business, profitability and growth prospects could suffer.
Our ability to continue to expand successfully through acquisitions and
alliances depends on many factors, including our ability to identify
acquisition or alliance prospects and negotiate and close transactions. Even if
we complete future acquisitions or alliances:
        
        we could fail to successfully integrate the operations, services and products of any acquired company;
        
        we could fail to select the best alliance partners or fail to effectively plan and manage any alliance strategy;
        
        our managements attention could be diverted from other business concerns; and
        
        we could lose key employees of the acquired company.Many companies compete for acquisition and alliance opportunities in the PBM
industry. Some of our competitors are companies that have significantly greater
financial and management resources than we do. This may reduce the likelihood
that we will be successful in completing acquisitions and alliances necessary
to the future success of our business.If our business continues to grow rapidly and we are unable to manage this
growth, our business, profitability and growth prospects could suffer.Our business has grown rapidly in the last six years due to our
acquisitions, with total revenues increasing from approximately $64.4 million
in fiscal year 1995 to $7.0 billion in fiscal year 2001. In the six months
ended March 31, 2001, which includes the results of operations of PCS, we
generated $5.9 billion in total revenues. If we continue to grow
rapidly,21Table of Contentswe will need to hire additional senior and line management, increase our
investment in employee recruitment, training and retention, and expand our
information processing and financing control systems. Our future operating
results will depend in part on the ability of our officers and other key
employees to continue to recruit, train, retain and effectively manage our
employees as well as to improve our operations, customer support and financial
control systems. Our future growth will also depend on our ability to access
capital. If we are unable to finance continued growth, manage future expansion
successfully or hire and retain the personnel needed to manage our business
successfully, then our business, profitability and growth prospects could
suffer.If we lose key employees on whom we depend, in particular our chairman and
chief executive officer, David D. Halbert, our business could suffer.We believe that our continued success will depend to a significant extent
upon retaining the services of our senior management. Our business could be
materially and adversely affected if we lose the services of Mr. David D.
Halbert, our chairman of the board and chief executive officer, or other
persons in senior management because we would lose the strategic
direction and experience that these officers contribute, as well as
the benefits of their relationships with customers, pharmaceutical
manufacturers and stockholders. Except as limited by their employment agreements,
any of our senior management could seek other employment at any time. We do not
currently have key-person life insurance policies on any of our employees. If
we cannot recruit, train, retain and effectively manage key employees, our
business, profitability and growth prospects could suffer.If we become subject to liability claims that are not covered by our insurance
policies, we may be liable for damages and other expenses that could have a
material adverse effect on our business, profitability and growth prospects.A successful product or professional liability claim in excess of our
insurance coverage where we are required to pay damages, incur
defense costs or face negative publicity, could have a material
adverse effect on our liquidity, our reputation in the industry and
our ability to attract and retain clients. While we intend to maintain professional
and general liability insurance coverage at all times, we cannot assure you
that we will be able to maintain insurance in the future, that insurance will
be available on acceptable terms or that insurance will be adequate to cover
any or all potential product or professional liability claims.Various aspects of our business may subject us to litigation and liability
for damages. For example, our clinical trials services involve the risk of
liability for personal injury from unforeseen adverse side effects or
improper administration of a new drug. Other aspects of our business
that may subject us to liability include:
        
        the dispensing of pharmaceutical products;
        
        the performance of clinical trials, PBM services and health improvement services; and
        
        the operation of our call centers and web sites.For example, our clinical research services involve the risk of liability
for personal injury or death from unforeseen adverse side effects or improper
administration of a new drug. We could be materially and adversely affected if
we were required to pay damages, incur defense costs or face negative publicity
in connection with a claim that is outside the scope of our contractual
indemnity or insurance coverage.New investors own a significant amount of our stock, giving them influence over
corporate transactions and other matters.As a result of our acquisition of PCS, Joseph Littlejohn & Levy Fund III,
L.P. and certain other investors, collectively referred to as JLL, and Rite Aid
received Series A preferred stock. The Series A preferred stock is convertible
into Class B common stock, which is convertible into our Class A common stock
on a one-for-one basis. Rite Aid sold substantially all of its shares of Class
A common stock pursuant to our secondary public offering that was completed in
March 2001. Assuming the conversion of all of the remaining outstanding
preferred stock and Class B common stock into Class A common stock, JLL would
beneficially own 18.8% of our Class A common stock. Accordingly, JLL may be
able to substantially influence the outcome of stockholder votes and otherwise
have influence over our business. In addition, JLL and Rite Aid under our
second amended and restated certificate of incorporation have the right to
designate four of our 11 directors, and we cannot take certain actions without
their consent. The interests of these investors may differ from interests of
other stockholders.Risks Related to Our IndustryPrior to our acquisition of PCS, PCS received a subpoena from the Department of
Health and Human Services Office of Inspector General in connection with an
industry-wide investigation, and although there has been no allegation of
wrongdoing on our part, we could be subject to scrutiny, investigation or
challenge under federal or state anti-kickback or other laws, which could cause
our business, profitability and growth prospects to suffer.Federal anti-kickback laws generally prohibit the receipt or solicitation
of payment in return for purchasing or ordering, or arranging for or
recommending the purchasing or ordering of, items and services reimbursable by
federal health care22Table of Contentsprograms. Some states have similar laws that apply across all payors. To
date, these laws have not been applied to prohibit the types of business
arrangements we have with pharmaceutical manufacturers, health plan sponsors or
retail pharmacies. However, courts and enforcement authorities that administer
the anti-kickback laws have historically interpreted these laws broadly.In November 1999, PCS received a subpoena by the Department of Health and
Human Services Office of Inspector General, or OIG, requesting PCS to produce
certain documents about its programs and how they operate in connection with an
industry-wide investigation. The investigation was instigated and is being
pursued by the United States Attorneys Office for the Eastern District of
Pennsylvania, which indicated an intention to review PBMs programs in light of
anti-kickback and other laws and regulations. Specifically, the focus of this
investigation appears to be PBMs relationships with pharmaceutical
manufacturers and retail pharmacies and PBMs programs relating to drug
formulary compliance, including rebate and other payments made by
pharmaceutical manufacturers to PBMs and payments made by PBMs to retail
pharmacies or others. AdvancePCS has turned over documents in response to the
subpoenas. The United States Attorneys Office has also contacted some of the
pharmaceutical manufacturers with which we have agreements, and has asked these
manufacturers to provide copies of documents relating to their agreements with
us. There has been no allegation of any wrongdoing on our part. At this time,
we are unable to predict whether the government will commence any action
challenging any of our programs and practices. We believe that our programs,
and those of PCS prior to the acquisition, are in compliance with the
requirements imposed by anti-kickback laws and other applicable laws and
regulations. Nevertheless, we could be subject to scrutiny, investigation or
challenge under these laws and regulations as a result of the OIG investigation
or otherwise. Such scrutiny, investigation or challenge could alter
our business practices related to formulary products and services and
our relationships with pharmaceutical manufacturers, which could
reduce our profitability and growth prospects.If legislative or regulatory initiatives restrict our ability to use patient
identifiable medical information, our clinical programs and our business growth
strategy based on these services could suffer.Through our health improvement programs, we help our health plan sponsor
customers identify individuals who will most benefit from the programs.
Governmental restrictions on the use of patient identifiable information may
adversely affect our ability to conduct health improvement programs and medical
outcome studies and could adversely affect our growth strategy based on these
programs. Federal and state legislation has been proposed, and some state laws
have been enacted, to restrict the use and disclosure of patient identifiable
medical information. Legislation could be enacted in the future that severely
restricts or prohibits our use of patient identifiable information, which could
harm our business, profitability and growth prospects.In December 2000, the Department of Health and Human Services, or HHS,
issued final regulations regarding the privacy of individually-identifiable
health information pursuant to the Health Insurance Portability and
Accountability Act of 1996, or HIPAA. This final rule on privacy applies to
both electronic and paper records and imposes extensive requirements on the way
in which health care providers, health plan sponsors and their business
associates use and disclose protected information. The final rule gives
patients significant rights to understand and control how their protected
health information is used and disclosed. Direct providers, such as pharmacies,
are required to obtain patient consents for treatment, payment and health care
operations. For all uses or disclosures of protected information that do not
involve treatment, payment or health care operations, the rule requires that
all covered entities obtain a valid patient authorization. In most cases, use
or disclosure of protected health information must be limited to the minimum
amount necessary to achieve the purpose of the use or disclosure. Organizations
subject to the rule will have approximately two years to comply with its
provisions. In addition, HHS has proposed, but not yet finalized, regulations
pursuant to HIPAA that govern the security of individually identifiable health
information. Sanctions for failing to comply with standards issued pursuant to
HIPAA include criminal penalties and civil sanctions. Due to the complex and
controversial nature of the privacy regulations, they may be subject to court
challenge, as well as further legislative and regulatory actions that could
alter their effect. We cannot at this time predict with specificity what impact
the adopted final rule on the privacy of individually identifiable health
information, or the proposed rule on security of individually-identifiable
health information may have on us. However, they will likely increase our
burden of regulatory compliance with respect to our health improvement programs
and other information-based products, and may reduce the amount of information
we may use if patients do not consent to such use. There can be no assurance
that the restrictions and duties imposed by the recently adopted final rule on
the privacy of individually-identifiable health information, or the proposed
rule on security of individually-identifiable health information, will not have
a material adverse effect on our business, profitability and growth prospects.Even without new legislation and beyond the final federal regulations,
individual health plan sponsor customers could prohibit us from including their
patients medical information in our various databases of medical data. They
could also prohibit us from offering services that involve the compilation of
such information.23Table of ContentsIf we are ever deemed to be a fiduciary of a health benefit plan governed by
ERISA, we could be subject to claims for benefit denials.We have agreements to provide PBM services to a number of self-funded
corporate health plans. These plans are subject to the Employee Retirement
Income Security Act of 1974, or ERISA, which regulates employee pension and
health benefit plans. We believe that our activities are sufficiently limited
that we do not assume any of the plan fiduciary responsibilities that would
subject us to regulation under ERISA. Our agreements with our self-funded
corporate plan customers state that we are not the fiduciary of the plan.
However, the U.S. Department of Labor, which is the agency that enforces ERISA,
could assert that the fiduciary obligations imposed by the statute apply to
certain aspects of our operations. If we were deemed to be a fiduciary, we
could potentially be subject to claims relating to benefit denials. In
addition, we could also be subject to claims for breaching fiduciary duties in
connection with the services we provide to the plan.In March 1998, a class action lawsuit captioned Mulder v. PCS Health Systems, Inc.was filed in the United States District Court for the District of
New Jersey. This action alleges that PCS is an ERISA fiduciary and that we
have breached our fiduciary obligations under ERISA in connection with our
development and implementation of formularies, preferred drug listings and
intervention programs for our sponsors of ERISA health plans. The plaintiffs are seeking injunctive relief and
monetary damages in an unspecified amount. A class of plaintiffs has not yet been certified, and
we intend to oppose such certification. AdvancePCS has denied all allegations of
wrongdoing and is vigorously defending this lawsuit. Although the ultimate
outcome is uncertain, an adverse determination could potentially
cause us to change our business practices with respect to
formularies, preferred drug listings and intervention programs,
potentially reducing our profitability and growth prospects.ERISA also prohibits a party in interest to a plan from engaging in
certain types of transactions with the plan, including purchases, sales and
loans. Violations are subject to civil and criminal liability. By providing
services to these plans, we are subject to the restrictions on a party in
interest. We believe that we are in compliance with these provisions of ERISA.
However, there is no guarantee that the government would not challenge our
practices.If there are changes in federal or state financing and regulation of the health
care industry, our customers may delay or reduce the purchase of our services.During the past several years, the United States health care industry has
been subject to an increase in governmental regulation, on both the federal and
state level. We cannot predict what effect, if any, these proposals might have
on our business, profitability and growth prospects. Congress is expected to
consider proposals to change Medicare drug coverage and reimbursement policies,
and many states are considering proposals to provide or expand drug assistance
programs. Some states have begun to seek supplemental Medicaid rebates from
drug manufacturers, beyond those required by the federal Medicaid statute.
Both Congress and the states are expected to consider legislation to increase
governmental regulation of managed care plans. Some of these initiatives would,
among other things, require that health plan members have greater access to
drugs not included on a plans formulary and give health plan members the right
to sue their health plans for malpractice when they have been denied care. The
scope of the managed care reform proposals under consideration by Congress and
state legislatures and enacted by states to date vary greatly, and the extent
to which future legislation may be enacted is uncertain. However, these
initiatives could greatly impact the managed care and pharmaceutical industries
and, therefore, could have a material adverse impact on our business,
profitability and growth prospects.In addition, several legislative proposals are under consideration in
Congress to provide Medicare recipients with outpatient drug benefits through
the use of PBMs. While we believe that a Medicare prescription drug benefit
could provide us with new business opportunities, the structure of such a
program could have a material adverse impact on our business, profitability and
growth prospects.Several states, including California, New Jersey and New York, have
introduced legislation that would directly regulate PBMs, but to our knowledge,
no state has passed such legislation. Several regulatory and quasi-regulatory
bodies, such as the National Association of Insurance Commissioners, the
National Association of Boards of Pharmacy and the National Committee on
Quality Assurance, are also considering proposals to regulate PBMs and
proposals to increase the regulation of certain PBM activities, such as
formulary and utilization management, and downstream risk assumption. While the
outcome of these initiatives is uncertain, any resulting legislation could
materially harm our business, both directly as a PBM, and indirectly through
the impact on the pharmacy benefit services we are able to deliver on behalf of
our health plan sponsors.There is great attention being paid to the pricing of prescription drug
products and how they are reimbursed by government programs. One pharmaceutical
manufacturer has settled a lawsuit with the federal government asserting that
it inappropriately calculated drug prices for Federal health care programs, and
agreed to provide a new calculation formula. Changes have been put forward
that would alter the calculation of drug prices for Federal programs and likely
reduce expenditures. These proposals may increase governmental involvement in
health care and health benefit management services and otherwise change the way
our customers do business. Health care organizations may react to these
proposals and the uncertainty surrounding them by cutting back or delaying the
purchase of our health benefit management services, and24Table of Contentsmanufacturers may react by reducing rebates or reducing supplies of
certain products, which would materially harm our business, profitability and
growth prospects.If government laws or regulations relating to the financial relationships
between PBMs and pharmaceutical manufacturers are interpreted and enforced in a
manner adverse to our PBM and health improvement programs, we may be subject to
enforcement actions and our business operations could be materially limited.In January 1998, the United States Food and Drug Administration, or FDA,
issued a Draft Guidance for Industry regarding the regulation of activities of
PBMs that are directly or indirectly controlled by pharmaceutical
manufacturers. To date, the FDA has not taken any further action. Although it
appears that the FDA has changed its position regarding regulation of
communications by PBMs, there is no assurance that it will not re-examine the
issue and seek to assert the authority to regulate the communications of such
PBMs.Since 1993, retail pharmacies have filed numerous separate lawsuits
against pharmaceutical manufacturers, wholesalers and other PBMs. These
lawsuits challenge brand name drug pricing practices under various state and
federal anti-trust laws. These suits also allege in part that the
pharmaceutical manufacturers offered, and some PBMs accepted, rebates and
discounts on brand name prescription drugs that violate the federal
Robinson-Patman Act and the federal Sherman Antitrust Act. Some pharmaceutical
manufacturers have settled certain of these actions. We are not a party to any
of these proceedings. However, at this time we cannot assess whether we will be
made a party to this type of lawsuit. Court decisions or terms of any
settlements relating to these lawsuits could materially and adversely affect us
in the future.If government laws or regulations are enacted, interpreted or enforced in a
manner adverse to our clinical research programs, we may be subject to
administrative enforcement actions, as well as civil and criminal liability.We assist pharmaceutical manufacturers in conducting clinical trials for
new drugs, or new uses for existing drugs. The conduct of clinical trials is
regulated by the FDA under the authority of the Federal Food, Drug and Cosmetic
Act and the related regulations. Oversight of clinical trials has received
increasing scrutiny in recent years. If government laws or regulations are
interpreted and enforced in a manner adverse to our clinical research programs,
we may be subject to administrative enforcement actions, as well as civil and
criminal liability. In general, the sponsor of the drug product that is being
studied, or the manufacturer that will have the right to market the drug
product if it is approved by the FDA, has the responsibility to comply with the
laws and regulations that apply to the conduct of the clinical trials. However,
in providing services related to the conduct of clinical trials, we may assume
some or all of the sponsors or clinical investigators obligations related to
the study of the drug. In October 1998, the FDA announced that the agency would
give Institutional Review Boards, which are independent bodies that oversee the
conduct of clinical investigations, increased access to information pointing to
violative or potentially violative conduct on the part of clinical
investigators, for example the physicians who conduct the clinical trials.Because the interpretation and enforcement of these laws and regulations
relating to the conduct of clinical trials is uncertain, the FDA may consider
our compliance efforts to be inadequate and initiate administrative enforcement
actions against us. If we fail to successfully defend against an administrative
enforcement action, it could result in an administrative order suspending,
restricting or eliminating our ability to participate in the clinical trial
process, which would materially limit our business operations. Moreover, some
violations of the Federal Food, Drug and Cosmetic Act are punishable by civil
and criminal penalties against both the violating company and responsible
individuals. If warranted by the facts, we and our employees involved in the
trials could face civil and criminal penalties, which include fines and
imprisonment.As a consequence of the severe penalties we and our employees potentially
could face, we must devote significant operational and managerial resources to
comply with these laws and regulations. Although we believe that we
substantially comply with all existing statutes and regulations material to the
operation of our business, regulatory authorities may disagree and initiate
enforcement or other actions against us. In addition, we cannot predict the
impact of future legislation and regulatory changes on our business or assure
you that we will be able to obtain or maintain the regulatory approvals
required to operate our business.
ITEM 2. PROPERTIESOur existing facilities consist of approximately 1,100,000 square feet, of
which we own 150,400 square feet and lease the remainder. The monthly
lease payments for these properties were approximately $1,180,000 in
the month of March 2001. The following table sets forth information with
 respect to our principal facilities.25Table of Contents

|                                                                                                                                                                                              |  |                                                                                                                                                                                                                       |  |             |                                                                                |  |           |                                                              
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------- | ------------------------------------------------------------------------------ |  | --------- | -------------------------------------------------------------
|                                                                                                                                                                                              |  |                                                                                                                                                                                                                       |  | Approximate |                                                                               
|                                                                                                                                                                                              |  |                                                                                                                                                                                                                       |  | Square      |                                                                               
|Facility                                                                                                                                                                                      |  | Location                                                                                                                                                                                                              |  | Footage     |                                                                                |  | Lease/Own
|                                                                                                                                                                                              |  |                                                                                                                                                                                                                       |  |             |                                                                                |  |          
|Corporate Headquarters
Corporate Office
Call Center
Call Center
Call Center
Clinical Services
Clinical Services
Mail Service Pharmacy
Mail Service Pharmacy
Mail Service Pharmacy
e-Solutions |  | Irving, Texas
Scottsdale, Arizona
Scottsdale, Arizona
Richardson, Texas
Gold River, California
Bloomington, Minnesota
Hunt Valley, Maryland
Birmingham, Alabama
Fort Worth, Texas
Richardson, Texas
Richardson, Texas |  |             | 24,500
354,800
53,800
52,000
20,700
45,300
23,200
112,000
93,800
38,400
48,300 |  |           | Lease
Lease
Lease
Lease
Lease
Lease
Lease
Own
Lease
Own
Lease

In addition, we have several other facilities throughout the United States that
we use for sales offices, clinics, data services and other corporate purposes.
We believe our facilities are adequate to meet our requirements for the
foreseeable future.




ITEM 3. LEGAL PROCEEDINGS AND GOVERNMENT INVESTIGATIONS

In November 1999, PCS received a subpoena by the Department of Health and
Human Services Office of Inspector General, or OIG, requesting PCS to produce
certain documents about its programs and how they operate in connection with an
industry-wide investigation. The investigation was instigated and is being
pursued by the United States Attorneys Office for the Eastern District of
Pennsylvania, which indicated an intention to review PBMs programs in light of
anti-kickback and other laws and regulations. Specifically, the focus of this
investigation appears to be PBMs relationships with pharmaceutical
manufacturers and retail pharmacies and PBMs programs relating to drug
formulary compliance, including rebate and other payments made by
pharmaceutical manufacturers to PBMs and payments made by PBMs to retail
pharmacies or others. The United States Attorneys Office has also contacted
some of the pharmaceutical manufacturers with which we have agreements, and has
asked these manufacturers to provide copies of documents relating to their
agreements with us. There has been no allegation of any wrongdoing on our part.
At this time, we are unable to predict whether the government will commence any
action challenging any of our programs and practices. AdvancePCS believes that
its programs, and those of PCS prior to the acquisition, are in compliance with
the requirements imposed by anti-kickback laws and other applicable laws and
regulations. AdvancePCS plans to continue to cooperate with the OIG with
respect to this investigation. Nevertheless, we could be subject to scrutiny,
investigation or challenge under these laws and regulations as a result of the
OIG investigation or otherwise, which could have a material adverse effect on
our business, profitability and growth prospects.

In March 1998, a class action lawsuit captioned Mulder v. PCS Health
Systems, Inc., case number 98-1003, was filed in the United States District
Court of the District of New Jersey. This action alleges that PCS is an ERISA
fiduciary and that we have breached our fiduciary obligations under ERISA in
connection with our development and implementation of formularies, preferred
drug listings and intervention programs for our sponsors of ERISA health plans.
In particular, plaintiffs allege that our therapeutic interchange programs and
negotiation of formulary rebates and discounts from pharmaceutical
manufacturers violate fiduciary obligations. The plaintiffs are
seeking injunctive relief and monetary damages in an unspecified
amount. AdvancePCS believes that it does
not assume any of the plan fiduciary responsibilities that would subject it to
regulations under ERISA. Although the ultimate outcome is uncertain, an adverse
determination could potentially cause us to change our business
practices with respect to formularies, preferred drug listings and
intervention programs, potentially reducing our profitability and growth
prospects. A class of plaintiffs has not yet been certified, and we intend to
oppose such certification. AdvancePCS has denied all allegations of wrongdoing
and is vigorously defending this suit.

In addition, we are a defendant in lawsuits from time to time arising in
the ordinary course of business, the outcome of which we believe will not have
a material adverse effect on our business, profitability and growth prospects.

26



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##### Table of Contents






PART II




ITEM 6. SELECTED HISTORICAL FINANCIAL AND OPERATING DATA

The following tables present selected consolidated statement of
operations, balance sheet and supplemental data of AdvancePCS for the periods
and dates indicated. The selected statement of operations for each of the years
in the five-year period ended March 31, 2001, and the balance sheet data as of
March 31, 1997, 1998, 1999, 2000 and 2001 presented below are derived from our
consolidated financial statements and accompanying notes, which have been
audited by Arthur Andersen LLP, independent public accountants.

The following tables also present selected historical statement of
operations and supplemental data of PCS for the periods and dates indicated.
The selected statement of operations data of PCS are derived from the
consolidated financial statements and accompanying notes of PCS, which have
been audited by Ernst & Young LLP. Prior to January 23, 1999, PCS was a wholly
owned subsidiary of Eli Lilly and Company, or Eli Lilly, and its financial
results for 1997 and 1998 were consolidated with those of Eli Lilly using a
fiscal year ending December 31. On January 23, 1999, PCS was acquired by Rite
Aid and its financial results for 1999 were consolidated with those of Rite Aid
using a fiscal year ended February 26, 2000.

The results of operations of PCS for the period commencing October 2,
2000, the date of our acquisition of PCS, are reflected in the financial
statements of AdvancePCS after that date. Historical revenues and cost of
revenues for AdvancePCS and PCS have been reclassified to reflect adoption of
consistent revenue recognition policies.

You should read the information contained in this section in conjunction
with Managements Discussion and Analysis of Financial Condition and Results
of Operations in the historical consolidated financial statements and related
notes of each of AdvancePCS and PCS.

27



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##### Table of Contents



AdvancePCS

|                                              |                                     |   |                                                 |        |  |      |         |        |      |   |         |        |  |   |           |        |  |   |           |        | 
|--------------------------------------------- | ----------------------------------- | - | ----------------------------------------------- | ------ |  | ---- | ------- | ------ | ---- | - | ------- | ------ |  | - | --------- | ------ |  | - | --------- | ------ | 
|                                              |                                     |   | Year Ended March 31,                            |       
|                                              |                                     |   |                                                 |       
|                                              |                                     |   | 1997                                            |        |  | 1998 |         |        | 1999 |   |         | 2000   |  |   | 2001(1)   |       
|                                              |                                     |   |                                                 |        |  |      |         |        |      |   |         |        |  |   |           |       
|                                              |                                     |   | (In thousands, except per share and ratio data) |       
|Statement of Operations Data:                
|                                             
|                                             
|                                             
|                                             
|Revenues(2)                                   |                                     | $ | 220,019                                         |        |  | $    | 473,761 |        |      | $ | 757,259 |        |  | $ | 1,833,888 |        |  | $ | 7,024,298 |       
|                                             
|                                             
|                                             
|                                             
|Gross profit                                  |                                     |   | 10,984                                          |        |  |      | 29,806  |        |      |   | 40,959  |        |  |   | 75,502    |        |  |   | 229,583   |       
|                                             
|                                             
|                                             
|                                             
|Selling, general, and
administrative expenses |                                     |   | 7,309                                           |        |  |      | 18,955  |        |      |   | 21,006  |        |  |   | 38,793    |        |  |   | 127,777   |       
|                                             
|                                             
|                                             
|                                             
|Non-recurring charges                         |                                     |   |                                                |        |  |      |        |        |      |   |        |        |  |   |          |        |  |   | 11,129    |       
|                                              |                                     |   |                                                 |        |  |      |         |        |      |   |         |        |  |   |          
|Operating income                              |                                     |   | 3,675                                           |        |  |      | 10,851  |        |      |   | 19,953  |        |  |   | 36,709    |        |  |   | 90,677    |       
|                                             
|                                             
|                                             
|                                             
|Interest income                               |                                     |   | 1,560                                           |        |  |      | 2,950   |        |      |   | 2,860   |        |  |   | 1,064     |        |  |   | 3,450     |       
|                                             
|                                             
|                                             
|                                             
|Interest expense                              |                                     |   | (445                                            | )      |  |      | (67     | )      |      |   |        |        |  |   | (3,943    | )      |  |   | (45,332   | )     
|                                             
|                                             
|                                             
|                                             
|Merger costs and asset disposal               |                                     |   |                                                |        |  |      | (689    | )      |      |   |        |        |  |   | (160      | )      |  |   | (1,200    | )     
|                                              |                                     |   |                                                 |        |  |      |         |        |      |   |         |        |  |   |          
|Income before income taxes                    |                                     |   | 4,790                                           |        |  |      | 13,045  |        |      |   | 22,813  |        |  |   | 33,670    |        |  |   | 47,595    |       
|                                             
|                                             
|                                             
|                                             
|Provision for income taxes                    |                                     |   | (1,564                                          | )      |  |      | (4,957  | )      |      |   | (8,669  | )      |  |   | (12,794   | )      |  |   | (24,927   | )     
|                                              |                                     |   |                                                 |        |  |      |         |        |      |   |         |        |  |   |          
|Net income                                    |                                     | $ | 3,226                                           |        |  | $    | 8,088   |        |      | $ | 14,144  |        |  | $ | 20,876    |        |  | $ | 22,668    |       
|                                              |                                     |   |                                                 |        |  |      |         |        |      |   |         |        |  |   |          
|Basic:                                       
|                                             
|                                             
|                                             
|                                             
|                                              | Net income per share                |   | $                                               | 0.21   |  |      | $       | 0.38   |      |   | $       | 0.59   |  |   | $         | 0.84   |  |   | $         | 0.78   | 
|                                             
|                                             
|                                             
|                                             
|                                              | Weighted average shares
outstanding |   |                                                 | 12,529 |  |      |         | 21,011 |      |   |         | 24,004 |  |   |           | 24,760 |  |   |           | 29,145 | 
|                                             
|                                             
|                                             
|                                             
|Diluted:                                     
|                                             
|                                             
|                                             
|                                             
|                                              | Net income per share                |   | $                                               | 0.18   |  |      | $       | 0.31   |      |   | $       | 0.53   |  |   | $         | 0.75   |  |   | $         | 0.63   | 
|                                             
|                                             
|                                             
|                                             
|                                              | Weighted average shares
outstanding |   |                                                 | 18,352 |  |      |         | 26,202 |      |   |         | 26,876 |  |   |           | 27,737 |  |   |           | 36,189 | 
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|Balance Sheet Data (as of end of period):    
|                                             
|                                             
|                                             
|                                             
|Cash and cash equivalents                     |                                     | $ | 51,172                                          |        |  | $    | 63,018  |        |      | $ | 45,895  |        |  | $ | 55,243    |        |  | $ | 110,048   |       
|                                             
|                                             
|                                             
|                                             
|Total assets                                  |                                     |   | 108,914                                         |        |  |      | 178,639 |        |      |   | 304,016 |        |  |   | 406,738   |        |  |   | 3,003,763 |       
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|Total debt                                    |                                     |   |                                                |        |  |      | 1,285   |        |      |   | 50,000  |        |  |   | 50,000    |        |  |   | 845,000   |       
|                                             
|                                             
|                                             
|                                             
|Stockholders equity                          |                                     |   | 42,577                                          |        |  |      | 50,342  |        |      |   | 68,773  |        |  |   | 98,044    |        |  |   | 405,704   |       
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|                                             
|Supplemental Data(3):                        
|                                             
|                                             
|                                             
|                                             
|Adjusted
EBITDA(4)                            |                                     | $ | 5,380                                           |        |  | $    | 13,320  |        |      | $ | 23,789  |        |  | $ | 45,819    |        |  | $ | 149,603   |       
|                                             
|                                             
|                                             
|                                             
|Capital expenditures                          |                                     |   | 3,147                                           |        |  |      | 6,795   |        |      |   | 7,860   |        |  |   | 22,807    |        |  |   | 41,197    |       
|                                             
|                                             
|                                             
|                                             
|Depreciation and amortization                 |                                     |   | 1,705                                           |        |  |      | 2,469   |        |      |   | 3,836   |        |  |   | 9,110     |        |  |   | 47,797    |       
|                                             
|                                             
|                                             
|                                             
|Goodwill amortization                         |                                     |   | 347                                             |        |  |      | 347     |        |      |   | 588     |        |  |   | 3,354     |        |  |   | 23,775    |       
|                                             
|                                             
|                                             
|                                             
|Pharmacy network claims
processed             |                                     |   | 26,579                                          |        |  |      | 38,319  |        |      |   | 50,588  |        |  |   | 81,225    |        |  |   | 269,501   |       
|                                             
|                                             
|                                             
|                                             
|Mail pharmacy prescriptions
filled            |                                     |   | 677                                             |        |  |      | 839     |        |      |   | 1,289   |        |  |   | 1,674     |        |  |   | 5,670     |       
|                                             
|                                             
|                                             
|                                             
|Estimated members (as of end of
period)       |                                     |   | 10,200                                          |        |  |      | 12,500  |        |      |   | 15,000  |        |  |   | 27,500    |        |  |   | 75,000    |       



---

|(1) |  | Includes PCS data since the acquisition on October 2, 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Historical revenues for AdvancePCS have been reclassified to reflect
adoption of consistent revenue recognition policies with PCS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   
|(3) |  | This data has not been audited.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|(4) |  | Adjusted EBITDA consists of operating income plus depreciation and amortization.
Adjusted EBITDA excludes merger costs, asset impairment and other
non-recurring charges. Adjusted EBITDA does not represent funds available for our discretionary use and is
not intended to represent cash flow from operations as measured under
generally accepted accounting principles. Adjusted EBITDA should not be considered
as an alternative to net income or net cash used in operating activities,
but may be useful to investors as an indication of operating performance.
Our calculations of adjusted EBITDA may not be consistent with calculations of
adjusted EBITDA used by other companies.

28



---



##### Table of Contents



PCS Holding Corporation

|                                                |  |                                   |            |   |            |   |           |      |  |              |           |  
|----------------------------------------------- |  | --------------------------------- | ---------- | - | ---------- | - | --------- | ---- |  | ------------ | --------- | -
|                                                |  | Year Ended December 31,           |           
|                                                |  |                                   |            |   | Year Ended |  
|                                                |  |                                   |            |   |            |   |           |      |  | February 26, |          
|                                                |  | 1997                              |            |   | 1998       |   |           | 2000 | 
|                                                |  |                                   |            |   |            |   |           |      | 
|                                                |  | (In thousands, except ratio data) |           
|Statement of Operations Data:                  
|                                               
|                                               
|                                               
|                                               
|Revenues(1)                                     |  | $                                 | 5,960,131  |   |            | $ | 7,117,702 |      |  | $            | 8,126,231 |  
|                                               
|                                               
|                                               
|                                               
|Gross profit                                    |  |                                   | 118,720    |   |            |   | 180,399   |      |  |              | 207,281   |  
|                                               
|                                               
|                                               
|                                               
|Selling, general and administrative expenses(2) |  |                                   | 163,982    |   |            |   | 134,226   |      |  |              | 154,116   |  
|                                               
|                                               
|                                               
|                                               
|Asset impairment(3)                             |  |                                   | (2,345,244 | ) |            |   |          |      |  |              |          |  
|                                                |  |                                   |            |   |            |   |           |      | 
|Operating income (loss)                         |  |                                   | (2,390,506 | ) |            |   | 46,173    |      |  |              | 53,165    |  
|                                               
|                                               
|                                               
|                                               
|Interest, net                                   |  |                                   | 1,202      |   |            |   | 2,417     |      |  |              | 5,867     |  
|                                                |  |                                   |            |   |            |   |           |      | 
|Income (loss) before income taxes               |  |                                   | (2,389,304 | ) |            |   | 48,590    |      |  |              | 59,032    |  
|                                               
|                                               
|                                               
|                                               
|Provision for income taxes                      |  |                                   | (6,264     | ) |            |   | (31,956   | )    |  |              | (37,536   | )
|                                                |  |                                   |            |   |            |   |           |      | 
|Net income (loss)                               |  | $                                 | (2,395,568 | ) |            | $ | 16,634    |      |  | $            | 21,496    |  
|                                                |  |                                   |            |   |            |   |           |      | 
|Supplemental Data(4):                          
|                                               
|                                               
|                                               
|                                               
|Adjusted
EBITDA(5)                              |  | $                                 | 37,432     |   |            | $ | 101,524   |      |  | $            | 125,382   |  
|                                               
|                                               
|                                               
|                                               
|Pharmacy network claims processed               |  |                                   | 248,800    |   |            |   | 287,700   |      |  |              | 315,979   |  
|                                               
|                                               
|                                               
|                                               
|Mail pharmacy prescriptions filled              |  |                                   | 2,500      |   |            |   | 4,700     |      |  |              | 6,768     |  



---

|(1) |  | Historical revenues for PCS have been reclassified to reflect adoption of
consistent revenue recognition policies with AdvancePCS. Prior to giving
effect to this reclassification, PCSs historical revenues were $547,425,
$840,704 and $1,264,694 in the years ended December 31, 1997 and 1998 and
February 26, 2000, respectively.                                                                                                                                                                                                                                                                                                                                              
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Includes goodwill amortization.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   
|(3) |  | Includes asset impairment charge of $2.3 billion recognized by Eli Lilly
and Company subsequent to its acquisition of PCS.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(4) |  | This data has not been audited.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   
|(5) |  | Adjusted EBITDA consists of operating income plus depreciation and amortization.
Adjusted EBITDA  excludes asset impairment and other non-recurring
charges. Adjusted EBITDA does not represent funds available for our discretionary use and is
not intended to represent cash flow from operations as measured under
generally accepted accounting principles. Adjusted EBITDA should not be considered
as an alternative to net income or net cash used in operating activities,
but may be useful to investors as an indication of operating performance.
Our calculations of adjusted EBITDA may not be consistent with calculations of
adjusted EBITDA used by other companies.




ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a leading provider of health improvement services in the United
States. As the largest PBM based on number of lives covered, we currently serve
more than 75 million health plan members and manage more than $21 billion in
prescription drug spending on an annualized basis on behalf of our health plan
sponsors. In addition, we offer a wide range of other health improvement
products and services, such as prescription discount cards for the uninsured
and under-insured, web-based programs, disease management, clinical trials and
outcomes studies. Our mission is to improve the quality of care delivered to
health plan members while helping health plan sponsors reduce overall costs.

Over the past few years, the PBM industry has undergone significant
consolidation. We believe such consolidation has principally been driven by the
significant benefits of size and scale, including:



| |  |  | cost-saving opportunities to leverage a fixed-cost infrastructure
over greater prescription claim volume, resulting in greater pricing
flexibility; and                  
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | increased negotiating leverage with pharmaceutical manufacturers and
retail pharmacies, resulting in greater ability to obtain lower drug
costs for health plan sponsors.

29



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##### Table of Contents



We believe PBMs that effectively capture these benefits will be positioned to
strengthen their relationships with plan members, physicians and health plan
sponsors and improve their competitive position.

Acquisitions

Effective October 2, 2000, we completed the acquisition of PCS for an
aggregate purchase price of approximately $1.0 billion, of which we paid Rite
Aid, the seller, $675 million in cash, and issued to Rite Aid $200 million in
senior subordinated notes and $125 million in our convertible preferred stock.
The cash portion of the purchase price was financed with the proceeds of an
$825 million senior secured credit facility and $150 million in equity
financing committed by JLL. In connection with the equity financing, we issued
to JLL 65,854 shares of Series A-1 preferred stock for an aggregate purchase
price of $65,854,000, six shares of Series B convertible preferred stock and
4,207,000 shares of our Class A common stock for an aggregate purchase price of
$84,146,000. On December 8, 2000, the six shares of Series B convertible
preferred stock and the 4,207,000 shares of Class A common stock automatically
converted into 4,207,300 shares of Class B-1 common stock. In connection with
the senior subordinated notes, we issued to Rite Aid warrants to purchase
780,000 shares of Class A common stock. The senior subordinated notes were
fully redeemed on March 13, 2001. The warrants terminated upon repayment of
the senior subordinated notes. The acquisition of PCS was accounted for using
the purchase method of accounting. The excess of the purchase price paid over
the net identifiable assets and liabilities of PCS was recorded as goodwill.

Effective July 5, 2000, we completed a merger with FFI. We issued 3.5
million shares of our Class A common stock in exchange for all of the
outstanding shares of FFI. The merger constituted a tax-free reorganization and
has been accounted for as a pooling of interests. The historical financial
results have been restated in accordance with APB No. 16 to reflect the merger
as though FFI had always been a part of AdvancePCS.

Effective March 31, 1999, we completed the acquisition of Foundation
Health Pharmaceutical Services for $70 million in cash and warrants to purchase
400,000 shares of our Class A common stock. We valued such warrants at fair
market value based upon the Black-Scholes valuation model. The acquisition of
Foundation Health Pharmaceutical Services was accounted for using the purchase
method of accounting. The purchase price was allocated to goodwill, certain
customer contracts and other intangible assets.

Effective December 1, 1998, we completed the acquisition of Baumel-Eisner
Neuromedical Institute, Inc., a privately held clinical trial firm, for $25
million in cash. The acquisition was accounted for using the purchase method of
accounting.

Anticipated Synergies Related to PCS Acquisition

We anticipate being able to generate synergies as a result of the PCS
acquisition by:



| |  |  | Consolidating and renegotiating existing contracts with
pharmaceutical manufacturers.A significant portion of our and PCSs
contracts with manufacturers allow for increasingly favorable terms as
volume increases. We have reviewed overlapping contracts and plan to
migrate combined volume to the contract with the best terms. PBM
contracts with manufacturers are generally not long-term in nature, and
we expect to be able to negotiate more favorable terms that reflect our
increased purchasing power.                                                                                                                                                                                
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Re-contracting with our retail pharmacy network.Historically, PCS
had not aggressively negotiated its contracts with retail pharmacies due
to its ownership history, as discussed in Results of Operations  PCS.
We believe we can increase profitability by renegotiating our contract
terms with retailers in our network that reflect the independence, as
well as the increased scale of our combined company.                                                                                                                                                                                                                                                                               
|
| |  |  | Rationalizing and gaining economies of scale in our mail service
operations.Volume is an important component of profitability in the
mail service business from both a fixed cost and purchasing power
perspective. We are consolidating the operations of our Richardson,
Texas mail service pharmacy into our larger facilities in Fort Worth,
Texas and Birmingham, Alabama. Through this consolidation and resulting
increased capacity utilization, we expect to realize significant cost
savings. In addition, we recently entered into a new contract with a
wholesale pharmaceutical supplier for our mail facilities with more
favorable terms that reflect our increased purchasing power.
|
| |  |  | Generating corporate overhead and information technology
efficiencies.Our combination with PCS puts us in a position to realize
significant cost savings by generating corporate overhead and
information technology efficiencies. We expect cost savings to result
from consolidation of corporate fixed costs and the utilization of best
practices from both companies. For example, we intend to relocate
selected information systems to PCSs facilities in an effort to
consolidate overhead and maximize efficiencies in this area.                                                                                                                                                         

30



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##### Table of Contents





| |  |  | Pursuing cross-selling opportunities with pharmaceutical
manufacturers and health plan sponsors.Our acquisition of PCS provides
us with a wider range of complementary products and services to sell to
a larger customer base. For example, we have historically offered
outcomes research to our customers, which we will now be able to
cross-sell to traditional PCS customers. Likewise, PCS offers certain
clinical programs and services that we have not previously provided to
our customers.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Integration Related to PCS Acquisition

We have successfully completed most of the steps in integrating PCS that
are necessary for us to operate as a single, combined company. Our combined
organizational and management reporting structure has been rolled out and
implemented at all levels of the organization. We have completed the
integration of the operational components of the call centers and mail
pharmacies. We have successfully completed an interface to all of our call
centers and our mail service pharmacies so clients can be supported by any
combination of these facilities. In addition, we have completed the evaluation
of vendor contracts, are reviewing and finalizing improved terms with our
pharmaceutical wholesalers, technology vendors and others, and have completed
the relocation of selected information systems to PCS facilities. By the end of
the quarter ending September 30, 2001, we expect to have completed the
remaining steps in integrating PCSs operations, including the rollout of an
interface between our data processing platforms, and a combination of other
technology systems.

Sources of Revenue

We group the revenues from all of our health improvement service offerings
into three categories: data, mail, and clinical services.

Data services

Through our data services operations we process prescription claims on
behalf of our health plan sponsor customers. When a member of one of our health
plan sponsors presents a prescription or health plan identification card to a
retail pharmacist in our network, the pharmacist accesses our online system to
receive information regarding eligibility, patient history, health plan
formulary listings, and negotiated price. The member generally pays a co-pay to
the retail pharmacy and the pharmacist fills the prescription. On behalf of our
health plan sponsors, during each billing cycle, our systems electronically
aggregate pharmacy benefit claims, which include prescription costs plus our
claims processing fees. Once we receive payments from health plan sponsors, we
remit the amounts owed by those health plan sponsors to the retail pharmacies
and keep the claims processing fees.

We have established a nationwide network of over 56,000 retail pharmacies,
each of which pay an access fee to be included in our network. Our contracts
with most of our health plan sponsors provide for member access to our retail
pharmacy network. Under these contracts, we have an independent obligation to
pay network retail pharmacies for the drugs dispensed, meaning we have assumed
this risk. We are a principal in the transaction; therefore, we record the
aggregate pharmacy benefit claim payments from our health plan sponsors as
revenues, and include prescription costs to be paid to retail pharmacies in
cost of revenues.

Some of our other customers have established their own pharmacy networks.
Under contracts with these customers, we are not at risk for retail pharmacy
payment obligations. Thus, we record only our claims processing fees as
revenues and do not include prescription costs in revenues or cost of revenues.

As a result, customers that use our network will generate higher revenues
than customers that use their own networks. Similarly, while a customer who
uses our network may contribute the same gross profit in terms of dollars as a
customer that uses its own network, gross profit as a percentage of revenue
will be significantly lower for the customer using our network because of the
higher level of revenue we recognize.

Mail services

We derive mail services revenues from the sale of pharmaceuticals to
members of our customers health plans. These revenues include the cost of the
pharmaceuticals plus a dispensing fee. Our cost of revenues includes product
costs and other direct costs associated with the dispensing of prescription
drugs.

Clinical and other services

We have historically derived our clinical revenues primarily from
formulary management and administration of rebate and volume discount programs
of pharmaceutical manufacturers relating to our PBM and consumer card
operations. We record revenues in the amount of the fees we charge for our
services and include the cost of such services in cost of revenues.
31Table of ContentsSome of these revenues are based on estimates of rebates generated for our
clients that are subject to final settlement with the manufacturer. In
addition, we generate clinical revenues on a fee-for-service basis on the sale
of our comprehensive health improvement products and services, including
disease management, clinical trials and outcomes studies.Changes in Revenue RecognitionWe purchased PCS Holding Corporation, or PCS, on October 2, 2000 and have
included this business in our consolidated results of operations since that
time. We made changes in our revenue recognition presentation to conform the
different policies used by us and PCS. These changes are reflected in all
periods presented. These changes are as follows:(1)
        
        The historical PCS amounts have been reclassified to reflect the change
in presentation of data services revenues. In cases in which we have
assumed an independent obligation to pay our network pharmacy providers
and acts as a principal in the transaction, we include payments from our
plan sponsors for these benefits as revenues and payments to our pharmacy
providers as cost of revenues (i.e. gross reporting). Historically, PCS
recorded only claims processing fees as revenues (i.e. net reporting).
The change results in higher revenues and an equal increase in cost of
revenues. This change had no effect on gross profit or operating income.(2)
        
        In addition, the historical financial statements of AdvancePCS have been
revised to reflect a change in recognition of clinical and other service
revenues. We receive funds from pharmaceutical manufacturers for
formulary rebate programs that we administer on behalf of our health plan
sponsors. We record revenues in the amount of the administration fees we
charge for our services (i.e. net reporting) and include the cost of such
services in cost of revenues. Previously, we recognized the entire amount
of the rebate, including our administration fee, in revenues and the
portion of the rebate paid to our client in cost of revenues (i.e. gross
reporting). This revision resulted in lower revenues and an equal decrease
in cost of revenues. This change had no effect on gross profit or
operating income.Revenues from the dispensing of pharmaceuticals from the Companys mail
service pharmacies are recognized when each prescription is shipped. Revenues
from the sales of prescription drugs by pharmacies in  the Companys nationwide network and
claims processing fees are recognized when the claims are adjudicated. At the
point of sale, the pharmacy claims are adjudicated using the Companys on-line claims
processing system.When the Company independently contracts to pay its network
pharmacy providers, it assumes credit  risk and acts as a principal in the transaction, the Company includes payments from plan sponsors for these benefits
as revenues and payments to its pharmacy providers as cost of revenues (i.e. gross reporting) in accordance with EITF 99-19 Reporting Gross Revenue as a Principal vs Net
as an Agent. If the Company is only administering plan sponsors' network pharmacy contracts, the Company records the claims
processing fees as revenue (i.e. net reporting). If we had reported
our data services revenues using net reporting, revenues and cost of
revenues would have decreased by $503 million, $1.5 billion and $5.9
billion, respectively, for the fiscal years ended March 31, 1999, 2000
and 2001.Clinical services fees received from the plan sponsors or
pharmaceutical manufacturers are recognized in revenues as earned in
accordance with the contractual agreements. Clinical services revenue
includes service fees for negotiating rebates with pharmaceutical
manufacturers on behalf of its health plan sponsor customers. The
rebate due from the manufacturer is determined based on a complex
formula including such factors as volume and quarterly drug
utilization. The Company estimates the most recent quarter's rebate
receivables from the manufacturers, rebate payable to plan sponsors
and its fees based on the terms of its contracts and claims for the
quarter. Following the end of the quarter, the Company invoices the
drug manufacturer. The Company revises its estimates based upon the
invoiced amounts. Rebates received from pharmaceutical manufacturers
on behalf of plan sponsors are excluded from revenues. Clinical
services revenues from certain disease management and health benefit management
products are reimbursed at predetermined contractual rates based on the
delivery or completion of the services.In December 1999, the Securities & Exchange Commission staff issued Staff
Accounting Bulletin (SAB) 101 Revenue Recognition in Financial Statements.
SAB 101 provides guidance on applying generally accepted accounting principles
to revenue recognition issues in financial statements. In addition, the
Emerging Issues Task Force (EITF) issued a consensus in EITF 99-19 Reporting
Gross Revenue as a Principal vs. Net as an Agent. The EITF also has issued
EITF 00-22 Accounting for ... Other Volume Based Sales Incentive Offers.
This pronouncement provides accounting guidance for certain volume rebate
programs. SAB 101 and the EITFs were effective in our fourth fiscal quarter of
2001. In connection with our recent acquisitions and the issuance of these
pronouncements, we have evaluated certain aspects of SAB 101 and the EITFs,
including gross versus net reporting of data and clinical revenues. Net
reporting of these revenues has no effect on gross profit or operating income.
If we had reported our data services revenues using net reporting, revenues and
cost of revenues would have decreased by $503 million, $1.5 billion, and $5.9
billion respectively, for the fiscal years ended March 31, 1999, 2000, and
2001.32Table of ContentsResults Of Operations  AdvancePCSThe following table sets forth certain consolidated historical financial
data of AdvancePCS. Historical revenues for AdvancePCS and PCS have been
revised to reflect adoption of consistent revenue recognition policies as
described above.

|                                              |                             |                |        |                                       |         |   |        |           |           |         |         |           |           | 
|--------------------------------------------- | --------------------------- | -------------- | ------ | ------------------------------------- | ------- | - | ------ | --------- | --------- | ------- | ------- | --------- | --------- | 
|                                              |                             |                |        | Year Ended March 31,                  |        
|                                              |                             |                |        |                                       |        
|                                              |                             |                |        | 1999                                  |         |   | 2000   |           |           | 2001(1) |        
|                                              |                             |                |        |                                       |         |   |        |           |           |         |        
|                                              |                             |                |        | (In thousands, except per share data) |        
|Revenues:                                    
|                                             
|                                             
|                                             
|                                             
|                                              | Data services               |                | $      | 554,716                               |         |   | $      | 1,558,113 |           |         | $       | 6,010,692 |          
|                                             
|                                             
|                                             
|                                             
|                                              | Mail services               |                |        | 127,297                               |         |   |        | 184,103   |           |         |         | 714,294   |          
|                                             
|                                             
|                                             
|                                             
|                                              | Clinical and other services |                |        | 75,246                                |         |   |        | 91,672    |           |         |         | 299,312   |          
|                                              |                             |                |        |                                       |         |   |        |           |          
|                                              |                             | Total revenues |        |                                       | 757,259 |   |        |           | 1,833,888 |         |         |           | 7,024,298 | 
|                                             
|                                             
|                                             
|                                             
|Gross profit                                  |                             |                | 40,959 |                                       |         |   | 75,502 |           |           |         | 229,583 |          
|                                             
|                                             
|                                             
|                                             
|Selling, general, and
administrative expenses |                             |                | 21,006 |                                       |         |   | 38,793 |           |           |         | 127,777 |          
|                                             
|                                             
|                                             
|                                             
|Non-recurring charges                         |                             |                |       |                                       |         |   |       |           |           |         | 11,129  |          
|                                             
|                                             
|                                             
|                                             
|Operating income                              |                             |                | 19,953 |                                       |         |   | 36,709 |           |           |         | 90,677  |          
|                                             
|                                             
|                                             
|                                             
|Net interest expense                          |                             |                | 2,860  |                                       |         |   | (2,879 | )         |           |         | (41,882 | )        
|                                             
|                                             
|                                             
|                                             
|Merger costs & asset disposal                 |                             |                |       |                                       |         |   | (160   | )         |           |         | (1,200  | )        
|                                             
|                                             
|                                             
|                                             
|Net income                                    |                             | $              | 14,144 |                                       |         | $ | 20,876 |           |           | $       | 22,668  |          
|                                             
|                                             
|                                             
|                                             
|Basic net income per share                    |                             | $              | 0.59   |                                       |         | $ | 0.84   |           |           | $       | 0.78    |          
|                                             
|                                             
|                                             
|                                             
|Diluted net income per share                  |                             | $              | 0.53   |                                       |         | $ | 0.75   |           |           | $       | 0.63    |          



---

|(1) |  | Includes PCS data since the acquisition on October 2, 2000.
|--- |  | -----------------------------------------------------------



---

Fiscal Year 2001 Compared to Fiscal Year 2000

Revenues.Our revenues for fiscal year 2001 increased by $5.2 billion, or
283%, compared to revenues for fiscal year 2000. The increase in revenues was
primarily the result of our acquisition of PCS on October 2, 2000.
Approximately $4.5 billion, or 86%, of the increase in revenues was
attributable to data services and a 232% increase in the number of pharmacy
claims processed during the period. Claims processed increased from 81 million
in fiscal year 2000 to 269 million for fiscal year 2001. The addition of PCS
added approximately 160 million claims for the period. Approximately 10% of the
increase was attributable to additional sales of our mail pharmacy services,
resulting from a 239% increase in the number of mail prescriptions dispensed.
Mail pharmacy prescriptions dispensed increased from 1.7 million in fiscal year
2000 to 5.7 million for fiscal year 2001. The addition of PCSs two mail
pharmacies accounted for approximately 91% of the increase. The remaining 4% of
the increase in revenues resulted from an increase in clinical and other
services revenues derived from formulary and disease management services as
well as clinical trials.

Gross profit.Our gross profit for fiscal year 2001 increased by $154
million, or 204%, compared to the same period in fiscal year 2000. This
increase was attributable primarily to the additional revenue and gross profit
associated with the PCS acquisition. As a percentage of revenues, gross profit
was approximately 3.3% in fiscal year 2001 compared to 4.1% in the same period
in fiscal year 2000. The decrease was primarily due to a substantial increase
in data services revenues from the PCS acquisition, which have lower margins
than other services.

Selling, general and administrative expenses.Our selling, general and
administrative expenses for fiscal year 2001 increased by $88.9 million, or
229%, compared to the same period in fiscal year 2000. This increase is due to
the acquisition of PCS. Approximately $26.8 million of the increase is due to
additional goodwill and other intangibles amortization associated with the PCS
acquisition. Selling, general, and administrative expenses as a percentage of
revenues was approximately 1.8% in fiscal year 2001 compared to 2.1% in the
same period in fiscal year 2000.

Non-recurring and impairment charges.Net income for the year ended March
31, 2001 reflected a non-recurring charge of $11,129,000 ($6,789,000 after
taxes, or $0.19 per diluted share) representing an impairment related to the
integration of the mail facility and AdvancePCS mail facilities. Our mail
facility in Richardson, Texas will be closed and operations moved to the Fort
Worth and Birmingham facilities. In addition, the charges include severance
costs for certain management employees that were terminated or resigned
following and as a result of the acquisition with PCS. All of these severance
costs to management employees were paid prior to March 31, 2001. We expect to
consolidate certain additional operations in connection with the integration of
PCS, which will result in future non-recurring charges consisting primarily of
facility closure, software abandonment, and severance costs in the year ended
March 31, 2002. We anticipate these additional charges will be approximately $3
to $4 million.

33



---



##### Table of Contents



Interest income and interest expense.Interest expense, net of interest
income, for fiscal year 2001 increased $39.0 million compared to the same
period in fiscal year 2000. The increase resulted from the acquisition of PCS,
which was partially funded by over $800 million in additional debt.

Merger costs.Net income for fiscal year 2001 reflected a pre-tax charge
of $1.2 million ($926,000 after taxes, or $0.03 per share) relating to merger
costs incurred in connection with the merger with FFI.

Income taxes.For fiscal year 2001 our effective tax rate was
approximately 52%. For fiscal year 2000 our recorded income tax expense
approximated an effective tax rate of 38%. The effective rate for fiscal year
2001 was higher due to the non-deductible nature of the goodwill and other
intangible assets acquired in the PCS acquisition.

Diluted net income per share.We reported diluted net income per share of
$0.63 per share for fiscal year 2001 compared to $0.75 per share for the same
period in fiscal year 2000. The weighted average shares outstanding were 27.7
million and 36.2 million for fiscal years 2000 and 2001, respectively. The
decrease in diluted net income per share resulted from additional interest
expense and goodwill and other intangibles amortization in connection with the
PCS acquisition. In addition, securities convertible into common stock were
issued in connection with the PCS acquisition resulting in an increase in
weighted average shares outstanding.

Fiscal Year 2000 Compared To Fiscal Year 1999

Revenues.Our revenues for fiscal year 2000 increased by $1.1 billion, or
142.2%, compared to revenues for fiscal year 1999. The number of individuals we
managed continued to increase in fiscal year 2000 as we obtained new customers
including our largest customer at that time, Foundation Health Systems, Inc.,
or FHS, whose service agreement began April 1, 1999. In addition, our current
customers continued to increase their membership and utilization levels. New
customer contracts resulted from increased marketing efforts and the expansion
of our sales and marketing department. Contracts with new customers in fiscal
year 2000 generally included all pharmacy benefit management products we offer,
including claims processing, mail and clinical and other services.

Our revenues from data services increased $1.0 billion, or 180.9%,
compared to the prior year. The increase resulted from the addition of new
contracts including the service agreement with FHS and an increase in the use
of our services by existing customers. The increase in new members resulted in
an increase in pharmacy claims processed from 50.6 million in fiscal year 1999
to 81.2 million in fiscal year 2000, a 60.5% increase. Virtually all of the new
fiscal year 2000 customer contracts, including FHS, use our pharmacy network,
which has shifted a larger percentage of our total revenues to data services.
Revenues from mail services increased $56.8 million, or 44.6%, compared to the
prior year. This increase resulted primarily from the new members added during
fiscal year 2000. The increase in new members resulted in an increase in mail
prescriptions dispensed from 1.3 million in fiscal year 1999 to 1.7 million in
fiscal year 2000, a 29.9% increase. Revenues from clinical and other services
increased $16.4 million, or 21.8%, compared to the prior year. The increase
resulted primarily from the new members added and the additional claims
processed during fiscal year 2000 compared to the prior year.

Gross profit.Our gross profit for fiscal year 2000 increased by $34.5
million, or 84.3%, compared to the prior fiscal year. This increase primarily
resulted from the additional costs associated with our claims processing growth
and the new customers, including FHS that are using our retail pharmacy
network. As a percentage of revenues, gross profit was 4.1% in fiscal year 2000
compared to 5.4% in fiscal year 1999.

Selling, general and administrative expenses.Our selling, general, and
administrative expense for fiscal year 2000 increased by $17.8 million, or
84.7%, compared to fiscal year 1999. This increase was primarily the result of
our acquisition of Foundation Health Pharmaceutical Services, Inc., or FHPS, in
March 1999 and the related amortization expense associated with the intangible
assets acquired. In addition, further expansion in management, sales and
marketing contributed to the increase. In spite of the increase, selling,
general and administrative expenses as a percentage of revenues decreased from
2.8% in fiscal year 1999 to 2.1% in fiscal year 2000 as the result of greater
economies of scale and due to the increase in revenues associated with our
claims processing services. Additional revenues generated by customers using
our network pharmacy providers typically do not result in an increase in
selling, general, and administrative expenses.

Interest income and interest expense.Our interest expense, net of
interest income was $2,879,000 for fiscal year 2000. We incurred no interest
expense for fiscal year 1999, since we had no outstanding indebtedness until
March 31, 1999 and had $2.9 million of interest income. Interest expense
increased as a result of the acquisition of FHPS on March 31, 1999 and the
related bank borrowings throughout fiscal year 2000

Income taxes.In fiscal years 2000 and 1999, our income tax expense
approximated an effective tax rate of 38%.
34Table of ContentsDiluted net income per share.We reported diluted net income per share of
$0.75 per share for fiscal year 2000 compared to $0.53 per share for the same
period in fiscal year 1999. The weighted average shares outstanding were 27.7
million and 26.9 million for fiscal years 2000 and 1999, respectively.Unaudited Pro Forma Results of Operations for PCS AcquisitionThe following table sets forth certain unaudited pro forma financial data
assuming the PCS acquisition occurred on April 1 of the periods presented.
Historical revenues for AdvancePCS and PCS have been revised to reflect
adoption of consistent revenue recognition policies as described in  Changes
in Revenue Recognition.

|                                              |                             |                |         |                      |           |  |         |           |            | 
|--------------------------------------------- | --------------------------- | -------------- | ------- | -------------------- | --------- |  | ------- | --------- | ---------- | 
|                                              |                             |                |         | Year Ended March 31, |          
|                                              |                             |                |         |                      |          
|                                              |                             |                |         | 2000                 |           |  | 2001    |          
|                                              |                             |                |         |                      |           |  |         |          
|                                              |                             |                |         | (In thousands)       |          
|Revenues                                     
|                                             
|                                             
|                                             
|                                             
|                                              | Data services               |                | $       | 8,619,596            |           |  | $       | 9,711,112 |           
|                                             
|                                             
|                                             
|                                             
|                                              | Mail services               |                |         | 937,228              |           |  |         | 1,143,087 |           
|                                             
|                                             
|                                             
|                                             
|                                              | Clinical and other services |                |         | 403,295              |           |  |         | 457,743   |           
|                                              |                             |                |         |                      |           | 
|                                              |                             | Total revenues |         |                      | 9,960,119 |  |         |           | 11,311,942 | 
|                                             
|                                             
|                                             
|                                             
|Gross profit                                  |                             |                | 282,783 |                      |           |  | 339,881 |          
|                                             
|                                             
|                                             
|                                             
|Selling, general, and
administrative expenses |                             |                | 191,521 |                      |           |  | 221,145 |          
|                                             
|                                             
|                                             
|                                             
|Operating income                              |                             |                | 91,262  |                      |           |  | 107,607 |          

Pro Forma AdvancePCS:

Pro Forma Fiscal Year 2001 Compared to Pro Forma Fiscal Year 2000

Revenues.Our pro forma revenues for fiscal year 2001 increased by $1.4
billion, or 14% compared to the pro forma revenues for fiscal year 2000.
Approximately $1.1 billion, or 81%, of the increase in revenues was
attributable to data services and a 9.9% increase in the number of pharmacy
claims processed during the period. Pro forma claims processed increased from
397.2 million in fiscal year 2000 to 436.5 million for fiscal year 2001.
Approximately 15% of the increase was attributable to additional sales of our
mail pharmacy services, resulting from an 10% increase in the number of mail
prescriptions dispensed. The remaining 4% of the increase in revenues resulted
from an increase in clinical and other services revenues derived from formulary
and disease management services.

Gross profit.Our gross profit for fiscal year 2001 increased by $57.1
million, or 20%, compared to the same period in fiscal year 2000 on a pro forma
basis. This increase was attributable primarily to the additional revenue and
gross profit generated by the improvement in operations at the two PCS mail
facilities. The improvement resulted from an overall decrease in headcount in
the mail facilities and the call centers despite a 10% growth in prescriptions
filled. As a percentage of revenues, gross profit was approximately 3.0% in
fiscal year 2001, compared to 2.8% in the same period in fiscal year 2000.

Selling, general and administrative expenses.Our pro forma selling,
general and administrative expenses for fiscal year 2001 increased by $29.6
million, or 15%, compared to the same period in fiscal year 2000. This increase
resulted from increased support to cover the increased revenues. Also, losses
of approximately $7 million were incurred in connection with performance-based
contracts in fiscal year 2001. In addition, we incurred expenses for severance
and retention costs related to executive employment agreements in fiscal year
2001.

Non-recurring and impairment charges.Net income for the year ended March
31, 2001 reflected a non-recurring charge of $11,129,000 ($6,789,000 after
taxes, or $0.19 per diluted share) representing facility closure costs related
to the combination of PCS and Advance facilities. The Companys mail facility
in Richardson, Texas will be closed and operations moved to the Fort Worth and
Birmingham facilities. In addition, the charges include severance costs for
certain management employees that were terminated or resigned following and as
a result of the acquisition with PCS. All of these severance costs to
management employees were paid prior to March 31, 2001. We expect to
consolidate certain additional operations in connection with the integration of
PCS, which will result in additional non-recurring charges consisting primarily
of facility closure and severance costs in the year ended March 31, 2002. We
anticipate these additional charges will be approximately $3 to $4 million.

Operating income.Our operating income increased by $16.3 million, or
18%, for fiscal year 2001 compared to the same period in fiscal year 2000 on a
pro forma basis. The increase resulted from the factors mentioned above as
revenues improved and PCSs headcount and costs declined.

35



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Liquidity and Capital Resources

As of March 31, 2001, we had a working capital deficit of $299.4 million.
The majority of our current obligations are not due until cash is collected
from our customers. We use our excess cash balances to reduce debt under our
revolving credit facility, which results in a net deficit in working capital.
Our net cash provided by operating activities was $92.3 million for fiscal year
2001 resulting primarily from net income and also due to the timing of
receivables and payables resulting from our continued growth. During fiscal
year 2001, we used cash of $41.2 million, or $44.5 million on a pro forma
basis, for purchases of property, plant and equipment associated with the
growth and expansion of our systems and facilities.

Historically, we have been able to fund our operations and continued
growth through cash flow from operations. In fiscal years 1999, 2000, and 2001
our operating cash flow funded our capital expenditures and our short-term
excess cash was used to reduce our debt or invested in money market funds.

In conjunction with our acquisition of PCS, we obtained an $825 million
senior secured credit facility that includes a $175.0 million revolving credit
facility, $100 million interim revolving credit facility and two term notes
totaling $550.0 million. Our $150 million Term A note accrues interest at LIBOR
plus 2.75%, with escalating quarterly principal payments, and is due on
September 30, 2005. Our $400 million Term B note accrues interest at LIBOR plus
3.5%, with quarterly principal payments of $1 million until December 31, 2006
and payments of $94.5 million thereafter on each of December 31, 2006, March
31, 2007, June 30, 2007 and September 30, 2007. Our revolving credit facilities
accrue interest at LIBOR plus 2.75%. These percentages may be lower based upon
our total leverage. The revolving credit facility expires on October 2, 2005.
As of March 31, 2001, $95 million was outstanding under this revolving credit
facility. We intend to refinance the $100 million interim revolving credit
facility with a collateralized accounts receivable facility in fiscal year
2002. The senior secured credit facility contains covenants that are typical
for this type of document. The senior secured credit facility has been
unconditionally guaranteed, jointly and severally, by all of our subsidiaries.
In addition, the senior secured credit facility is secured by a first priority
lien on the stock of our subsidiaries and substantially all of our assets and
the assets of our subsidiaries. Each subsidiary is 100% owned. There are no
restrictions on the ability of the subsidiary guarantors to pay dividends or
make loans or advances to the parent. We also issued to Rite Aid $125 million
in convertible preferred stock substantially all of which was subsequently
converted into Class A common stock and sold by Rite Aid. In addition, we
issued $150 million in 4,207,300 shares of common stock and 65,854 shares of
convertible preferred stock to JLL. Also, we issued to Rite Aid $200 million
in senior subordinated notes. In March 2001, the Company issued $200 million in
8 1/2 % Senior Notes Due 2008 (Senior Notes). The proceeds from this offering
were used to retire the $200 million senior subordinated notes due 2010 that
were issued to Rite Aid in connection with the PCS acquisition. The Senior
Notes contain covenants that are typical for this type of debt. The Senior
Notes have been unconditionally guaranteed, jointly and severally, by all of
our subsidiaries, which are all 100% owned. There are no restrictions on the
ability of the guarantors to pay dividends, make loans or advances to the
parent.

We anticipate that cash flow from operations, combined with our current
cash balances and amounts available under our credit facility, will be
sufficient to meet our internal operating requirements and expansion programs,
including capital expenditures, for at least the next 18 months. However, if we
successfully continue our expansion, acquisition and alliance plans, we may be
required to seek additional debt or equity financing in order to achieve these
plans.

Recent Accounting Pronouncements

In June 1998, Financial Accounting Standards Board issued SFAS 133
Accounting for Derivative Instruments and Hedging Activities. SFAS 133
requires all derivatives to be recognized as either assets or liabilities in
the statement of financial position and measured at fair value. In addition,
SFAS 133 specifies the accounting for changes in the fair value of a derivative
based on the intended use of the derivative and the resulting designation. SFAS
133, as amended by SFAS 137 and SFAS 138, is effective beginning in fiscal year
March 31, 2002. We have entered into interest rate protection agreements that
have fixed the LIBOR rate as of November 7, 2000 at 6.60% for $400 million of
our variable rate debt under our credit facility. The notional amount drops to
$300 million in October 2001 and to $200 million in October 2002. We will
declare these agreements hedges in accordance with SFAS 133, as amended, and
will recognize the fair value of these financial instruments on the balance
sheet effective April 1, 2001 upon adoption of SFAS 133. These instruments will
be marked to market at each reporting date with the adjustment recognized as a
component of other comprehensive income (loss) in stockholders equity. The
fair value of our interest rate swaps, a liability of $12,566,000 at March 31,
2001, was based upon quoted market prices. Under SFAS 133, we will record a
transition liability of $12,565,000 and a charge to other comprehensive income
(loss) as of April 1, 2001.

In March 2000, the
Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 44 (FIN 44), Accounting for Certain
Transactions Involving Stock Compensation  an Interpretation of APB
Opinion No. 25. FIN 44 is intended to clarify the application of APB
No. 25 by providing guidance regarding among other issues: the
definition of an employee for purposes of applying APB Opinion No.
25; the criteria for determining whether a plan qualifies as a
noncompensatory plan; the accounting consequence of various
modifications to the terms of the previously fixed stock options or
awards; and the accounting for an exchange of stock compensation
awards in a business combination. FIN 44 was effective July 1, 2000
but certain provisions covered specific events occurring after
December 15, 1998 or January 12, 2000. The adoption of FIN 44 did not
have a material impact on the Company's consolidated financial
position or results of operations.

In December 1999, the Securities and Exchange Commission staff issued SAB
101 Revenue Recognition in Financial Statements. SAB 101 provides guidance on
applying generally accepted accounting principles to revenue recognition issues
in financial statements. In addition, the EITF issued a consensus in EITF 99-19
Reporting Gross Revenue as a Principal vs.

36



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##### Table of Contents



Net as an Agent. SAB 101 and the EITF were effective in our fourth fiscal
quarter of 2001. The adoption of SAB 101 and EITF 99-19 had no material effect
on our statement of operations.

In 1999, the FASB issued an exposure draft for a proposed statement on
business combinations and intangible assets (new rules). This exposure
draft, among other things, eliminates pooling of interest business
combinations, eliminates the amortization of goodwill and starts assessing
goodwill on the impairment approach. Non-calendar year-end companies that have
new fiscal years beginning after March 15, 2001, but before December 15, 2001,
have a choice for date of adoption of the new rules. March 31 year end
companies that issue first quarter financial statements before the new rules
are issued will not be eligible for this choice. During the first year of
application of the new rules, companies will test for goodwill impairment at
the transaction date. Management expects to adopt the new rules upon their
final issuance prior to the release of the Companys fiscal 2002 first quarter
financial statements.

Impact Of Inflation

Changes in prices charged by manufacturers and wholesalers for
pharmaceuticals we dispense affect our cost of revenues. Historically, we have
been able to pass the effect of such price changes to our customers under the
terms of our agreements. As a result, changes in pharmaceutical prices due to
inflation have not adversely affected us.




ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have entered into
interest rate protection agreements (interest
rate swaps  see Note 5 to the consolidated financial statements) that have
fixed the LIBOR rate as of November 7, 2000 at 6.60% for $400 million of our
variable rate debt under our credit facility. The notional amount drops to $300
million in October 2001 and to $200 million in October 2002. We use the interest
rate swaps to manage our interest rate risk on future interest payments.
Interest rate risk is monitored on the basis of changes in interest rates, in
particular, changes in the three month LIBOR rate and sensitivity analysis is
used to determine the impact interest rate changes will have on the fair value
of the interest rate swaps, measuring the change in the net present value
arising from the change in the interest rate. The fair value of the swaps are
determined by calculating the present value of all expected cash flows, with
future interest rate levels implied from prevailing mid-market yields for money
market instruments, interest rate futures and/or prevailing mid-market swap
rates. Anticipated cash flows are then discounted on the assumption of a
continuously compounding zero-coupon yield curve. The Company does not enter
into derivatives or other financial instruments for trading purposes.

As of March 31, 2001 the Company has $200 million of 8 1/2% Senior
Notes and $645 million in bank debt. The interest on the bank debt is calculated
based upon a margin over LIBOR. A change in LIBOR or the Prime Rate as set by
Bank of America, N.A. would affect the rate at which we could borrow funds under
our credit facilities. Since the Company has interest rate swaps hedging $400
million of this variable rate debt, an additional $245 million is subject to
changes in interest rates. A 1% change in interest rates would affect net income
by approximately $1.5 million for the year ended March 31, 2001.

As of March 31, 2000, the Company had borrowed $50 million under a
revolving credit facility. Interest on the credit facility accrued at a
specified margin above the LIBOR, or an alternate base rate. For LIBOR loans the
applicable margin was 1.375% per annum as of March 31, 2000 and the effective
interest rate was 7.435%. A change in LIBOR or an alternate base rate would
affect the rate at which we could borrow funds under the credit facility. The
Company had not entered into any interest rate swaps to hedge interest rate
exposure on this credit facility as of March 31, 2000. A 1% change in interest
rates would affect net income by approximately $305,000 for the year ended March
31, 2000.




ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information
required by this item is found on pages F-1 through F-20
hereof.

37



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##### Table of Contents






PART III




ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Consulting Agreements

In connection with the acquisition of PCS, and in consideration for the
commitment of Jean-Pierre Millon to assist us during the transitional period,
AdvancePCS entered into a consulting agreement with Mr. Millon effective October
2, 2000. The consulting agreement was for a six-month term and entitled Mr.
Millon to compensation in the amount of $490,000 in addition to benefits
received by our other non-employee directors. Mr. Millon and his family are
entitled to benefits under our employee benefit plans through January 22, 2002.
The consulting agreement contains non-competition provisions effective for the
term of the consulting agreement and for a period of one year thereafter.

On June 1, 2001, AdvancePCS entered into a Consulting Services Agreement
with Mr. Millon pursuant to which he will assist AdvancePCS in developing
international business opportunities and analyze opportunities for AdvancePCS to
expand its offerings worldwide. The consulting agreement is for a six-month term
and entitles Mr. Millon to compensation in the amount of $25,000 per month. In
addition, it contains non-competition provisions effective for the term of the
consulting agreement and for one year thereafter outside of the U.S. and for
six-months thereafter within the U.S.

Former Employment Agreements

Prior to the acquisition of PCS, Rite Aid Corporation, or Rite Aid, entered
into employment agreements with certain PCS executives. In connection with the
acquisition of PCS, AdvancePCS assumed liabilities under these employment
agreements and paid amounts due under the change in control provisions. This
resulted in payments to Mr. Millon of $7,155,894, Mr. Thomas J. Garrity of
$1,488,094, Mr. Jeffrey G. Sanders of $1,280,034 and Mr. Ken Zadoorian of
$256,007. These payments were accounted for as part of the
acquisition of PCS.

Stockholders' Agreement

On October 2, 2000, AdvancePCS entered into a Stockholders' Agreement with
Rite Aid and Joseph Littlejohn & Levy Fund III LLP, or JLL, which, among other
things, contains certain registration rights, "standstill" provisions and
agreements relating to our corporate governance. Under this agreement, Rite Aid
and JLL have piggyback registration rights with respect to the Class A common
stock issuable upon conversion of the Class B-1 and Class B-2 common stock they
own. In addition to piggyback rights, each of the holders of the Class B-1 and
Class B-2 common stock have two demand registration rights that may only be used
after April 2, 2001. On May 29, 2001, AdvancePCS filed a registration statement
registering a total of 7,300,000 shares of Class A common stock to be sold from
time to time by AdvancePCS and certain stockholders including
JLL.

Employee Loan

Effective as of October 2, 2000, AdvancePCS entered into a three-year
employment agreement with David A. George to serve as President of the Company.
Pursuant to the employment agreement, the Company reimbursed Mr. George for
certain relocation expenses in connection with his relocation to Phoenix,
Arizona, including a no-interest loan of $500,000 to be applied to the purchase
of a home. The Company shall reduce the principal amount of this loan by 20% per
year over a five year period; provided that the current balance of this loan
shall become immediately due and payable upon termination of Mr. George's
employment either by the Company for cause or by Mr. George without
good reason.

AdvancePCS believes that the transactions set forth above were made on
terms no less favorable to AdvancePCS than could have been obtained from
unaffiliated third parties. All future transactions between AdvancePCS and its
officers, directors, principal stockholders and affiliates will be approved by a
majority of the Board of Directors, including a majority of the independent and
disinterested outside directors on the Board of Directors, and will be on terms
no less favorable to AdvancePCS than could be obtained from unaffiliated third
parties.




PART IV




ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K



| | (a) |  | The following documents are filed as part of this report.
| | --- |  | ---------------------------------------------------------



| |  |  | (1) |  | Financial Statements. See index to financial
statements on page F-1 of this report.                  
| |  |  | --- |  | -----------------------------------------------------------------------------------------------------
|
| |  |  | (2) |  | Financial Statement Schedules. See index to
financial statement schedules on page F-1 of this report.
|
| |  |  | (3) |  | Exhibit. See index to exhibits.                                                                      



| | (b) |  | Reports on Form 8-K. We filed the following reports on Form
8-K during the quarter ended March 31, 2001:
| | --- |  | --------------------------------------------------------------------------------------------------------



| |  |  | (1) |  | Report on Form 8-K/A filed with the Securities and
Exchange Commission on February 16, 2001 to provide selected
consolidated financial data, managements discussion and
analysis of financial condition and results of operations and
consolidated financial statements to give effect to our
acquisition of FFI.           
| |  |  | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | (2) |  | Report on Form 8-K/A filed with the Securities and
Exchange Commission on February 16, 2001 to provide updated
financial statements and revised unaudited pro forma financial
statements of AdvancePCS for a reclassification of its revenues
and cost of revenues in order to conform to the policies of
AdvancePCS and PCS.
|
| |  |  | (3) |  | Report on Form 8-K filed with the Securities and
Exchange Commission on February 16, 2001 to update our risk
factors relating to our Class A common stock.                                                                                                                                                                   
|
| |  |  | (4) |  | Report on Form 8-K filed with the Securities and
Exchange Commission on February 23, 2001 to report a press
release we issued with respect to a new venture by and among
AdvancePCS, Express Scripts, Inc. and Merck-Medco Managed Care,
L.L.C                                                                               
|
| |  |  | (5) |  | Report on Form 8-K filed with the Securities and
Exchange Commission on February 28,2001 to report a press
release we issued announcing out intent to offer approximately
$200 million of notes.                                                                                                                             

38



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##### Table of Contents






SIGNATURES

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

|                 |            |                                                                   
|---------------- | ---------- | ------------------------------------------------------------------
|January 10,
2002 | AdvancePCS
|                
|                 | By:        | /s/ David D. Halbert                                              
|                 |            |                                                                   
|                 |            | David D. Halbert
Chairman of the Board and Chief Executive Officer

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

|                                       |  |                                                                                              |  |                 
|-------------------------------------- |  | -------------------------------------------------------------------------------------------- |  | ----------------
|Signature                              |  | Title                                                                                        |  | Date            
|                                      
|/s/  David D. Halbert
David D. Halbert |  | Chairman of the Board
& Chief Executive Officer
(Principal Executive Officer)                |  | January 10,
2002
|                                      
|*
Jon S. Halbert                       |  | Vice Chairman, e-Business
& Technology & Director                                            |  | January 10,
2002
|                                      
|*David A. George                       |  | President & Director                                                                         |  | January 10,
2002
|                                      
|*
T. Danny Phillips                    |  | Executive Vice President, Chief
Financial Officer (Principal
Financial & Accounting Officer) |  | January 10,
2002
|                                      
|*Ramsey A. Frank                       |  | Director                                                                                     |  | January 10,
2002
|                                      
|*Stephen L. Green                      |  | Director                                                                                     |  | January 10,
2002
|                                      
|*David R. Jessick                      |  | Director                                                                                     |  | January 10,
2002

39



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##### Table of Contents



|                                                                                  |  |          |  |                 
|--------------------------------------------------------------------------------- |  | -------- |  | ----------------
|Signature                                                                         |  | Title    |  | Date            
|                                                                                 
|                                                                                 
|* Paul S. Levy                                                                    |  | Director |  | January 10, 2002
|                                                                                 
|* Robert G. Miller                                                                |  | Director |  | January 10, 2002
|                                                                                 
|* Jean-Pierre Millon                                                              |  | Director |  | January 10, 2002
|                                                                                 
|* Michael D. Ware                                                                 |  | Director |  | January 10, 2002
|                                                                                 
|*  By:/s/  David D.
Halbert           David
D. Halbert           Attorney-in-Fact |  |          |  | January 10, 2002

40



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##### Table of Contents



INDEX TO FINANCIAL STATEMENTS
AdvancePCS and Subsidiaries

|                                                                                                  |  |  |     | 
|------------------------------------------------------------------------------------------------- |  |  | --- | 
|Report of Independent Public Accountants                                                          |  |  | F-2 | 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Consolidated Balance Sheets as of March 31, 2000 and 2001                                         |  |  | F-3 | 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Consolidated Statements of Operations for the Years Ended March 31, 1999,
2000 and 2001           |  |  | F-4 | 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Consolidated Statements of Stockholders Equity for the Years Ended
March 31, 1999, 2000 and 2001 |  |  | F-5 | 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Consolidated Statements of Cash Flows for the Years Ended March 31, 1999,
2000 and 2001           |  |  | F-7 | 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Notes to Consolidated Financial Statements                                                        |  |  | F-8 | 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Report of Independent Public Accountants on Financial Statement Schedule                          |  |  | S-1 | 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Schedule II. Valuation and Qualifying Accounts for the
Years Ended March 31, 1999, 2000 and 2001  |  |  | S-2 | 

F-1



---



##### Table of Contents



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of AdvancePCS:

We have audited the accompanying consolidated balance sheets of AdvancePCS
(a Delaware corporation) and subsidiaries as of March 31, 2000 and 2001, and
the related consolidated statements of operations, stockholders equity and
cash flows for each of the three years in the period ended March 31, 2001.
These financial statements are the responsibility of the Companys management.
Our responsibility is to express an opinion on these financial statements based
on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of AdvancePCS and subsidiaries
as of March 31, 2000 and 2001, and the results of their operations and their
cash flows for each of the three years in the period ended March 31, 2001, in
conformity with accounting principles generally accepted in the United States.



ARTHUR ANDERSEN LLP

Dallas, Texas,
May 29, 2001 (except with respect to the matter
discussed in Note 15, as to which the date is June 18, 2001).

F-2



---



##### Table of Contents



AdvancePCS and Subsidiaries

Consolidated Balance Sheets

|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |             |               |               |         |               | 
|-------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----------- | --------- | ----------- | ------------- | ------------- | ------- | ------------- | 
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             | March 31, |            
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             | 2000      |             |               | 2001          |        
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |             |               |               |        
|                                                                                                                     |                                                                                                        |                                                                                                                 | ASSETS                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|Current assets:                                                                                                     
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Cash and cash equivalents                                                                              |                                                                                                                 | $                                          | 55,243,000  |           |             | $             | 110,048,000   |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Accounts receivable, net of allowance for doubtful
accounts of $5,639,000 and $18,840,000 respectively |                                                                                                                 |                                            | 200,288,000 |           |             |               | 1,055,927,000 |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Inventories, net                                                                                       |                                                                                                                 |                                            | 5,965,000   |           |             |               | 34,814,000    |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Prepaid expenses and other                                                                             |                                                                                                                 |                                            | 3,241,000   |           |             |               | 11,920,000    |        
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|                                                                                                                     |                                                                                                        |                                                                                                                 | Total current assets                       |             |           | 264,737,000 |               |               |         | 1,212,709,000 | 
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|Property and equipment, net of accumulated depreciation and
amortization of $14,311,000 and $37,720,000
respectively |                                                                                                        |                                                                                                                 | 33,107,000                                 |             |           |             | 96,640,000    |              
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|Goodwill, net                                                                                                        |                                                                                                        |                                                                                                                 | 93,710,000                                 |             |           |             | 1,282,192,000 |              
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|Intangible assets, net                                                                                               |                                                                                                        |                                                                                                                 | 7,444,000                                  |             |           |             | 382,937,000   |              
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|Other assets                                                                                                         |                                                                                                        |                                                                                                                 | 7,740,000                                  |             |           |             | 29,285,000    |              
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|                                                                                                                     |                                                                                                        |                                                                                                                 | Total assets                               |             | $         | 406,738,000 |               |               | $       | 3,003,763,000 | 
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|                                                                                                                     |                                                                                                        |                                                                                                                 | LIABILITIES AND STOCKHOLDERS EQUITY      
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|Current liabilities:                                                                                                
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Current portion of long-term debt                                                                      |                                                                                                                 | $                                          |            |           |             | $             | 15,250,000    |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Claims and accounts payable                                                                            |                                                                                                                 |                                            | 242,440,000 |           |             |               | 1,382,458,000 |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Accrued salaries and benefits                                                                          |                                                                                                                 |                                            | 5,386,000   |           |             |               | 23,871,000    |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Other accrued expenses                                                                                 |                                                                                                                 |                                            | 4,803,000   |           |             |               | 90,524,000    |        
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|                                                                                                                     |                                                                                                        |                                                                                                                 | Total current liabilities                  |             |           | 252,629,000 |               |               |         | 1,512,103,000 | 
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|Noncurrent liabilities:                                                                                             
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Long-term debt, net of current portion                                                                 |                                                                                                                 |                                            | 50,000,000  |           |             |               | 829,750,000   |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Deferred income taxes                                                                                  |                                                                                                                 |                                            | 3,904,000   |           |             |               | 238,419,000   |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Other noncurrent liabilities                                                                           |                                                                                                                 |                                            | 2,161,000   |           |             |               | 17,788,000    |        
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|                                                                                                                     |                                                                                                        |                                                                                                                 | Total liabilities                          |             |           | 308,694,000 |               |               |         | 2,598,060,000 | 
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|Commitments
and contingenciesStockholders equity:                                                                  
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Preferred stock, $.01 par value; 5,000,000 shares authorized                                          
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     |                                                                                                        | Series A-1 convertible preferred stock, $.01 par value;
0 and 65,854 shares issued and outstanding respectively |                                            |             |          |             |               |               | 1,000   |              
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     |                                                                                                        | Series A-2 convertible preferred stock, $.01 par value;
no shares issued or outstanding                         |                                            |             |          |             |               |               |        |              
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Common stock, $.01 par value; 100,000,000 shares authorized                                           
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     |                                                                                                        | Class A common stock, $.01 par value, 25,017,154
and 32,282,307 shares issued and outstanding respectively      |                                            |             | 250,000   |             |               |               | 322,000 |              
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     |                                                                                                        | Class B-1 common stock, $.01 par value;
0 and 4,207,300 shares issued and outstanding respectively              |                                            |             |          |             |               |               | 42,000  |              
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Additional paid-in capital                                                                             |                                                                                                                 |                                            | 58,927,000  |           |             |               | 351,622,000   |        
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Accumulated other comprehensive income (loss)                                                          |                                                                                                                 |                                            |            |           |             |               | (3,849,000    | )      
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                    
|                                                                                                                     | Accumulated earnings                                                                                   |                                                                                                                 |                                            | 38,867,000  |           |             |               | 57,565,000    |        
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|                                                                                                                     |                                                                                                        |                                                                                                                 | Total stockholders equity                 |             |           | 98,044,000  |               |               |         | 405,703,000   | 
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            
|                                                                                                                     |                                                                                                        |                                                                                                                 | Total liabilities and stockholders equity |             | $         | 406,738,000 |               |               | $       | 3,003,763,000 | 
|                                                                                                                     |                                                                                                        |                                                                                                                 |                                            |             |           |            

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

F-3



---



##### Table of Contents



AdvancePCS and Subsidiaries

Consolidated Statements of Operations

|                           |                                               |   |                          |             |                       |             |               |               |  |               |               |               |  |               | 
|-------------------------- | --------------------------------------------- | - | ------------------------ | ----------- | --------------------- | ----------- | ------------- | ------------- |  | ------------- | ------------- | ------------- |  | ------------- | 
|                           |                                               |   |                          |             | Years Ended March 31, |            
|                           |                                               |   |                          |             |                       |            
|                           |                                               |   |                          |             | 1999                  |             |               | 2000          |  |               | 2001          |              
|                           |                                               |   |                          |             |                       |             |               |               |  |               |               |              
|Revenues                   |                                               | $ | 757,259,000              |             |                       | $           | 1,833,888,000 |               |  | $             | 7,024,298,000 |              
|                           |                                               |   |                          |             |                       |             |               |               | 
|Cost of operations:       
|                          
|                          
|                          
|                          
|                           | Cost of revenues                              |   |                          | 716,300,000 |                       |             |               | 1,758,386,000 |  |               |               | 6,794,715,000 | 
|                          
|                          
|                          
|                          
|                           | Selling, general, and administrative
expenses |   |                          | 21,006,000  |                       |             |               | 38,793,000    |  |               |               | 127,777,000   | 
|                          
|                          
|                          
|                          
|                           | Non-recurring and impairment expenses         |   |                          |            |                       |             |               |              |  |               |               | 11,129,000    | 
|                           |                                               |   |                          |             |                       |             |               |               | 
|                           |                                               |   | Total cost of operations |             |                       | 737,306,000 |               |               |  | 1,797,179,000 |               |               |  | 6,933,621,000 | 
|                           |                                               |   |                          |             |                       |             |               |               | 
|Operating income           |                                               |   | 19,953,000               |             |                       |             | 36,709,000    |               |  |               | 90,677,000    |              
|                          
|                          
|                          
|                          
|Interest income            |                                               |   | 2,860,000                |             |                       |             | 1,064,000     |               |  |               | 3,450,000     |              
|                          
|                          
|                          
|                          
|Interest expense           |                                               |   |                         |             |                       |             | (3,943,000    | )             |  |               | (45,332,000   | )            
|                          
|                          
|                          
|                          
|Loss on disposal of asset  |                                               |   |                         |             |                       |             | (160,000      | )             |  |               |              |              
|                          
|                          
|                          
|                          
|Merger costs               |                                               |   |                         |             |                       |             |              |               |  |               | (1,200,000    | )            
|                           |                                               |   |                          |             |                       |             |               |               | 
|Income before income taxes |                                               |   | 22,813,000               |             |                       |             | 33,670,000    |               |  |               | 47,595,000    |              
|                          
|                          
|                          
|                          
|Provision for income taxes |                                               |   | 8,669,000                |             |                       |             | 12,794,000    |               |  |               | 24,927,000    |              
|                           |                                               |   |                          |             |                       |             |               |               | 
|Net income                 |                                               | $ | 14,144,000               |             |                       | $           | 20,876,000    |               |  | $             | 22,668,000    |              
|                           |                                               |   |                          |             |                       |             |               |               | 
|Basic:                    
|                          
|                          
|                          
|                          
|                           | Net income available to common
stockholders   |   | $                        | 14,144,000  |                       |             | $             | 20,876,000    |  |               | $             | 22,668,000    | 
|                          
|                          
|                          
|                          
|                           | Net income per share                          |   | $                        | 0.59        |                       |             | $             | 0.84          |  |               | $             | 0.78          | 
|                          
|                          
|                          
|                          
|                           | Weighted average shares outstanding           |   |                          | 24,004,290  |                       |             |               | 24,760,163    |  |               |               | 29,145,057    | 
|                          
|                          
|                          
|                          
|Diluted:                  
|                          
|                          
|                          
|                          
|                           | Net income available to common
stockholders   |   | $                        | 14,144,000  |                       |             | $             | 20,876,000    |  |               | $             | 22,668,000    | 
|                          
|                          
|                          
|                          
|                           | Net income per share                          |   | $                        | 0.53        |                       |             | $             | 0.75          |  |               | $             | 0.63          | 
|                          
|                          
|                          
|                          
|                           | Weighted average shares outstanding           |   |                          | 26,876,202  |                       |             |               | 27,737,216    |  |               |               | 36,188,793    | 

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

F-4



---



##### Table of Contents



AdvancePCS and Subsidiaries

Consolidated Statements of Stockholders Equity
For the Years Ended March 31, 1999, 2000, and 2001

|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |            |  |  |   |             |  
|--------------------------------------------- | -------------------------------------------------------- |  | ---- | ---------- | - | ------- | ---------- | ---------- | ---- |  | - | ---------- |  |  | - | ----------- | -
|                                              |                                                          |  |      |            |   |         | Unreported |           
|                                              |                                                          |  |      |            |   |         | Period     |           
|                                              |                                                          |  | 1999 |            |   | 1999(1) |            |            | 2000 |  |   | 2001       | 
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |            | 
|Common stock  Class A (# of shares)         
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  |      | 21,308,944 |   |         |            | 24,556,898 |      |  |   | 24,556,898 |  |  |   | 25,017,154  |  
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series B Preferred Stock to Common Stock   |  |      | 2,222,222  |   |         |            |           |      |  |   |           | 
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series A-2 Preferred Stock to Common Stock |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 6,250,000   |  
|                                             
|                                             
|                                             
|                                             
|                                              | Investment in CHI                                        |  |      |           |   |         |            |           |      |  |   | 231,884    |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Stock issued with the exercise of options and warrants   |  |      | 1,025,732  |   |         |            |           |      |  |   | 228,372    |  |  |   | 1,015,153   |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  |      | 24,556,898 |   |         |            | 24,556,898 |      |  |   | 25,017,154 |  |  |   | 32,282,307  |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Common Stock  Class A (dollars)             
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  | $    | 214,000    |   |         | $          | 246,000    |      |  | $ | 246,000    |  |  | $ | 250,000     |  
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series B Preferred Stock to Common Stock   |  |      | 22,000     |   |         |            |           |      |  |   |           |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series A-2 Preferred Stock to Common Stock |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 62,000      |  
|                                             
|                                             
|                                             
|                                             
|                                              | Investment in CHI                                        |  |      |           |   |         |            |           |      |  |   | 2,000      |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Stock issued with the exercise of options and warrants   |  |      | 10,000     |   |         |            |           |      |  |   | 2,000      |  |  |   | 10,000      |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  | $    | 246,000    |   |         | $          | 246,000    |      |  | $ | 250,000    |  |  | $ | 322,000     |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Common Stock  Class B-1 (# of shares)       
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  |      |           |   |         |            |           |      |  |   |           |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of Series B-1 Common Stock                      |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 4,207,300   |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 4,207,300   |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Common Stock  Class B-1 (dollars)           
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  | $    |           |   |         | $          |           |      |  | $ |           |  |  | $ |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of Series B-1 Common Stock                      |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 42,000      |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  | $    |           |   |         | $          |           |      |  | $ |           |  |  | $ | 42,000      |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Preferred Stock  Class A-1 (# of shares)    
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  |      |           |   |         |            |           |      |  |   |           |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of Series A-1 Preferred Stock                   |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 65,854      |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 65,854      |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Preferred Stock  Class A-1 (dollars)        
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  | $    |           |   |         | $          |           |      |  | $ |           |  |  | $ |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of Series B-1 Common Stock                      |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 1,000       |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  | $    |           |   |         | $          |           |      |  | $ |           |  |  | $ | 1,000       |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Preferred Stock  Class A-2 (# of shares)    
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  |      |           |   |         |            |           |      |  |   |           |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of Series A-2 Preferred Stock                   |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 125,000     |  
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series A-2 Preferred Stock to Common Stock |  |      |           |   |         |            |           |      |  |   |           |  |  |   | (125,000    | )
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  |      |           |   |         |            |           |      |  |   |           |  |  |   |            |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Preferred Stock  Class A-2 (dollars)        
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  | $    |           |   |         | $          |           |      |  | $ |           |  |  | $ |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of Series A-2 Preferred Stock                   |  |      |           |   |         |            |           |      |  |   |           |  |  |   | 1,000       |  
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series A-2 Preferred Stock to Common Stock |  |      |           |   |         |            |           |      |  |   |           |  |  |   | (1,000      | )
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  | $    |           |   |         | $          |           |      |  | $ |           |  |  | $ |            |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Preferred Stock  Series B (# of shares)     
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  |      | 4,444      |   |         |            |           |      |  |   |           |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series B Preferred Stock to Common Stock   |  |      | (4,444     | ) |         |            |           |      |  |   |           |  |  |   |            |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  |      |           |   |         |            |           |      |  |   |           |  |  |   |            |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Additional Paid-In Capital                   
|                                             
|                                             
|                                             
|                                             
|                                              | Balance at beginning of year                             |  | $    | 43,039,000 |   |         | $          | 48,795,000 |      |  | $ | 48,795,000 |  |  | $ | 58,927,000  |  
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series B Preferred Stock to Common Stock   |  |      | (22,000    | ) |         |            |           |      |  |   |           |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Conversion of Series A-2 Preferred Stock to Common Stock |  |      |           |   |         |            |           |      |  |   |           |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of stock for investment in CHI                  |  |      |           |   |         |            |           |      |  |   | 4,998,000  |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Stock issued with the exercise of options and warrants   |  |      | 2,415,000  |   |         |            |           |      |  |   | 1,567,000  |  |  |   | 6,748,000   |  
|                                             
|                                             
|                                             
|                                             
|                                              | Purchase of treasury stock                               |  |      | (14,000    | ) |         |            |           |      |  |   |           |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Tax benefit of stock options                             |  |      | 877,000    |   |         |            |           |      |  |   |           |  |  |   | 7,266,000   |  
|                                             
|                                             
|                                             
|                                             
|                                              | Exercise of employee stock options and other             |  |      |           |   |         |            |           |      |  |   | 3,323,000  |  |  |   |            |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of stock for acquisitions                       |  |      |           |   |         |            |           |      |  |   | 244,000    |  |  |   | 274,896,000 |  
|                                             
|                                             
|                                             
|                                             
|                                              | Issuance of warrants and options                         |  |      | 2,500,000  |   |         |            |           |      |  |   |           |  |  |   | 3,785,000   |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  | $    | 48,795,000 |   |         | $          | 48,795,000 |      |  | $ | 58,927,000 |  |  | $ | 351,622,000 |  
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|Accumulated Other Comprehensive Income (Loss)
|                                             
|                                             
|                                             
|                                             
|                                              | Pension liability adjustment                             |  | $    |           |   |         | $          |           |      |  | $ |           |  |  | $ | (3,849,000  | )
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           
|                                              | Balance at end of year                                   |  | $    |           |   |         | $          |           |      |  | $ |           |  |  | $ | (3,849,000  | )
|                                              |                                                          |  |      |            |   |         |            |            |      |  |   |           



---

F-5



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##### Table of Contents



AdvancePCS and Subsidiaries

Consolidated Statements of Stockholders Equity (cont.)
For the Years Ended March 31, 1999, 2000, and 2001

|                     |                              |  |      |            |   |      |            |            |      |  |   |            |   |  |   |            |  
|-------------------- | ---------------------------- |  | ---- | ---------- | - | ---- | ---------- | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                     |                              |  |      |            |   |      | Unreported |           
|                     |                              |  |      |            |   |      | Period     |           
|                     |                              |  | 1999 |            |   | 1999 |            |            | 2000 |  |   | 2001       |  
|                     |                              |  |      |            |   |      |            |            |      |  |   |            |  
|Accumulated Earnings
|                    
|                    
|                    
|                    
|                     | Balance at beginning of year |  | $    | 7,089,000  |   |      | $          | 19,732,000 |      |  | $ | 19,941,000 |   |  | $ | 38,867,000 |  
|                    
|                    
|                    
|                    
|                     | Net Income                   |  |      | 14,144,000 |   |      |            | 509,000    |      |  |   | 20,876,000 |   |  |   | 22,668,000 |  
|                    
|                    
|                    
|                    
|                     | Distributions to FFI owners  |  |      | (1,265,000 | ) |      |            | (300,000   | )    |  |   | (1,950,000 | ) |  |   | (3,970,000 | )
|                    
|                    
|                    
|                    
|                     | Purchase of treasury stock   |  |      | (236,000   | ) |      |            |           |      |  |   |           |   |  |   |           |  
|                     |                              |  |      |            |   |      |            |            |      |  |   |           
|                     | Balance at end of year       |  | $    | 19,732,000 |   |      | $          | 19,941,000 |      |  | $ | 38,867,000 |   |  | $ | 57,565,000 |  
|                     |                              |  |      |            |   |      |            |            |      |  |   |           
|Comprehensive Income
|                    
|                    
|                    
|                    
|                     | Net income                   |  | $    | 14,144,000 |   |      | $          | 509,000    |      |  | $ | 20,876,000 |   |  | $ | 22,668,000 |  
|                    
|                    
|                    
|                    
|                     | Pension liability adjustment |  |      |           |   |      |            |           |      |  |   |           |   |  |   | (3,849,000 | )
|                     |                              |  |      |            |   |      |            |            |      |  |   |           
|                     | Total comprehensive income   |  | $    | 14,144,000 |   |      | $          | 509,000    |      |  | $ | 20,876,000 |   |  | $ | 18,819,000 |  
|                     |                              |  |      |            |   |      |            |            |      |  |   |           

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

F-6



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##### Table of Contents



AdvancePCS and Subsidiaries

Consolidated Statements of Cash Flows

|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |           |             |             |              |            |              |              |  
|---------------------------------------------------------- | ---------------------------------------------------------------------------------- | ------------------------------------------ | ------------------------------------------------------------------------------ | --------------------------------------------------- | --------- | --------------------- | ----------- | ----------- | --------- | ----------- | ----------- | ------------ | ---------- | ------------ | ------------ | -
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           | Years Ended March 31, |            
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |            
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           | 1999                  |             |             | 2000      |             |             | 2001         |           
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |           |             |             |              |           
|Cash flows from operating activities:                     
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Net income                                                                         |                                            | $                                                                              | 14,144,000                                          |           |                       | $           | 20,876,000  |           |             | $           | 22,668,000   |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Adjustments to reconcile net income to net cash
provided by operating activities 
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    | Depreciation and amortization              |                                                                                |                                                     | 3,836,000 |                       |             |             | 9,110,000 |             |             |              | 47,797,000 |             
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    | Non-recurring and impairment expense       |                                                                                |                                                     |          |                       |             |             |          |             |             |              | 7,862,000  |             
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    | Loss on disposal of assets                 |                                                                                |                                                     |          |                       |             |             | 160,000   |             |             |              |           |             
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    | Provision for doubtful accounts            |                                                                                |                                                     | 2,544,000 |                       |             |             | 923,000   |             |             |              | 8,204,000  |             
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    | Deferred income taxes                      |                                                                                |                                                     | 1,312,000 |                       |             |             | 1,307,000 |             |             |              | (2,219,000 | )           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    | Value of options and warrants issued       |                                                                                |                                                     |          |                       |             |             |          |             |             |              | 3,785,000  |             
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    | Change in certain assets and liabilities 
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    |                                            | Accounts receivable                                                            |                                                     |           | (45,493,000           | )           |             |           | (76,050,000 | )           |              |            | (277,558,000 | )           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    |                                            | Inventories                                                                    |                                                     |           | (1,128,000            | )           |             |           | (1,950,000  | )           |              |            | (2,068,000   | )           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    |                                            | Prepaid expenses and other assets                                              |                                                     |           | (953,000              | )           |             |           | (588,000    | )           |              |            | (4,262,000   | )           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           |                                                                                    |                                            | Claims and accounts payable, accrued
expenses
and other noncurrent liabilities |                                                     |           | 55,298,000            |             |             |           | 77,401,000  |             |              |            | 288,071,000  |             
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |          
|                                                           |                                                                                    |                                            |                                                                                | Net cash provided by operating
activities           |           |                       | 29,560,000  |             |           |             | 31,189,000  |              |            |              | 92,280,000   |  
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |          
|Cash flows from investing activities:                     
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Purchases of property and equipment                                                |                                            |                                                                                | (7,860,000                                          | )         |                       |             | (22,807,000 | )         |             |             | (41,197,000  | )         
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Purchase of subsidiaries, net of cash acquired                                     |                                            |                                                                                | (89,701,000                                         | )         |                       |             |            |           |             |             | (722,045,000 | )         
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |          
|                                                           |                                                                                    |                                            |                                                                                | Net cash used in investing activities               |           |                       | (97,561,000 | )           |           |             | (22,807,000 | )            |            |              | (763,242,000 | )
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |          
|Cash flows from financing activities:                     
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Net proceeds from issuance of Common Stock                                         |                                            |                                                                                | 2,425,000                                           |           |                       |             | 1,811,000   |           |             |             | 6,759,000    |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Proceeds from old credit facility                                                  |                                            |                                                                                | 50,000,000                                          |           |                       |             | 37,000,000  |           |             |             |             |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Stock issued to fund acquisition                                                   |                                            |                                                                                |                                                    |           |                       |             |            |           |             |             | 150,000,000  |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Issuance of debt to fund acquisition                                               |                                            |                                                                                |                                                    |           |                       |             |            |           |             |             | 620,000,000  |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Issuance of senior notes to fund acquisition                                       |                                            |                                                                                |                                                    |           |                       |             |            |           |             |             | 200,000,000  |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Borrowings on new credit facilities                                                |                                            |                                                                                |                                                    |           |                       |             |            |           |             |             | 255,000,000  |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Repayment of RiteAid senior subordinated notes                                     |                                            |                                                                                |                                                    |           |                       |             |            |           |             |             | (200,000,000 | )         
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Payments on new credit facility                                                    |                                            |                                                                                |                                                    |           |                       |             |            |           |             |             | (230,000,000 | )         
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Payments on old credit facility                                                    |                                            |                                                                                | (10,000                                             | )         |                       |             | (37,000,000 | )         |             |             | (50,000,000  | )         
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Capital lease obligations                                                          |                                            |                                                                                | (21,000                                             | )         |                       |             | 22,000      |           |             |             |             |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Deferred financing costs                                                           |                                            |                                                                                |                                                    |           |                       |             |            |           |             |             | (22,022,000  | )         
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Distributions
to FFI owners                                                        |                                            |                                                                                | (1,266,000                                          | )         |                       |             | (1,950,000  | )         |             |             | (3,970,000   | )         
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Purchase of treasury shares                                                        |                                            |                                                                                | (250,000                                            | )         |                       |             |            |           |             |             |             |           
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |          
|                                                           |                                                                                    |                                            |                                                                                | Net cash provided by (used in) financing
activities |           |                       | 50,878,000  |             |           |             | (117,000    | )            |            |              | 725,767,000  |  
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |          
|Net increase in cash during unreported period (see
Note 2) |                                                                                    |                                            |                                                                               |                                                     |           |                       | 1,083,000   |             |           |             |            |             
|                                                          
|                                                          
|                                                          
|                                                          
|Net increase (decrease) in cash and cash
equivalents       |                                                                                    |                                            | (17,123,000                                                                    | )                                                   |           |                       | 9,348,000   |             |           |             | 54,805,000  |             
|                                                          
|                                                          
|                                                          
|                                                          
|Cash and cash equivalents, beginning of year               |                                                                                    |                                            | 63,018,000                                                                     |                                                     |           |                       | 45,895,000  |             |           |             | 55,243,000  |             
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |          
|Cash and cash equivalents, end of year                     |                                                                                    | $                                          | 45,895,000                                                                     |                                                     |           | $                     | 55,243,000  |             |           | $           | 110,048,000 |             
|                                                           |                                                                                    |                                            |                                                                                |                                                     |           |                       |             |             |          
|Supplementary information:                                
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Cash paid for interest                                                             |                                            | $                                                                              |                                                    |           |                       | $           | 3,943,000   |           |             | $           | 32,974,000   |           
|                                                          
|                                                          
|                                                          
|                                                          
|                                                           | Cash paid for income taxes                                                         |                                            | $                                                                              | 5,900,000                                           |           |                       | $           | 7,000,000   |           |             | $           | 21,000,000   |           
|                                                          
|                                                          
|                                                          
|                                                          
|Assets acquired and liabilities assumed (see Note 3)      

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

F-7



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##### Table of Contents



AdvancePCS and Subsidiaries

Notes to Consolidated Financial Statements

1. General

AdvancePCS and Subsidiaries (the Company or Advance), a Delaware
corporation, is a leading independent provider of health benefit management
services, providing integrated pharmacy benefit management, disease management,
clinical trials and research and other health related programs. The Company
markets its services to managed care organizations, third-party health plan
administrators, insurance companies, government agencies, employer groups and
labor union-based trusts. In addition, the Company transacts business with
pharmaceutical manufacturers as both suppliers and customers.

In October 2000, we acquired PCS Holding Corporation (PCS) for an
aggregate purchase price of approximately $1.0 billion, of which we paid Rite
Aid Corporation (Rite Aid), the seller, $675 million in cash, and issued to
Rite Aid $200 million in senior subordinated notes and $125 million of our
convertible preferred stock. PCS, based in Scottsdale, Arizona, was one of the
nations largest pharmacy benefit managers (PBMs) and the originator of the
on-line pharmacy claim processing system.

In July of 2000, we merged with FFI Health Services, a privately held
health benefit management and direct-to-consumer pharmaceutical marketing
services company. FFI Health Services includes the operations of the affiliated
companies, First Florida International Holdings, Inc., Phoenix Communications
International, Inc., Innovative Pharmaceutical Strategies, Inc., HMN Health
Services, and Mature Rx Plus of Nevada, Inc. (collectively FFI). FFI, based
in Cleveland, Ohio, offers several pharmacy-related product lines marketed
under the names AvidaRx(TM), femScript(R), MatureRx(R) and MatureRx Plus(TM) to
under-insured or uninsured individuals, women, and senior citizens. In
addition, FFI provides prescription benefit management services to employers,
health plans, and third party administrators.

During the year ended March 31, 1999, the Company purchased two companies
for cash. Foundation Health Pharmaceutical Services, Inc. (FHPS) was acquired
on March 31, 1999, for approximately $70 million. FHPS was the pharmacy benefit
management business of Foundation Health Systems, Inc. (FHS). On December 1,
1998, Baumel-Eisner Neuromedical Institute (Baumel-Eisner) was acquired for
approximately $25 million. Baumel-Eisner was a privately held clinical trials
company based in South Florida. (See Note 3)

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements give retroactive
effect, for all periods presented, to the combination of Advance and FFI on
July 5, 2000, which has been accounted for as a pooling of interests. The
consolidated balance sheets include Advances historical balance sheets as of
March 31, 1999 and 2000, and the corresponding FFI balance sheets at December
31, 1998 and March 31, 2000.

The consolidated statements of operations, stockholders equity and cash
flows include the Companys historical statements of operations, stockholders
equity, and cash flows for each of the three years in the period ended March
31, 2001, and the corresponding historical statements of operations,
stockholders equity, and cash flows of FFI for the years ended December 31,
1998 and the historical statements for the fiscal years ended March 31, 2000
and 2001. The three month period from January 1, 1999 through March 31, 1999,
(the unreported period), including $13,330,000 and $509,000 in revenues and
net income of FFI, respectively, is not reported in the consolidated financial
statements. In accordance with APB Opinion No. 16, Accounting for Business
Combinations, the unreported period is included in the beginning accumulated
earnings of the consolidated balance sheet as of March 31, 2000, to conform the
year-ends of Advance and FFI. The consolidated statements of stockholders
equity reflect the exchange of all outstanding FFI common shares for the 3.5
million shares of Advance Common Stock as if such exchange happened at April 1,
1998. (see Note 3).

Use of Estimates

Preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts
of revenues and expenses during the reporting periods. As of March 31, 2001 the
Company had made significant estimates of the purchase price, fair market value
of the assets acquired and liabilities assumed in the PCS
F-8Table of Contentsacquisition; clinical service revenues, and costs; reserves for
uncollectable accounts and contract losses; and the value of our investment in
Consumer Health Interactive, among others. The Company continually evaluates
the appropriateness of the amounts recorded and revises these estimates
regularly. Actual results could differ from those estimates.Operating SegmentThe Company operates as a single operating segment. The chief executive
officer (CEO) of the Company is considered the chief operating decision-maker
and reviews the financial information on a consolidated basis. Typically, all of our services are provided
to each of our customers and are negotiated as part of a single contract. Our services
have similar economic characteristics and are interdependent. The CEO does review discrete revenue
information by service as reflected below for each of the periods presented.

|          |                             |                |   |                                       |         |  |      |           |           |          |   |           |           | 
|--------- | --------------------------- | -------------- | - | ------------------------------------- | ------- |  | ---- | --------- | --------- | -------- | - | --------- | --------- | 
|          |                             |                |   | Year Ended March 31,                  |        
|          |                             |                |   |                                       |        
|          |                             |                |   | 1999                                  |         |  | 2000 |           |           | 2001 (1) |  
|          |                             |                |   |                                       |         |  |      |           |           |          |  
|          |                             |                |   | (In thousands, except per share data) |        
|Revenues: |                             |                |   |                                       |         |  |      |           |           |          |   |          
|          | Data services               |                | $ | 554,716                               |         |  | $    | 1,558,113 |           |          | $ | 6,010,692 |          
|          | Mail services               |                |   | 127,297                               |         |  |      | 184,103   |           |          |   | 714,294   |          
|          | Clinical and other services |                |   | 75,246                                |         |  |      | 91,672    |           |          |   | 299,312   |          
|          |                             | Total revenues |   |                                       | 757,259 |  |      |           | 1,833,888 |          |   |           | 7,024,298 | 



|(1) |  | Includes PCS data since the acquisition on October 2,
2000.
|--- |  | -----------------------------------------------------------

Cash and Cash Equivalents

Cash and cash equivalents include overnight investments, money market
accounts, and high-grade commercial paper with original maturities of three
months or less.

Accounts Receivable

As of March 31, 2000 and 2001, unbilled receivables were $98,624,000 and
$418,642,000, respectively. Unbilled receivables to clients are typically
billed within 15 days based on the contractual billing schedule agreed upon
with the client.

Inventories

Inventories consist of purchased pharmaceuticals stated at the lower of
cost or market under the first-in, first-out method.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation is computed on the straight-line method over
estimated useful lives ranging from three to twenty years. Amortization of
internal use software and leasehold improvements is computed over the lives of
the assets or the lease terms, whichever is shorter. Major renewals and
betterments are added to the property and equipment accounts while costs of
repairs and maintenance are charged to operating expenses in the period
incurred. The cost of assets retired, sold, or otherwise disposed of and the
applicable accumulated depreciation are removed from the accounts, and the
resultant gain or loss, if any, is reflected in the statement of operations.

Goodwill and Other Intangible Assets

Goodwill represents the excess of cost over the fair market value of
tangible net assets acquired. Goodwill is amortized on a straight-line basis
over periods from 25 to 40 years with a weighted average of 29 years. Goodwill
amortization expense was approximately $668,000, $3,354,000, and $23,775,000 in
the years ended March 31, 1999, 2000, and 2001, respectively and is included in
selling, general, & administrative expenses. Based on an external valuation,
other Intangibles consists of customer contracts, trade name, internally
developed software, assembled workforce acquired, and noncompete agreements.
The Company estimates the acquired trade name will be used indefinitely and
amortizes it over 40 years. Customer contracts and noncompete agreements are
amortized over 15 to 30 years. Acquired software and assembled workforce are
being amortized over 7 to 12 years. Other Intangible Asset amortization
expense was approximately $22,000 $533,000, and $6,908,000 in the years ended
March 31, 1999, 2000, and 2001, respectively, and is included in selling,
general, and administrative expenses. Goodwill and Other Intangible Assets
include the following at March 31, 2001:

|                              |                               |                               |           |                |           |  
|----------------------------- | ----------------------------- | ----------------------------- | --------- | -------------- | --------- | -
|                              |                               |                               |           | 2001           |          
|                              |                               |                               |           | (in thousands) |          
|                              |                               |                               |          
|Goodwill                     
|                             
|                             
|                             
|                             
|                              |                               | Goodwill                      |           | $              | 1,311,489 |  
|                             
|                             
|                             
|                             
|                              |                               | Less accumulated amortization |           |                | (29,297   | )
|                              |                               |                               |          
|Net goodwill                  |                               | $                             | 1,282,192 |               
|                              |                               |                               |          
|Other intangibles assets     
|                             
|                             
|                             
|                             
|                              |                               | Customer base                 |           | $              | 265,600   |  
|                             
|                             
|                             
|                             
|                              |                               | Trade name                    |           |                | 106,600   |  
|                             
|                             
|                             
|                             
|                              |                               | Contracts                     |           |                | 7,000     |  
|                             
|                             
|                             
|                             
|                              |                               | Other                         |           |                | 11,200    |  
|                              |                               |                               |          
|Total other intangible assets |                               |                               | 390,400   |               
|                             
|                             
|                             
|                             
|                              | Less accumulated amortization |                               |           | (7,463         | )        
|                              |                               |                               |          
|Net other intangible assets   |                               | $                             | 382,937   |               
|                              |                               |                               |          

Other Assets

Other assets consist primarily of deferred financing costs and investments
in equity securities. Deferred financing costs of $22,022,000 represent fees
incurred in connection with the issuance of our subordinated debt and the
senior credit facility and are amortized over the life of the related debt. In
fiscal year 2000, the Company issued 231,884 shares of its Common Stock, valued
at $5,000,000, to acquire a 19 percent interest in Consumer Health Interactive,
Inc. (CHI). The Company

F-9



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##### Table of Contents



does not control CHI nor does it hold a majority of CHI board seats. The
investment is carried at cost and reflected in other assets. CHI has been in
the development stage and has incurred operating losses. The Company evaluated
whether the downturn in the economy and the operating losses indicate a
possible impairment of this investment. The assessment of possible impairment
is based on the ability to recover the carrying amount of the asset considering
the financial condition and near-term prospects of the issuer, and or intent
and ability to retain the investment for a period of time to allow for recovery
of any loss in estimated value. Management has assessed that a decline in
value, if any, is temporary in nature. However, given the development stage of
CHI and the current market conditions, there can be no assurance that CHI will
be able to generate cash flows in the near term or that the Company will
ultimately be able to realize its investment.

Impairment of Long-Lived Assets

The Company evaluates whether events and circumstances have occurred that
indicate the remaining estimated useful life of long-lived assets, including
goodwill and other intangibles, may warrant revision or that the remaining
balance of an asset may not be recoverable. The assessment of possible
impairment is based on the ability to recover the carrying amount of the asset
from expected future cash flows on an undiscounted basis. If the assessment
indicates that the carrying amount of the asset exceeds the undiscounted cash
flows, an impairment has occurred. The impairment is calculated as the total by
which the carrying amount of the asset exceeds its fair value. The fair value
of long-lived assets and goodwill is estimated based on quoted market prices,
if available, or the expected total value of the cash flows on a discounted
basis. The Company recorded no impairment charges in fiscal 1999 or 2000. With
respect to 2001 see Note 6.

Fair Value of Financial Instruments and Derivatives

The carrying values of cash, receivables, payables, and accrued
liabilities approximate the fair values of these instruments because of their
short-term maturities. The fair value of the Companys bank debt and Senior
Notes, which approximates the carrying value, was estimated at current rates
for similar debt with similar maturity. We have entered into an interest rate
swap as of November 2000 in order to manage exposure to interest rate risk. The
interest rate swap is designated as a hedge of variable interest rate payments
under our credit facility. Amounts received or paid are recorded as interest
expense. The fair value of the swap, an obligation of $12,565,000 at March 31,
2001 was based upon quoted market prices. The fair value represents the
estimated amount the Company would have to pay to terminate the swap agreement
taking into account current interest rates at March 31, 2001.

Other Noncurrent Liabilities

Other noncurrent liabilities are primarily composed of deferred
compensation and pension obligations.

Revenue Recognition

Revenues from the dispensing of pharmaceuticals from the Companys mail
service pharmacies are recognized when each prescription is shipped. Revenues
from the sales of prescription drugs by pharmacies in the Companys nationwide
network and claims processing fees are recognized when the claims are
adjudicated. At the point of sale, the pharmacy claims are adjudicated using
the Companys on-line claims processing system.

When the Company independently contracts to pay its network pharmacy
providers, it assumes credit risk and acts as a principal in the transaction,
therefore the Company includes payments from plan sponsors for these benefits
as revenues and payments to its pharmacy providers as cost of revenues (i.e.
gross reporting) in accordance with EIFT 99-19 Reporting Gross Revenue as a
Principal vs Net as an Agent. When the Company is only
administering the plan sponsors network pharmacy contracts, it does
not assume credit risk or act as a principal in the transaction,
therefore the Company only records the claims processing fees as
revenues (i.e. net reporting).

Clinical services fees received from the
plan sponsors or pharmaceutical manufacturers are recognized in revenues as
earned in accordance with the contractual agreements. Clinical
services revenue includes service fees for negotiating rebates with
pharmaceutical manufacturers on behalf of its health plan sponsor
customers. The rebate due from the manufacturer is determined based
on a complex formula including such factors as volume and quarterly
drug utilization. The Company estimates the most recent quarter's
rebate receivables from the manufacturers, rebate payable to plan
sponsors and its fees based on the terms of its contracts and claims
for the quarter. Following the end of the quarter, the Company
invoices the drug manufacturer. The Company revises its estimates
based upon the invoiced amounts.
Rebates received from pharmaceutical manufacturers on behalf of plan sponsors
are excluded from revenues. Clinical services revenues from certain disease management and
health benefit management products are reimbursed at predetermined contractual
rates based on the delivery or completion of the services.

In December 1999, the SEC staff issued Staff Accounting Board (SAB) No.
101 Revenue Recognition in Financial Statements. SAB 101 provides guidance
on applying generally accepted accounting principles to revenue recognition
issues in financial statements. The Company adopted SAB 101 in the fourth
quarter of 2001. The adoption of SAB 101 had no material impact on the
statement of operations. The Company adopted EITF 99-19 in the third quarter of
2001 as discussed above. In addition, the EITF issued a consensus in EITF
00-22 Accounting for...Other Volume Based Sales Incentive

F-10



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##### Table of Contents



Offers. The Company adopted EITF 00-22 in the fourth fiscal quarter for
2001. EITF 00-22 had no material effect on the statement of operations.

The Company purchased PCS on October 2, 2000 and has included this
business in our consolidated results of operations since that date. The
Company changed its revenue recognition policy to conform with the different
policies used by Advance and PCS. Historically, PCS had recorded its claims
processing fees net as opposed to gross as discussed above. In addition the
historical statements of operations of the Company have been revised to
recognize clinical service fees in accordance with the current policy, as
discussed above, and conform its policy with those previously followed by PCS.
Previously, the Company recognized the entire amount of the rebate, including
the service fee, in revenues and the portion of the rebate paid to plan
sponsors in cost of revenues. The change in policy resulted in lower revenues
and an equal decrease in cost of revenues. The change had no effect on gross
profit or operating income.

Cost of Revenues

Cost of revenues includes product costs, pharmacy claims payments made to
our retail network pharmacies, and other direct costs associated with the sale
and/or dispensing of prescriptions. Rebate amounts paid to plan sponsors,
collected from pharmaceutical manufacturers, are excluded from cost of
revenues.

Stock Split

On October 12, 1999, the Company announced a two-for-one stock split,
effected in the form of a stock dividend of the Companys common stock. The
record date was November 11, 1999, and the date of payment was November 30,
1999. Financial information and stock prices contained throughout the financial
statements have been retroactively adjusted to reflect the impact of the stock
split in all periods presented.

Net Income Per Share

Net income per share is computed using the weighted average number of
common and dilutive shares outstanding during the period. A reconciliation of
the numerators and denominators of the basic and diluted per-share computations
follows:

|        |                            |                                                      |                      |   |                      |      |  |      |            |      |      |   |            |      | 
|------- | -------------------------- | ---------------------------------------------------- | -------------------- | - | -------------------- | ---- |  | ---- | ---------- | ---- | ---- | - | ---------- | ---- | 
|        |                            |                                                      |                      |   | Year Ended March 31, |     
|        |                            |                                                      |                      |   |                      |     
|        |                            |                                                      |                      |   | 1999                 |      |  | 2000 |            |      | 2001 |  
|        |                            |                                                      |                      |   |                      |      |  |      |            |      |      |  
|Basic  
|       
|       
|       
|       
|        | Numerator:                
|       
|       
|       
|       
|        |                            | Net income                                           |                      | $ | 14,144,000           |      |  | $    | 20,876,000 |      |      | $ | 22,668,000 |     
|        |                            |                                                      |                      |   |                      |      |  |      |           
|        | Denominator:              
|       
|       
|       
|       
|        |                            | Weighted average common stock
outstanding            |                      |   | 24,004,290           |      |  |      | 24,760,163 |      |      |   | 29,145,057 |     
|        |                            |                                                      |                      |   |                      |      |  |      |           
|        |                            |                                                      | Net income per share |   | $                    | 0.59 |  |      | $          | 0.84 |      |   | $          | 0.78 | 
|        |                            |                                                      |                      |   |                      |      |  |      |           
|Diluted
|       
|       
|       
|       
|        | Numerator:                
|       
|       
|       
|       
|        |                            | Net income                                           |                      | $ | 14,144,000           |      |  | $    | 20,876,000 |      |      | $ | 22,668,000 |     
|        |                            |                                                      |                      |   |                      |      |  |      |           
|        | Denominator:              
|       
|       
|       
|       
|        |                            | Weighted average common stock
Outstanding            |                      |   | 24,004,290           |      |  |      | 24,760,163 |      |      |   | 29,145,057 |     
|       
|       
|       
|       
|        | Other Dilutive Securities:
|       
|       
|       
|       
|        |                            | Preferred stock                                      |                      |   | 73,260               |      |  |      |           |      |      |   | 3,750,000  |     
|       
|       
|       
|       
|        |                            | Options and warrants using the treasury
stock method |                      |   | 2,798,652            |      |  |      | 2,977,053  |      |      |   | 3,293,736  |     
|        |                            |                                                      |                      |   |                      |      |  |      |           
|        |                            | Weighted average shares outstanding                  |                      |   | 26,876,202           |      |  |      | 27,737,216 |      |      |   | 36,188,793 |     
|        |                            |                                                      |                      |   |                      |      |  |      |           
|        |                            |                                                      | Net income per share |   | $                    | 0.53 |  |      | $          | 0.75 |      |   | $          | 0.63 | 
|        |                            |                                                      |                      |   |                      |      |  |      |           

Reclassification

Certain prior year amounts have been reclassified to conform with the
current year presentation.

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##### Table of Contents



Recent Accounting Pronouncements

In June 1998, SFAS 133 Accounting for Derivative Instruments and Hedging
Activities was issued. SFAS 133 requires all derivatives to be recognized as
either assets or liabilities in the statement of financial position and
measured at fair value. In addition, SFAS 133 specifies the accounting for
changes in the fair value of a derivative based on the intended use of the
derivative and the resulting designation. SFAS 133, as amended by SFAS 137 and
SFAS 138, is effective beginning in fiscal year March 31, 2002. We have entered
into interest rate protection agreements that have fixed the LIBOR rate as of
November 7, 2000 at 6.60% for $400 million of our variable rate debt under our
credit facility. The notional amount drops to $300 million in October 2001 and
to $200 million in October 2002. We will declare these agreements hedges in
accordance with SFAS 133, as amended, and will recognize the fair value of
these financial instruments on the balance sheet effective April 1, 2001 upon
adoption of SFAS 133. These instruments will be marked to market at each
reporting date with the adjustment recognized as a component of other
comprehensive income (loss) in stockholders equity. Upon adoption of SFAS 133
on April 1, 2001, the Company recorded a transition obligation of $12,565,000
related to an interest rate swap agreement. Additionally, the Company recorded
a charge to other comprehensive income of $12,565,000. (see Note 5)

In March 2000, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 44 (FIN 44), Accounting for Certain Transactions
Involving Stock Compensation  an Interpretation of APB Opinion No. 25. FIN
44 is intended to clarify the application of APB No. 25 by providing guidance
regarding among other issues: the definition of an employee for purposes of
applying APB Opinion No. 25; the criteria for determining whether a plan
qualifies as a noncompensatory plan; the accounting consequence of various
modifications to the terms of the previously fixed stock options or awards; and
the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 was effective July 1, 2000 but certain provisions covered
specific events occurring after December 15, 1998 or January 12, 2000. The
adoption of FIN 44 did not have a material impact on the Companys consolidated
financial position or results of operations.

In 1999, the FASB issued an exposure draft for a proposed statement on
business combinations and intangible assets (new rules). This exposure
draft, among other things, eliminates pooling of interest business
combinations, eliminates the amortization of goodwill and starts assessing
goodwill on the impairment approach. Non-calendar year-end companies that have
new fiscal years beginning after March 15, 2001, but before December 15, 2001,
have a choice for date of adoption of the new rules. March 31 year end
companies that issue first quarter financial statements before the new rules
are issued will not be eligible for this choice. During the first year of
application of the new rules, companies will test for goodwill impairment at
the transaction date. Management expects to adopt the new rules upon their
final issuance prior to the release of the Companys fiscal 2002 first quarter
financial statements.

See our Revenue Recognition policy for other new accounting pronouncements

3. Acquisitions

Effective October 1, 2000, Advance acquired all of the equity of PCS. The
aggregate purchase price paid by Advance was approximately $1.0 billion, of
which Advance paid Rite Aid, the seller, $675 million in cash, and issued to
Rite Aid $200 million in senior subordinated notes and $125 million in Advance
convertible preferred stock. The senior subordinated notes were paid in full in
March 2001 through proceeds obtained from the issuance of $200 million in
Senior Notes. The cash portion of the purchase price was financed with the
proceeds of an $825 million senior secured credit facility and $150 million in
equity financing committed by Joseph, Littlejohn & Levy, Inc. (JLL). The
acquisition of PCS has been accounted for using the purchase method of
accounting. The Company incurred approximately $50 million in acquisition
costs. The excess of the purchase price paid over the net identifiable assets
and liabilities of PCS has been recorded as goodwill.

The allocation of the net purchase price is as follows (in thousands):

|                              |  |   |           |  
|----------------------------- |  | - | --------- | -
|Assets                        |  | $ | 667,274   |  
|                             
|                             
|                             
|                             
|Goodwill                      |  |   | 1,212,840 |  
|                             
|                             
|                             
|                             
|Intangibles                   |  |   | 382,400   |  
|                             
|                             
|                             
|                             
|Liabilities assumed           |  |   | (968,514  | )
|                             
|                             
|                             
|                             
|Deferred income tax liability |  |   | (244,000  | )
|                              |  |   |          
|Net purchase price            |  | $ | 1,050,000 |  
|                              |  |   |          

The excess of the purchase price paid over the net identifiable assets and
liabilities of PCS has been recorded as goodwill. Identifiable intangible
assets are being amortized over 7 to 40 years. Goodwill is being amortized over
30 years.

F-12



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##### Table of Contents



The allocation of the purchase price may be adjusted in future periods based
upon further analysis of assets received and costs incurred in the acquisition.

The following unaudited pro forma information presents the results of
operations of the Company as if the PCS acquisition had taken place at the
beginning of the period presented (in thousands, except per share amounts):

|                                   |         |   |           |        |   |      |            |        | 
|---------------------------------- | ------- | - | --------- | ------ | - | ---- | ---------- | ------ | 
|                                   |         |   | 2000      |        |   | 2001 |           
|                                   |         |   |           |        |   |      |           
|Revenues                           |         | $ | 9,960,119 |        |   | $    | 11,311,942 |       
|                                  
|                                  
|                                  
|                                  
|Net income (loss)                  |         |   | (8,060    | )      |   |      | 495        |       
|                                  
|                                  
|                                  
|                                  
|Net income (loss) per share:      
|                                  
|                                  
|                                  
|                                  
|                                   | Basic   |   | $         | (0.28  | ) |      | $          | 0.02   | 
|                                  
|                                  
|                                  
|                                  
|                                   | Diluted |   | $         | (0.28  | ) |      | $          | 0.01   | 
|                                  
|                                  
|                                  
|                                  
|Weight average shares outstanding:
|                                  
|                                  
|                                  
|                                  
|                                   | Basic   |   |           | 28,967 |   |      |            | 31,249 | 
|                                  
|                                  
|                                  
|                                  
|                                   | Diluted |   |           | 28,967 |   |      |            | 43,060 | 

Pro forma information for 2001 includes
non-recurring and impairment
charges. Pro forma information for fiscal year 1999 would indicate a
significant loss due to the amortization and interest expense and the size of
Advance during that year. Management believes that such information
is not indicative of future operating results.

On July 5, 2000, Advance completed a merger with FFI (the Combination).
The Company issued 3.5 million shares of its common stock in exchange for all
the outstanding shares of FFI. The merger constituted a tax-free reorganization
and has been accounted for as a pooling of interests under APB 16.
Accordingly, all prior period consolidated financial statements presented have
been restated to include the combined results of operations, financial
position, and cash flows as though FFI had always been a part of the Company.
Total combination related costs and provisions were approximately $1,200,000
and reflected as an expense in the second fiscal quarter of 2001.

The table below presents a reconciliation of revenues and net income, as
reported in the consolidated statements of operations with those previously
reported by the Company. The references to Advance in this table are to the
Companys historical operating results prior to the merger with FFI.

|            |         |                               |   |                    |             |  |      |               |               | 
|----------- | ------- | ----------------------------- | - | ------------------ | ----------- |  | ---- | ------------- | ------------- | 
|            |         |                               |   | Fiscal Years Ended |            
|            |         |                               |   |                    |            
|            |         |                               |   | 1999               |             |  | 2000 |              
|            |         |                               |   |                    |             |  |      |              
|Revenues:  
|           
|           
|           
|           
|            | Advance |                               | $ | 692,873,000        |             |  | $    | 1,773,557,000 |              
|           
|           
|           
|           
|            | FFI     |                               |   | 64,386,000         |             |  |      | 60,331,000    |              
|            |         |                               |   |                    |             | 
|            |         | Total consolidated revenues   |   | $                  | 757,259,000 |  |      | $             | 1,833,888,000 | 
|            |         |                               |   |                    |             | 
|Net income:
|           
|           
|           
|           
|            | Advance |                               | $ | 12,694,000         |             |  | $    | 20,555,000    |              
|           
|           
|           
|           
|            | FFI     |                               |   | 1,450,000          |             |  |      | 321,000       |              
|            |         |                               |   |                    |             | 
|            |         | Total consolidated net
Income |   | $                  | 14,144,000  |  |      | $             | 20,876,000    | 
|            |         |                               |   |                    |             | 

On March 31, 1999, the Company acquired the outstanding stock of FHPS for
$70 million in cash and warrants to purchase 400,000 shares of its $0.01 par
value common stock (Common Stock). The Company valued such warrants at fair
market value based upon the Black-Scholes valuation model. Such warrants are
valued at $2.5 million. The acquisition has been accounted for using the
purchase method of accounting. The purchase price was allocated to goodwill,
certain customer contracts, and other intangible assets. Goodwill was valued at
approximately $61.3 million and is amortized on a straight-line basis over 30
years. Customer contracts were valued at $7.0 million and are amortized over 15
years.

The following unaudited pro forma information presents the results of
operations of the Company as if the FHPS acquisition had taken place at the
beginning of fiscal 1999 (in thousands, except net income per share amounts):

|                                     |         |   |         |        | 
|------------------------------------ | ------- | - | ------- | ------ | 
|                                     |         |   | 1999    |       
|                                     |         |   |         |       
|Revenues                             |         | $ | 838,247 |       
|                                    
|                                    
|                                    
|                                    
|Net income                           |         | $ | 14,000  |       
|                                    
|                                    
|                                    
|                                    
|Net income per share:               
|                                    
|                                    
|                                    
|                                    
|                                     | Basic   |   | $       | 0.58   | 
|                                    
|                                    
|                                    
|                                    
|                                     | Diluted |   | $       | 0.52   | 
|                                    
|                                    
|                                    
|                                    
|Weighted average shares outstanding:
|                                    
|                                    
|                                    
|                                    
|                                     | Basic   |   |         | 24,004 | 
|                                    
|                                    
|                                    
|                                    
|                                     | Diluted |   |         | 26,876 | 

F-13



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##### Table of Contents



In December 1998, the Company acquired the outstanding stock of
Baumel-Eisner for $25 million in cash. The acquisition has been accounted for
using the purchase method of accounting. Baumel-Eisners results have been
included in the Companys consolidated statements of operations since December
1998. The purchase price was allocated to the net assets acquired, primarily
goodwill, based on their estimated fair values. The excess of the purchase
price over the fair value of the net assets acquired (goodwill) was
approximately $24.2 million and is amortized on a straight-line basis over 25
years.

4. Property and Equipment

Property and equipment consisted of the following:

|                                                 |  |           |             |   |      |   |             |  
|------------------------------------------------ |  | --------- | ----------- | - | ---- | - | ----------- | -
|                                                 |  | March 31, |            
|                                                 |  |           |            
|                                                 |  | 2000      |             |   | 2001 |  
|                                                 |  |           |             |   |      |  
|Machinery and equipment                          |  | $         | 6,332,000   |   |      | $ | 21,224,000  |  
|                                                
|                                                
|                                                
|                                                
|Computer equipment and software                  |  |           | 29,468,000  |   |      |   | 61,400,000  |  
|                                                
|                                                
|                                                
|                                                
|Furniture and equipment                          |  |           | 4,915,000   |   |      |   | 21,563,000  |  
|                                                
|                                                
|                                                
|                                                
|Leasehold improvements                           |  |           | 5,029,000   |   |      |   | 17,780,000  |  
|                                                
|                                                
|                                                
|                                                
|Land and buildings                               |  |           | 1,674,000   |   |      |   | 12,393,000  |  
|                                                 |  |           |             |   |      |  
|                                                 |  |           | 47,418,000  |   |      |   | 134,360,000 |  
|                                                
|                                                
|                                                
|                                                
|Less  Accumulated depreciation and amortization |  |           | (14,311,000 | ) |      |   | (37,720,000 | )
|                                                 |  |           |             |   |      |  
|                                                 |  | $         | 33,107,000  |   |      | $ | 96,640,000  |  
|                                                 |  |           |             |   |      |  

5. Debt

In conjunction with our acquisition of PCS, the Company obtained an $825
million senior secured credit facility that includes a $175.0 million revolving
credit facility, $100 million interim revolving credit facility, and two term
notes totaling $550.0 million. The revolving credit facilities expire on
October 2, 2005. As of March 31, 2001, $95 million is outstanding under the
$175 million revolving credit facility and $0 is outstanding under the $100
million interim revolving credit facility. The term notes are due on October
2, 2005 and October 2, 2007. The revolving credit facilities accrue interest
at LIBOR plus 2.75%. The term notes accrue interest at LIBOR plus 2.75% and
LIBOR plus 3.5%. The credit facility contains covenants that are typical for
this type of debt, including limitations on capital expenditures,
minimum fixed charge, interest coverage, and total leverage ratios.
The Company is in compliance with all covenants. The
secured credit facility replaced the Companys previous $75.0 million,
three-year revolving credit facility dated April 1999.

The Company has entered into interest rate protection agreements
(interest rate swaps) that have fixed the LIBOR rate as of November 7, 2000
at 6.60% for $400 million of our variable rate debt under our credit facility.
The notional amount drops to $300 million in October 2001 and to $200 million
in October 2002. The fair value of the interest rate swaps, a liability of
$12,565,000, at March 31, 2001, was based upon quoted market prices.

In March 2001, the Company issued $200 million in 8 1/2 % Senior Notes Due
2008 (Senior Notes). The proceeds from this offering were used to retire the
$200 million senior subordinated notes due 2010 that were issued to Rite Aid in
connection with the PCS acquisition. The Senior Notes contain covenants that
are typical for this type of debt including, among others, fixed
charge ratio, payment of dividends, and sales of assets. The Senior Notes have been unconditionally
guaranteed, jointly and severally, by all of our subsidiaries, which are all
100% owned. There are no restrictions on the ability of the guarantors to pay
dividends, make loans or advances to the parent.

The following represents the schedule of current maturities for our
long-term debt (in thousands).

|                       |            |                      |   |         |         | 
|---------------------- | ---------- | -------------------- | - | ------- | ------- | 
|Years Ending March 31,
|                      
|                      
|                      
|                      
|                       | 2002       |                      | $ | 15,250  |        
|                      
|                      
|                      
|                      
|                       | 2003       |                      |   | 30,250  |        
|                      
|                      
|                      
|                      
|                       | 2004       |                      |   | 34,000  |        
|                      
|                      
|                      
|                      
|                       | 2005       |                      |   | 41,500  |        
|                      
|                      
|                      
|                      
|                       | 2006       |                      |   | 144,000 |        
|                      
|                      
|                      
|                      
|                       | thereafter |                      |   | 580,000 |        
|                       |            |                      |  
|                       |            | Total long-term debt |   | $       | 845,000 | 
|                       |            |                      |  

6. Acquisition Integration

Merger costs.Net income for the year ended March 31, 2001 reflected a
pre-tax charge of $1.2 million ($926,000 after taxes) relating to merger costs
incurred in connection with the merger with FFI.

Non-recurring and impairment expenses.Net income for the year ended March
31, 2001 reflects a non-recurring and impairment expenses of $11,129,000
($6,789,000 after taxes, or $0.19 per diluted share). This amount represents facility
impairment costs, and severance costs related to the integration and
rationalization of PCS and Advance personnel and facilities. Management
committed to this plan and publicly announced it in February 2001, and
subsequently initiated the plan. Under the terms of the plan Advances mail
facility in Richardson, Texas will be closed, within the first six months of
fiscal 2002, and

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operations moved to the PCS Fort Worth and Birmingham facilities. The Fort Worth and Birmingham facilities obtained in the acquisition of PCS had the capacity to immediately absorb the operations of Advance's mail facility in Richardson. This
action triggered an assessment of the recoverability of the Advance mail
facility carrying costs and the resulting recognition of an impairment loss.
The determination of the impairment loss was based on an evaluation
of the carrying amount vs. the estimated fair value less selling
costs of the mail facility to be abandoned using the
held-for-disposal model in accordance with SFAS No. 121,
Accounting for Impairment of Long-lived Assets and Long-lived
Assets to be Disposed of. The net book value
of the facility's non-current assets including property, equipment, and software
totaled $10,388,000. We estimated the fair value of these assets less
selling costs to be $2,669,000, resulting in a loss of $7,719,000.
Approximately $7,400,000 of the loss is attributable to mail services
software that has no fair market value or alternative use. In
addition, the non-recurring expenses include severance costs for
the mail facility and other Advance management employees that were terminated or
resigned as a result of the acquisition with PCS. All of these severance costs
to management employees were paid prior to March 31, 2001. Payments made to
terminated employees were based substantially on a standard severance package
available to employees. The following summarizes the expenses:

|                                          |                                    |   |            |           | 
|----------------------------------------- | ---------------------------------- | - | ---------- | --------- | 
|                                          | Impairment of Mail Facility        | $ | 7,719,000  |          
|                                         
|                                         
|                                         
|                                         
|                                          | Severance and other employee costs |   |            | 2,982,000 | 
|                                         
|                                         
|                                         
|                                         
|                                          | Other                              |   |            | 428,000   | 
|                                          |                                    |   |           
|Total non-recurring & impairment expenses |                                    | $ | 11,129,000 |          
|                                          |                                    |   |           

The Company expects to consolidate certain additional operations in
connection with the integration of PCS, which will result in additional
non-recurring charges consisting primarily of severance costs, fixed asset and
software disposals and other related costs in the year ended March 31, 2002.

7. Leases

The Company leases office and dispensing facility space, equipment, and
automobiles under various operating leases. The Company was obligated to make
future minimum payments under noncancelable operating lease agreements as of
March 31, 2001, as follows:

|                       |                     |                              |   |            |             | 
|---------------------- | ------------------- | ---------------------------- | - | ---------- | ----------- | 
|Years Ending March 31,
|                      
|                      
|                      
|                      
|                       | 2002                |                              | $ | 26,474,000 |            
|                      
|                      
|                      
|                      
|                       | 2003                |                              |   | 20,082,000 |            
|                      
|                      
|                      
|                      
|                       | 2004                |                              |   | 14,644,000 |            
|                      
|                      
|                      
|                      
|                       | 2005                |                              |   | 11,153,000 |            
|                      
|                      
|                      
|                      
|                       | 2006 and thereafter |                              |   | 55,301,000 |            
|                       |                     |                              |  
|                       |                     | Total minimum lease payments |   | $          | 127,654,000 | 
|                       |                     |                              |  

Total rent expense incurred in the years ended March 31, 1999, 2000, and
2001 was approximately $4,435,000, $6,302,000, and $18,735,000 respectively.

8. Commitments and Contingencies

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

In November 1999, PCS received a subpoena by the Department of Health and
Human Services Office of Inspector General, or OIG, requesting PCS to produce
certain documents about its programs and how they operate in connection with an
industry-wide investigation. The investigation was instigated and is being
pursued by the United States Attorneys Office for the Eastern District of
Pennsylvania, which indicated an intention to review PBMs programs in light of
anti-kickback and other laws and regulations. Specifically, the focus of this
investigation appears to be PBMs relationships with pharmaceutical
manufacturers and retail pharmacies and PBMs programs relating to drug
formulary compliance, including rebate and other payments made by
pharmaceutical manufacturers to PBMs and payments made by PBMs to retail
pharmacies or others. The United States Attorneys Office has also contacted
some of the pharmaceutical manufacturers with which we have agreements, and has
asked these manufacturers to provide copies of documents relating to their
agreements with us. There has been no allegation of any wrongdoing on our part.
At this time, we are unable to predict whether the government will commence any
action challenging any of our programs and practices. AdvancePCS believes that
its programs, and those of PCS prior to the acquisition, are in compliance with
the requirements imposed by anti-kickback laws and other applicable laws and
regulations. AdvancePCS plans to continue to cooperate with the OIG with
respect to this investigation. Nevertheless, we could be subject to scrutiny,
investigation or challenge under these laws and regulations as a result of the
OIG investigation or otherwise, which could have a material adverse effect on
our business, profitability and growth prospects.

In March 1998, a class action lawsuit captioned Mulder v. PCS Health
Systems, Inc., case number 98-1003, was filed in the United States District
Court of the District of New Jersey. This action alleges that PCS is an ERISA
fiduciary and that we have breached our fiduciary obligations under ERISA in
connection with our development and implementation of formularies, preferred
drug listings and intervention programs for our sponsors of ERISA health plans.
In particular, plaintiffs

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allege that our therapeutic interchange programs and negotiation of
formulary rebates and discounts from pharmaceutical manufacturers violate
fiduciary obligations. The plaintiffs are seeking injunctive relief
and monetary damages in an unspecified amount. AdvancePCS believes that it does not assume any of the
plan fiduciary responsibilities that would subject it to regulations under
ERISA. Although the ultimate outcome is uncertain, an adverse determination
could potentially cause us to change our business practices with
respect to formularies, preferred drug listings and intervention
programs, potentially reducing our profitability and growth prospects. A class
of plaintiffs has not yet been certified, and we intend to oppose such
certification. AdvancePCS has denied all allegations of wrongdoing and is
vigorously defending this suit.

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

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

9. Concentration of Business

A significant portion of the Companys revenues result from contracts with
customers. These contracts normally have terms of one to ten years with renewal
options.

Effective April 1, 1999, the Company entered into a Pharmacy Benefit
Services Agreement with FHS. Under the terms of this ten-year Service Agreement
the Company provides pharmacy services to FHS affiliated health plans. FHS
accounted for 41% and 14% of the Companys revenues for the years ended March
31, 2000 and 2001, respectively. Blue Cross and Blue Shield Association
Federal Employee Program accounted for 11% of the companys revenues for the
year ended March 31, 2001. Another customer of the Company accounted for
approximately 18% and 8% of the Companys revenues for the years ended March
31, 1999, and 2000, respectively. No other customer accounted for over 10% of
the Companys revenues in fiscal years 1999, 2000, or 2001.

10. Stockholders Equity

Common Stock

At March 31, 2000 the Company had 25,000,000 authorized shares of its $.01 par
value Class A Common Stock and 5,000,000 authorized shares of its preferred
stock, of which 5,000 shares were designated as Series B Preferred Stock At
the 2000 Annual Meeting of Stockholders, the Company amended and restated the
Certificate of Incorporation to increase the number of authorized shares of its
Class A Common Stock from 50,000,000 to 100,000,000.

On October 12, 1999, the Company announced a two-for-one stock split,
effected in the form of a stock dividend of our Class A Common Stock. The
record date was November 11, 1999, and the date of distribution was November
30, 1999. Financial information and stock prices contained throughout the
financial statements have been adjusted to retroactively reflect the impact of
the stock split.

In connection with our acquisition of PCS the Company issued Rite Aid
125,000 shares of Series A-2 Convertible Preferred Stock that was convertible
into Class B-2 Common Stock for $125 million. In addition, the Company issued
JLL 4,207,300 shares of Class B-1 Common Stock and 65,854 shares of Series A-1
Preferred Convertible Stock for $150 million.

Common Stock Voting Rights

Class A Common Stock
entitles the holder to one vote on each matter submitted to
stockholders for vote. Class B-1 and B-2 Common Stock entitles the
holder to vote as a single class with Class A Common Stock. The
affirmative vote of at least 2/3 of the outstanding shares of Class
B-1 and B-2 Common Stock is required for actions including, a change
in bylaws to adversely affect this class of stock, amendment or
repeal of Series A-1 and A-2 certificates of
designation, authorization of the issuance of additional shares of
Class B-1 and B-2 Common Stock, increasing the number of Company
directors, and incurring certain indebtedness.

The Series A-1 and Series A-2 Convertible Preferred Stock is currently convertible into
Class B-1 and Class B-2 Common Stock, respectively, at a conversion ratio of
1:50.

On December 8, 1999 the Company issued 231,884 shares of its Class A
Common Stock to acquire a 19 percent interest in CHI.

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In connection with the FFI merger, the Company issued 3,500,000 shares of
its Class A Common Stock in exchange for all the outstanding shares of FFI.
Under the provisions of APB 16, the shares are reflected as outstanding as
though FFI had always been a part of the Company.

Series A Convertible Preferred Stock

On October 2, 2000, in conjunction with our acquisition of PCS we issued
to Rite Aid 125,000 shares of Series A-2 Convertible Preferred Stock. In
addition, the Company issued to JLL 65,854 shares of Series A-1 Convertible
Preferred Stock.

Series B Preferred Stock

On June 25, 1996, the Company issued a total of 4,444 shares of $.01 par
value, Series B Convertible Preferred Stock (Series B Preferred Stock) to a
customer at a price of $2,250 per share. Shares of the Series B Preferred Stock
could be converted by the holder into 500 fully paid and non-assessable shares
of Class A Common Stock. On April 13, 1998, the holder of the Series B
Preferred Stock converted all of the shares into 2,222,222 shares of Class A
Common Stock.

Preferred Stock Voting Rights

The Series A-1
Convertible Preferred Stock does not have any voting rights, except
as provided by law. As long as the number of outstanding shares of
Series A-1 Convertible Preferred Stock equals 10% or more of the
Series A-1 Convertible Preferred Stock issued on October 2, 2000, the
approval of the majority holders of the Series A-1 Convertible
Preferred Stock will be required for amending and repealing certain
provisions of the incorporation or bylaws, creating or issuing any
class of senior stock, repurchasing or redeeming capital stock, and
incurring certain indebtedness.

Warrants to Purchase Common Stock

In connection with the issuance of the senior subordinated notes in Note 5
above, the Company issued Rite Aid warrants to purchase 780,000 shares of our
Class A Common Stock. The warrants terminated once we repaid the senior
subordinated notes in March 2001.

The Company has issued warrants to five of our key health plan sponsor
customers representing the right to purchase up to a total of 652,860 shares of
our Common Stock at prices per share ranging from $16.31 to $39.50. The right
to exercise each warrant vests in equal installments on the first five
anniversaries of the date of grant so long as the customers service agreement
remains in effect.

Prior to November of 1997, the Company accounted for these warrant
agreements under the provisions of SFAS 123 and the related Emerging Issues
Task Force (EITF) 96-3. These pronouncements require that all stock issued to
nonemployees be accounted for based on the fair value of the consideration
received or the fair value of equity instruments issued. In addition, they
require that the fair value be measured on the date the parties come to a
mutual understanding of the terms of the arrangement and agree to a binding
contract (i.e. the grant date). If the number of equity instruments is
contingent upon the outcome of future events, the number of instruments that
should be accounted for when determining the fair value of the transaction
should be based on the best available estimate of the number of instruments
expected to be issued. In managements opinion, the fair value of the warrants
at the date of the agreements was not material.

Subsequent to November 20, 1997, the Company follows the guidance of EITF
96-18, under which the measurement date is the earlier of the performance
commitment date or completed performance date. The Company chose not to
retroactively apply EITF 96-18 to the eligible warrants, but chose to apply
this EITF prospectively to new arrangements and any modifications of existing
arrangements.

The Company has reserved shares of Common Stock at March 31, 2001, for the
following:

|                          |  |  |           | 
|------------------------- |  |  | --------- | 
|Exercise of stock options |  |  | 8,501,258 | 
|                         
|                         
|                         
|                         
|Exercise of warrants      |  |  | 652,860   | 
|                          |  |  |          
|                          |  |  | 9,154,118 | 
|                          |  |  |          

11. Stock Option Plan

At March 31, 2001, the Company has three stock-based compensation plans:
Incentive Stock Option Plan, Amended and Restated Incentive Stock Option Plan,
and the 1997 Nonstatutory Stock Option Plan (the Plans). The Plans provide
for the granting of qualified stock options and incentive options to officers,
directors, advisors and employees of the Company. The options must be granted
with exercise prices which equal or exceed the market value of the Common Stock
at the date of grant. As of March 31, 2001, the number of shares of Common
Stock issuable under the Plans may not exceed 10,675,500 shares. The Plans are
administered by a compensation committee appointed by the Board of Directors of
the Company.

The stock options generally vest over 5-year periods. In the event of the
sale or merger with an outside corporation gaining 50% or greater ownership,
options granted to certain employees become 100% vested. The options are
exercisable for a period not to exceed 10 years from the date of grant. As of
March 31, 2001, 2,333,391 options were vested at exercise

F-17



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##### Table of Contents



prices of $0.59 to $31.17 per share. The Company recognized compensation
expense related to options granted, and the acceleration of option vesting, of
$1,300,000 for the year ended March 31, 2001.

SFAS 123 establishes a fair value-based method of accounting for
stock-based compensation. The Company has elected to adopt SFAS 123 through
disclosure with respect to employee stock-based compensation. The following
table summarizes the Companys stock option activity.

|                                               |           |   |                |           |   |           |           |       |        |   |                |           |   |           |        |       |  |           |                |            |           |   |       |       | 
|---------------------------------------------- | --------- | - | -------------- | --------- | - | --------- | --------- | ----- | ------ | - | -------------- | --------- | - | --------- | ------ | ----- |  | --------- | -------------- | ---------- | --------- | - | ----- | ----- | 
|                                               |           |   | 1999           |           |   | 2000      |           |       | 2001   |  
|                                               |           |   |                |           |   |           |           |       |        |  
|                                               |           |   |                |           |   |           | Wtd. Avg. |       |        |   |                |           |   | Wtd. Avg. |        |       |  |           |                |            | Wtd. Avg. |  
|                                               |           |   | Shares         |           |   | Ex. Price |           |       | Shares |   |                | Ex. Price |   |           | Shares |       |  | Ex. Price |               
|                                               |           |   |                |           |   |           |           |       |        |   |                |           |   |           |        |       |  |           |               
|Outstanding at beginning of
year               |           |   | 4,123,490      |           |   | $         | 5.27      |       |        |   | 4,553,276      |           |   | $         | 8.61   |       |  |           | 5,596,252      |            |           | $ | 11.58 |      
|                                              
|                                              
|                                              
|                                              
|                                               | Granted   |   |                | 1,392,300 |   |           |           | 15.71 |        |   |                | 1,458,700 |   |           |        | 20.82 |  |           |                | 3,660,500  |           |   |       | 24.75 | 
|                                              
|                                              
|                                              
|                                              
|                                               | Exercised |   |                | (726,644  | ) |           |           | 3.40  |        |   |                | (177,734  | ) |           |        | 6.23  |  |           |                | (1,088,650 | )         |   |       | 6.34  | 
|                                              
|                                              
|                                              
|                                              
|                                               | Canceled  |   |                | (235,870  | ) |           |           | 14.51 |        |   |                | (237,990  | ) |           |        | 15.01 |  |           |                | (236,410   | )         |   |       | 19.49 | 
|                                               |           |   |                |           |   |           |           |       |        |   |                |           |   |           |        |       |  |          
|Outstanding at end of
year                     |           |   | 4,553,276      |           |   | $         | 8.61      |       |        |   | 5,596,252      |           |   | $         | 11.58  |       |  |           | 7,931,692      |            |           | $ | 18.14 |      
|                                               |           |   |                |           |   |           |           |       |        |   |                |           |   |           |        |       |  |          
|Exercisable at end of
year                     |           |   | 1,815,200      |           |   | $         | 3.34      |       |        |   | 2,488,092      |           |   | $         | 5.42   |       |  |           | 2,333,391      |            |           | $ | 8.95  |      
|                                              
|                                              
|                                              
|                                              
|Price range                                    |           | $ | 0.33 to $20.69 |           |   |           |           |       |        | $ | 0.49 to $29.08 |           |   |           |        |       |  | $         | 0.59 to $31.17 |           
|                                              
|                                              
|                                              
|                                              
|Weighted average fair value
of options granted |           | $ | 7.32           |           |   |           |           |       |        | $ | 10.58          |           |   |           |        |       |  | $         | 17.60          |           

The following table reflects the weighted average exercise price and
weighted average contractual life of various exercise price ranges of the
7,931,692 options outstanding as of March 31, 2001.

|                     |  |                     |           |  |                     |               |       |             |             |  |        |  |  |       |           |               |  |   |       | 
|-------------------- |  | ------------------- | --------- |  | ------------------- | ------------- | ----- | ----------- | ----------- |  | ------ |  |  | ----- | --------- | ------------- |  | - | ----- | 
|                     |  | Options Outstanding |           |  | Options Exercisable |              
|                     |  |                     |           |  |                     |              
|                     |  |                     |           |  |                     | Weighted      |       |             | Wtd. Avg.   |  |        |  |  |       |           | Weighted      | 
|                     |  |                     |           |  |                     | Avg. Exercise |       |             | Contractual |  |        |  |  |       |           | Avg. Exercise | 
|Exercise Price Range |  | Shares              |           |  | Price               |               |       | Life (yrs.) |             |  | Shares |  |  | Price |          
|                     |  |                     |           |  |                     |               |       |             |             |  |        |  |  |       |          
|$0.59 to $4.50       |  |                     | 1,092,766 |  |                     | $             | 2.56  |             |             |  | 3.6    |  |  |       | 985,766   |               |  | $ | 2.35  | 
|                    
|                    
|                    
|                    
|$5.50 to $9.38       |  |                     | 533,100   |  |                     |               | 6.28  |             |             |  | 5.6    |  |  |       | 426,500   |               |  |   | 6.23  | 
|                    
|                    
|                    
|                    
|$11.88 to $14.69     |  |                     | 881,374   |  |                     |               | 14.32 |             |             |  | 7.4    |  |  |       | 295,574   |               |  |   | 14.56 | 
|                    
|                    
|                    
|                    
|$15.44 to $19.50     |  |                     | 1,478,902 |  |                     |               | 17.68 |             |             |  | 8.1    |  |  |       | 513,245   |               |  |   | 17.36 | 
|                    
|                    
|                    
|                    
|$20.00 to $24.25     |  |                     | 2,154,600 |  |                     |               | 20.51 |             |             |  | 9.1    |  |  |       | 67,766    |               |  |   | 22.21 | 
|                    
|                    
|                    
|                    
|$25.38 to $29.08     |  |                     | 194,700   |  |                     |               | 25.72 |             |             |  | 8.1    |  |  |       | 36,540    |               |  |   | 25.71 | 
|                    
|                    
|                    
|                    
|$31.17 to $31.17     |  |                     | 1,596,250 |  |                     |               | 31.17 |             |             |  | 9.5    |  |  |       | 8,000     |               |  |   | 31.17 | 
|                     |  |                     |           |  |                     |               |       |             |             |  |        |  |  |       |          
|$0.59 to $31.17      |  |                     | 7,931,692 |  |                     | $             | 18.14 |             |             |  | 7.8    |  |  |       | 2,333,391 |               |  | $ | 8.95  | 

The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted
average ranges of assumptions for the years ended March 31, 1999, 2000, and
2001, respectively: risk-free interest rates of 4.6% to 6.6%; expected lives of
three to five years; expected volatility of 30% to 75%. The Company continues
to account for stock based compensation under APB 25, Accounting for Stock
Issued to Employees, as allowed by SFAS 123. Had compensation cost for these
plans been determined consistent with SFAS 123, the Companys net income and
net income per share would have been reduced to the following pro forma
amounts:

|                              |             |  |      |            |  |      |   |            |      |  |   |            | 
|----------------------------- | ----------- |  | ---- | ---------- |  | ---- | - | ---------- | ---- |  | - | ---------- | 
|                              |             |  | 1999 |            |  | 2000 |   |            | 2001 | 
|                              |             |  |      |            |  |      |   |            |      | 
|Net income:                  
|                             
|                             
|                             
|                             
|                              | As reported |  | $    | 14,144,000 |  |      | $ | 20,876,000 |      |  | $ | 22,668,000 | 
|                             
|                             
|                             
|                             
|                              | Pro forma   |  | $    | 12,571,000 |  |      | $ | 17,349,000 |      |  | $ | 9,729,000  | 
|                             
|                             
|                             
|                             
|Basic net income per share:  
|                             
|                             
|                             
|                             
|                              | As reported |  | $    | 0.59       |  |      | $ | 0.84       |      |  | $ | 0.78       | 
|                             
|                             
|                             
|                             
|                              | Pro forma   |  | $    | 0.52       |  |      | $ | 0.70       |      |  | $ | 0.33       | 
|                             
|                             
|                             
|                             
|Diluted net income per share:
|                             
|                             
|                             
|                             
|                              | As reported |  | $    | 0.53       |  |      | $ | 0.75       |      |  | $ | 0.63       | 
|                             
|                             
|                             
|                             
|                              | Pro forma   |  | $    | 0.47       |  |      | $ | 0.63       |      |  | $ | 0.27       | 

Because SFAS 123 method of accounting has not been applied to options
granted prior to April 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.

12. Related Party Transactions

In fiscal 1998, the Company entered into an agreement with Advance Capital
Markets (ACM) pursuant to which ACM agreed to act as financial advisor for
the Company. In exchange for these professional services, the Company paid ACM
a fee of $150,000 in 1998 in connection with the IMR transaction and $85,000 in
connection with the Baumel-Eisner transaction. The fees paid are equivalent to
or less than similar fees incurred in arms-length transactions. The Managing
Director of ACM is also a Director of the Company. In fiscal 2001, the Company
has a non-interest bearing note receivable of $500,000 due from an executive officer of the Company
issued in conjunction with his relocation to Phoenix, Arizona as a result of
the acquisition of PCS.

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##### Table of Contents



13. Retirement Plan Benefits

In connection with the acquisition of PCS, the Company acquired certain
existing retirement plans. The funded status and amounts recognized in the
consolidated balance sheets at March 31, 2001 for the Companys defined benefit
pension and retiree health benefit plans, as well as changes in the benefit
obligation and plan assets subsequent to the acquisition, were as follows:

|                                                                |                                             |   |                 |            |   |                 |            |           |  
|--------------------------------------------------------------- | ------------------------------------------- | - | --------------- | ---------- | - | --------------- | ---------- | --------- | -
|                                                                |                                             |   | Defined Benefit |            |   | Retiree         |           
|                                                                |                                             |   | Pension Plan    |            |   | Health Benefits |           
|                                                                |                                             |   |                 |            |   |                 |           
|Change in benefit obligation:                                  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Benefit obligation at March 31, 2000        |   | $               |           |   |                 | $          |          |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | PBO, Acquired                               |   |                 | 20,945,000 |   |                 |            | 6,954,000 |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Service cost                                |   |                 | 1,561,000  |   |                 |            | 685,000   |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Interest cost                               |   |                 | 747,000    |   |                 |            | 332,000   |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Actuarial loss                              |   |                 | 1,918,000  |   |                 |            | 609,000   |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Benefits paid                               |   |                 | (88,000    | ) |                 |            | (34,000   | )
|                                                                |                                             |   |                 |            |   |                 |           
|                                                                | Benefit obligation at March 31, 2001        |   |                 | 25,083,000 |   |                 |            | 8,546,000 |  
|                                                               
|                                                               
|                                                               
|                                                               
|Change in plan assets:                                         
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Fair value of plan assets at March 31, 2000 |   |                 |           |   |                 |            |          |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Fair Value, Acquired                        |   |                 | 27,981,000 |   |                 |            |          |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Actual return on plan assets                |   |                 | (4,747,000 | ) |                 |            |          |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Employer contribution                       |   |                 | 7,000      |   |                 |            | 34,000    |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Benefits paid                               |   |                 | (88,000    | ) |                 |            | (34,000   | )
|                                                                |                                             |   |                 |            |   |                 |           
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Fair value of plan assets at March 31, 2001 |   |                 | 23,153,000 |   |                 |            |          |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                               
|                                                               
|                                                               
|                                                               
|                                                               
|                                                               
|                                                               
|                                                               
|Funded status                                                   |                                             |   | (1,930,000      | )          |   |                 | (8,546,000 | )        
|                                                               
|                                                               
|                                                               
|                                                               
|Unrecognized net actuarial loss                                 |                                             |   | 7,747,000       |            |   |                 | 479,000    |          
|                                                                |                                             |   |                 |            |   |                 |           
|Net amount recognized                                           |                                             |   | 5,817,000       |            |   |                 | (8,067,000 | )        
|                                                                |                                             |   |                 |            |   |                 |           
|Amounts recognized in consolidation balance sheet consisted of:
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Accrued benefit liability                   |   |                 | 618,000    |   |                 |            | 8,067,000 |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Deferred Tax (Asset)                        |   |                 | (2,586,000 | ) |                 |            |          |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | (Charge) to Equity, net of tax              |   |                 | (3,849,000 | ) |                 |            |          |  
|                                                                |                                             |   |                 |            |   |                 |           
|Net amount recognized                                           |                                             | $ | (5,817,000      | )          |   | $               | 8,067,000  |          
|                                                                |                                             |   |                 |            |   |                 |           
|Weighted-average assumptions as of March 31, 2001:             
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Discount rate as of Acquisition Date        |   |                 | 7.75       | % |                 |            | 7.75      | %
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Discount rate as of 3/31                    |   |                 | 7.25       | % |                 |            | 7.25      | %
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Expected return on plan assets              |   |                 | 9.00       | % |                 |            |          |  
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Rate of compensation increase               |   |                 | 5.90       | % |                 |            |          |  

Health care trend rates were assumed to increase at an annual rate of 6.5%
in 2002 and decrease 1/2% per year to 5.0% in 2005 and thereafter.

Net pension and retiree health benefit expense for the year ended March
31, 2001 include the following components:

|                                         |                                 |   |              |           |   |          |           |         | 
|---------------------------------------- | ------------------------------- | - | ------------ | --------- | - | -------- | --------- | ------- | 
|                                         |                                 |   | Defined      |           |   | Retiree  |          
|                                         |                                 |   | Benefit      |           |   | Health   |          
|                                         |                                 |   | Pension Plan |           |   | Benefits |          
|                                         |                                 |   |              |           |   |          |          
|Components of net periodic benefit cost:
|                                        
|                                        
|                                        
|                                        
|                                         | Service cost                    |   | $            | 1,561,000 |   |          | $         | 685,000 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Interest cost                   |   |              | 747,000   |   |          |           | 332,000 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Expected return on plan assets  |   |              | (882,000  | ) |          |           |        | 
|                                        
|                                        
|                                        
|                                        
|                                         | Amortization of net (Gain)/Loss |   |              | (133,000  | ) |          |           | 143,000 | 
|                                         |                                 |   |              |           |   |          |          
|Net periodic benefit cost                |                                 | $ | 1,293,000    |           |   | $        | 1,160,000 |        
|                                         |                                 |   |              |           |   |          |          

The assumed health care cost trend rates have a significant effect on the
retiree health benefits amounts reported. If these trend rates were to be
increased by one percentage point each future year, the March 31, 2001
accumulated post retirement benefit obligation would increase by 25.5%, and the
aggregate of the service cost and interest components of the 2001 annual
expense would increase by 20.0%. A one percentage point decrease in these
rates would decrease the March 31, 2001 accumulated post retirement benefit
obligation by 20.1% and the aggregate of the 2000 service cost and interest
cost components of the 2001 annual expense would decrease by 15.6%.

All defined plan benefit obligations have been adjusted to reflect the
effect of plan changes adopted as of the acquisition of PCS. Any associated
gain or loss relating to these changes is not reflected in the operations of
the Company.
F-19Table of ContentsThe Company also sponsors defined contribution retirement plans for all
eligible employees, as defined in the plan documents. These plans are qualified
under Section 401(k) of the Internal Revenue Code. Company contributions to
the plans are based on employee contributions and the level of Company match.
Expenses under the plan totaled $2,671,250 during the fiscal year 2001, and
$623,000 during fiscal year 2000.14. Income TaxesThe provision for income taxes for the years ended March 31, 1999, 2000,
and 2001, differed from the amounts computed by applying the U.S. federal tax
rate of 34 percent in 1999 and 35 percent in 2000 and 2001 to pretax earnings
as a result of the following:

|                                                    |  |      |           |  |      |   |            |      |  |   |            |  
|--------------------------------------------------- |  | ---- | --------- |  | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                    |  | 1999 |           |  | 2000 |   |            | 2001 | 
|                                                    |  |      |           |  |      |   |            |      | 
|Tax at U.S. federal income tax rate                 |  | $    | 7,756,000 |  |      | $ | 11,800,000 |      |  | $ | 16,658,000 |  
|                                                   
|                                                   
|                                                   
|                                                   
|Non-deductible goodwill and
intangible amortization |  |      | 113,000   |  |      |   | 338,000    |      |  |   | 9,548,000  |  
|                                                   
|                                                   
|                                                   
|                                                   
|State taxes                                         |  |      | 666,000   |  |      |   | 540,000    |      |  |   | 2,304,000  |  
|                                                   
|                                                   
|                                                   
|                                                   
|Intangible amortization                             |  |      |          |  |      |   |           |      |  |   | (4,067,000 | )
|                                                   
|                                                   
|                                                   
|                                                   
|Other, net                                          |  |      | 134,000   |  |      |   | 116,000    |      |  |   | 484,000    |  
|                                                    |  |      |           |  |      |   |            |      | 
|Provision for income taxes                          |  | $    | 8,669,000 |  |      | $ | 12,794,000 |      |  | $ | 24,927,000 |  
|                                                    |  |      |           |  |      |   |            |      | 

|         |  |      |           |  |      |   |            |      |  |   |            |  
|-------- |  | ---- | --------- |  | ---- | - | ---------- | ---- |  | - | ---------- | -
|         |  | 1999 |           |  | 2000 |   |            | 2001 | 
|         |  |      |           |  |      |   |            |      | 
|Current  |  | $    | 7,357,000 |  |      | $ | 11,487,000 |      |  | $ | 25,071,000 |  
|        
|        
|        
|        
|Deferred |  |      | 1,312,000 |  |      |   | 1,307,000  |      |  |   | (144,000   | )
|         |  |      |           |  |      |   |            |      | 
|         |  | $    | 8,669,000 |  |      | $ | 12,794,000 |      |  | $ | 24,927,000 |  
|         |  |      |           |  |      |   |            |      | 

Deferred income taxes reflect the tax consequences on future years of
temporary differences between the tax bases of assets and liabilities and their
financial reporting bases and the potential benefits of certain tax
carryforwards. The significant deferred tax assets and liabilities and the
changes in those assets and liabilities are as follows:

|                                |                                      |                            |            |            |            |   |              |              |              |      |              |              |              |  
|------------------------------- | ------------------------------------ | -------------------------- | ---------- | ---------- | ---------- | - | ------------ | ------------ | ------------ | ---- | ------------ | ------------ | ------------ | -
|                                |                                      |                            |            | March 31,  |            |   |              |              |              |      | March 31,    |             
|                                |                                      |                            |            | 2000       |            |   | Changes      |              |              | 2001 |             
|                                |                                      |                            |            |            |            |   |              |              |              |      |             
|Gross deferred tax assets:     
|                               
|                               
|                               
|                               
|                                | Accruals and reserves                |                            | $          | 321,000    |            |   | $            | 4,256,000    |              |      | $            | 4,577,000    |             
|                               
|                               
|                               
|                               
|                                | Non-recurring and impairment charges |                            |            |           |            |   |              | 3,615,000    |              |      |              | 3,615,000    |             
|                               
|                               
|                               
|                               
|                                | Other                                |                            |            | 140,000    |            |   |              | 517,000      |              |      |              | 657,000      |             
|                                |                                      |                            |            |            |            |   |              |              |             
|                                |                                      |                            | 461,000    |            |            |   | 8,388,000    |              |              |      | 8,849,000    |             
|                                |                                      |                            |            |            |            |   |              |              |             
|Gross deferred tax liabilities:
|                               
|                               
|                               
|                               
|                                | Intangible assets                    |                            |            |           |            |   |              | (239,933,000 | )            |      |              | (239,933,000 | )           
|                               
|                               
|                               
|                               
|                                | Amortization of deductible goodwill  |                            |            | (2,165,000 | )          |   |              | (916,000     | )            |      |              | (3,081,000   | )           
|                               
|                               
|                               
|                               
|                                | Depreciation                         |                            |            | (1,473,000 | )          |   |              | (2,135,000   | )            |      |              | (3,608,000   | )           
|                               
|                               
|                               
|                               
|                                | Other                                |                            |            | (727,000   | )          |   |              | 81,000       |              |      |              | (646,000     | )           
|                                |                                      |                            |            |            |            |   |              |              |             
|                                |                                      |                            | (4,365,000 | )          |            |   | (242,903,000 | )            |              |      | (247,268,000 | )           
|                                |                                      |                            |            |            |            |   |              |              |             
|                                |                                      | Net deferred tax liability |            | $          | (3,904,000 | ) |              | $            | (234,515,000 | )    |              | $            | (238,419,000 | )
|                                |                                      |                            |            |            |            |   |              |              |             

15. Subsequent Events

On June 18, 2001, the Company announced the launch of AdvancePCS
SpecialtyRx to provide health care for patients using injectable and other
expensive, high-technology drugs, while controlling the costs incurred by
medical plan sponsors to provide these therapies. As a result, the Company
entered into a definitive agreement to acquire the outstanding common stock of
TheraCom, Inc., a specialty pharmacy and distribution company located in
Bethesda, Maryland. The acquisition will be accounted for using the purchase
method of accounting. Also, the Company has signed a definitive agreement to
establish a joint venture with Priority Healthcare Corp., a national specialty
pharmacy and distribution company located in Lake Mary, Florida.
AdvancePriority SpecialtyRx will begin immediately utilizing the existing
infrastructures of both companies. AdvancePCS will own 51% of the venture and
Priority Healthcare Corp will own 49%.

F-20



---



##### Table of Contents



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE

We have audited in accordance with auditing standards generally accepted
in the United States, the consolidated financial statements of AdvancePCS
and subsidiaries included in this Form 10-K and have issued our report thereon
dated May 29, 2001. Our audit was made for the purpose of forming an opinion
on the basic consolidated financial statements taken as a whole. Schedule II
is presented for purposes of complying with the Securities and Exchange
Commissions rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures
applied in the audit of the basic consolidated financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic consolidated financial statements
taken as a whole.

| |                    
| | -------------------
| | ARTHUR ANDERSEN LLP

Dallas, Texas,
May 29, 2001 (except with respect to the matter
discussed in Note 15, as to which the date is June 18, 2001).

S-1



---



##### Table of Contents



ADVANCEPCS
SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS

|                                                  |  |            |           |  |            |   |            |            |  |   |            |     |  |      |           |            |  |   |            | 
|------------------------------------------------- |  | ---------- | --------- |  | ---------- | - | ---------- | ---------- |  | - | ---------- | --- |  | ---- | --------- | ---------- |  | - | ---------- | 
|                                                  |  | Balance at |           |  | Additions  |   |            |            |  |   |            |     |  |      |           | Balance at | 
|                                                  |  | Beginning  |           |  | Charged to |   |            |            |  |   |            |     |  |      |           | End of     | 
|                                                  |  | of Year    |           |  | Expenses   |   |            | Deductions |  |   | Other      |     |  | Year |          
|                                                  |  |            |           |  |            |   |            |            |  |   |            |     |  |      |          
|Year ended March 31, 1999:                       
|                                                 
|                                                 
|                                                 
|                                                 
|Allowance for doubtful A/R                        |  | $          | 2,199,000 |  |            | $ | 2,444,000  |            |  | $ |           |     |  | $    | 100,000   | (2)        |  | $ | 4,743,000  | 
|                                                 
|                                                 
|                                                 
|                                                 
|Year ended March 31, 2000:                       
|                                                 
|                                                 
|                                                 
|                                                 
|Allowance for doubtful A/R                        |  | $          | 4,743,000 |  |            | $ | 923,000    |            |  | $ | 27,000     | (1) |  | $    |          |            |  | $ | 5,639,000  | 
|                                                 
|                                                 
|                                                 
|                                                 
|Year ended March 31, 2001:                       
|                                                 
|                                                 
|                                                 
|                                                 
|Allowance for doubtful A/R                        |  | $          | 5,639,000 |  |            | $ | 8,204,000  |            |  | $ | 753,000    | (1) |  | $    | 5,750,000 | (3)        |  | $ | 18,840,000 | 
|                                                 
|                                                 
|                                                 
|                                                 
|Reserve for non-recurring
and impairment expenses |  | $          |          |  |            | $ | 11,129,000 |            |  | $ | 10,351,000 |     |  | $    |          |            |  | $ | 778,000    | 



---

|(1) |  | Uncollectible accounts written off, net of recoveries          
|--- |  | ---------------------------------------------------------------
|(2) |  | Includes $100,000 reflected in the acquisition of Baumel-Eisner
|(3) |  | Assumed in the acquisition of PCS                              

Reclassification

Certain prior year amounts have been reclassified to conform with current
year presentation.

S-2



---



##### Table of Contents



INDEX TO EXHIBITS

|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT
|NO.     |  | EXHIBIT                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|2.1     |  | Stock Purchase Agreement dated as of July 11, 2000 by and between
AdvancePCS and Rite Aid (incorporated by reference to Exhibit 2.1
to our Form 8-K as filed with the Securities and Exchange
Commission on July 31, 2000).                                                                                                                                                                                                                                                                     
|       
|       
|       
|       
|2.2     |  | Securities Purchase Agreement dated as of July 11, 2000 by and
between AdvancePCS and JLL (incorporated by reference to Exhibit
2.2 to our Form 8-K as filed with the Securities and Exchange
Commission on October 16, 2000).                                                                                                                                                                                                                                                                  
|       
|       
|       
|       
|3.1     |  | Second Amended and Restated Certificate of Incorporation of
AdvancePCS (incorporated by reference to Exhibit 99.1 of
AdvancePCSs Current Report on Form 8-K as filed with the
Securities and Exchange Commission on December 11, 2000).                                                                                                                                                                                                                                                        
|       
|       
|       
|       
|3.2     |  | Second Amended and Restated Bylaws of AdvancePCS (incorporated by
reference to Exhibit 3.1 of AdvancePCSs Current Report on Form
8-K as filed with the Securities and Exchange Commission on
October 16, 2000).                                                                                                                                                                                                                                                                                
|       
|       
|       
|       
|4.1     |  | Form of Stock Certificate of Class A Common Stock of AdvancePCS
(incorporated by reference to Exhibit 4.1 of AdvancePCSs
Registration Statement on Form 8-A/A as filed with the Securities
and Exchange Commission on December 14, 2000).                                                                                                                                                                                                                                                      
|       
|       
|       
|       
|4.2     |  | Indenture dated as of March 13, 2001 by and among AdvancePCS,
various guarantors and U.S. Trust Company of Texas, N.A.
(incorporated by reference to Exhibit 4.2 of AdvancePCSs
Registration Statement on Form S-4 as filed with the Securities
and Exchange Commission on April 18, 2001).                                                                                                                                                                                                    
|       
|       
|       
|       
|4.3     |  | Registration Rights Agreement dated as of March 13, 2001 by and
among AdvancePCS, various guarantors named therein and Banc of
America Securities LLC, Merrill Lynch, Pierce, Fenner & Smith
Incorporated, Banc One Capital Markets, Inc., Chase Securities,
Inc., CIBC World Markets Corp. and Scotia Capital USA, Inc.
(incorporated by reference to Exhibit 4.3 of AdvancePCSs
Registration Statement on Form S-4 as filed with the Securities
and Exchange Commission on April 18, 2001).
|       
|       
|       
|       
|4.4     |  | Stockholders Agreement dated as of October 2, 2000 by and among
AdvancePCS, Rite Aid Corporation, JLL and various other investors
named therein (incorporated by reference to Exhibit 10.1 to
AdvancePCSs Form 8-K as filed with the Securities and Exchange
Commission on October 16, 2000).                                                                                                                                                                                                 
|       
|       
|       
|       
|4.5     |  | Amendment No. 1 to Stockholders Agreement dated as of October 20,
2000 by and among AdvancePCS, Rite Aid Corporation, JLL and
various other investors named therein (incorporated by reference
to Exhibit 10.3 to AdvancePCSs Form 10-Q as filed with the
Securities and Exchange Commission on February 14, 2001).                                                                                                                                                                           
|       
|       
|       
|       
|4.6     |  | Warrant Agreement, dated as of September 12, 1996, by and between
AdvancePCS and VHA, Inc. (incorporated by reference to Exhibit
4.16 to AdvancePCSs Form S-1 as filed with the Securities and
Exchange Commission on October 8, 1996 (No. 333-06931)).                                                                                                                                                                                                                                        
|       
|       
|       
|       
|4.7     |  | Warrant Agreement, dated as of February 26, 1999, by and between
AdvancePCS and Foundation Health Systems, Inc. (incorporated by
reference to Exhibit 4.1 to AdvancePCSs Current Report on Form
8-K as filed with the Securities and Exchange Commission dated
April 15, 1999).                                                                                                                                                                                                                
|       
|       
|       
|       
|4.8     |  | Warrant Agreement, dated as of February 25, 1999, by and between
AdvancePCS and Arkansas BlueCross BlueShield (incorporated by
reference to Exhibit 4.8 to AdvancePCSs Annual Report on Form
10-K as filed with the Securities and Exchange Commission dated
March 31, 1999).                                                                                                                                                                                                                  
|       
|       
|       
|       
|4.9     |  | Warrant Agreement, dated as of June 12, 1998, by and between
AdvancePCS and Wellmark, Inc. (incorporated by reference to
Exhibit 4.9 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission dated March 31, 1999).                                                                                                                                                                                                                                     
|       
|       
|       
|       
|4.10    |  | Warrant Agreement, dated December 10, 1999, by and between
AdvancePCS and CareFirst of Maryland, Inc., Group Hospitalization
and Medical Services, Inc., FreeState Health Plan, Inc., Delmarva
Health Plan, Inc. and Capital Care, Inc. (incorporated by
reference to Exhibit 4.10 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                           
|       
|       
|       
|       
|10.1    |  | Amended and Restated Incentive Stock Option Plan (incorporated by
reference from AdvancePCSs Definitive Proxy Statement on Schedule
14A as filed with the Securities and Exchange Commission on
October 22, 1999).                                                                                                                                                                                                                                                                             
|10.2    |  | Amendment Number 1 to Amended and Restated Incentive Stock Option
Plan (incorporated by reference to Exhibit 4.5 to AdvancePCSs
Registration Statement on Form S-8 as filed with the Securities
and Exchange Commission on May 3, 2001).                                                                                                                                                                                                                                                       





---



##### Table of Contents



|      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     
|     
|     
|     
|10.3  |  | Amended and Restated Nonstatutory Stock Option Plan (incorporated
by reference to Exhibit 4.3 to AdvancePCSs Registration Statement
on Form S-8 as filed with the Securities and Exchange Commission
on January 28, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|     
|     
|     
|     
|10.4  |  | Corporate Officer Incentive Plan (incorporated by reference from
AdvancePCSs Proxy Statement on Schedule 14A as filed with the
Securities and Exchange Commission on October 22, 1999).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|     
|     
|     
|     
|10.5  |  | Lease, dated March 6, 1994, by and between Hill Management
Services, Inc. and Advance Clinical (formerly ParadigM)
(incorporated by reference to Exhibit 10.11 to AdvancePCSs Form
S-1 as filed with the Securities and Exchange Commission on
October 8, 1996 (No. 333-06931)).                                                                                                                                                                                                                                                                                                                                                                                                       
|     
|     
|     
|     
|10.6  |  | Amendment to Lease, dated October 19, 1996, by and between Hill
Management Services, Inc. and AdvancePCS Clinical Services, Inc. (incorporated by reference to Exhibit 10.6 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                          
|     
|     
|     
|     
|10.7  |  | Second Amendment to Lease, dated September 30, 1998, by and
between Hill Management Services, Inc. and AdvancePCS Clinical
Services, Inc. (incorporated by reference to Exhibit 10.7 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                 
|     
|     
|     
|     
|10.8  |  | Third Amendment to Lease, dated December 1, 1999, by and between
Hill Management Services, Inc. and AdvancePCS Clinical Services,
Inc. (incorporated by reference to Exhibit 10.8 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                    
|     
|     
|     
|     
|10.9  |  | Fourth Amendment to Lease, dated April 25, 2000, by and between
Hill Management Services, Inc. and AdvancePCS Clinical Services,
Inc. (incorporated by reference to Exhibit 10.9 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                     
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|10.10 |  | Fifth Amendment to Lease, dated December 18, 2000, by and between
Hill Management Services, Inc. and AdvancePCS Clinical Services,
Inc. (incorporated by reference to Exhibit 10.10 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                  
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|10.11 |  | Commercial Lease Agreement, commencing November 1, 1998, by and
between Crin-Richardson I, L.P. and AdvancePCS (incorporated by
reference to Exhibit 10.19 to AdvancePCSs Form 10-K as filed with
the Securities and Exchange Commission for the year ended March
31, 1999).                                                                                                                                                                                                                                                                                                                                                                                                           
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|10.12 |  | Credit Agreement dated as of October 2, 2000 by and among
AdvancePCS, Merrill Lynch Capital Corporation and a syndicate of
banks (incorporated by reference to Exhibit 10.4 to our Form 8-K
as filed with the Securities and Exchange Commission on October 16, 2000).                                                                                                                                                                                                                                                                                                                                                                                                                  
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|10.13 |  | Amendment No. 1 to Credit Agreement dated as of October 2, 2000 by
and among AdvancePCS, Merrill Lynch Capital Corporation and a
syndicate of banks (incorporated by reference to Exhibit 10.13 AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                         
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|10.14 |  | Form of Employment Agreement dated as of October 2, 2000 by and
between AdvancePCS and each of Jon S. Halbert, David A. George, T.
Danny Phillips, Joseph J. Filipek, Jr., Susan S. de Mars, Jeffrey
G. Sanders, Laura I. Johansen, Andrew C. Garling, Rudy Mladenovic
and John H. Sattler (incorporated by reference to Exhibit 10.5 to
AdvancePCS's Form 10-Q as filed with the Securities and Exchange
Commission on February 14, 2001).                                                                                                                                                                                                                                             
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|10.15 |  | Employment Agreement dated as of July 11, 2000, by and between
AdvancePCS and David D. Halbert (incorporated by reference to Exhibit 10.15 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                           
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|10.16 |  | Sublease, dated December 16, 1999, by and between TIG Insurance
Company and AdvancePCS (incorporated by reference to
Exhibit 10.16 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|10.17 |  | Lease Agreement, dated April 30, 2000, by and between Cardinal
Technology Center II, Inc. and AdvancePCS, as amended by the First
Amendment to the Lease Agreement dated June 19, 2000, the Second
Amendment to the Lease Agreement dated September 15, 2000 and the
Third Amendment to the Lease Agreement dated March 2001 (incorporated by reference to Exhibit 10.17 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                             
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|10.18 |  | Lease Agreement, dated March 26, 1996, by and between Alliance
Commerce Center No 5, Ltd. and PCS Mail Services, Inc., as amended
by the Amendment to the Lease Agreement, dated June 9, 1999, by
and between Alliance Commerce Center No. 5, Ltd. and PCS Mail
Services of Fort Worth, Inc. (incorporated by reference to Exhibit 10.18 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                             
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|10.19 |  | Lease Agreement, effective September 30, 2000, by and between DRUG
(AZ) QRS 14-42, Inc. and PCS Health Systems, Inc. (incorporated by reference to
Exhibit 10.19 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                                     
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|10.20 |  | Office Lease, dated April 18, 1997, by and between 9060 East Via
Linda Co. Ltd. Limited Partnership and PCS Health Systems, Inc. (incorporated by reference to
Exhibit 10.20 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                         
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|10.21 |  | Lease Agreement, dated August 6, 1993, by and between MEPC
American Properties, Inc. and McKesson Corporation, as amended by
the First Lease Amendment, dated November 1999, by and between
Duke-Weeks Realty Limited Partnership and PCS Health Systems, Inc. (incorporated by reference to
Exhibit 10.21 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                           
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|10.22 |  | Office Lease, dated May 18, 1999, by and between Signature
Services and AdvancePCS, as amended by the First Amendment to the
Lease, dated October 28, 1999 by and between Signature Services
and AdvancePCS, the Second Amendment to the Lease, dated November
30, 1999, by and between Signature Services and AdvancePCS, the
Third Amendment to Lease, dated March 23, 2000, by and between
Signature Services and AdvancePCS and the Fourth Amendment to the
Lease, by and between North Parkcenter LLC and AdvancePCS (incorporated by reference to
Exhibit 10.22 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).
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|11.1  |  | Statement Regarding Computation of Per Share Earnings (incorporated by reference to
Exhibit 11.1 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|21.1  |  | Subsidiaries of AdvancePCS (incorporated by reference to Exhibit 21.1 to AdvancePCSs Annual Report on Form 10-K as filed
with the Securities and Exchange Commission on June 29, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
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|23.1  |  | Consent of Arthur Andersen LLP. (previously filed)