##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-Q



---

(Mark One)

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

For the quarterly period ended September 30, 2006

OR



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

For the transition period from  to

Commission File Number: 1-31312



---

MEDCO HEALTH SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)



---



|                                               |  |                                     
|---------------------------------------------- |  | ------------------------------------
|Delaware                                       |  | 22-3461740                          
|(State or other jurisdiction of incorporation) |  | (I.R.S. Employer Identification No.)



|                                           |  |           
|------------------------------------------ |  | ----------
|100 Parsons Pond Drive, Franklin Lakes, NJ |  | 07417-2603
|(Address of principal executive offices)   |  | (Zip Code)

Registrants telephone number, including area code: 201-269-3400



---

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

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

Large accelerated
filer  x    Accelerated filer ̈Non-Accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes ̈No  x

As of the close of business on October 26, 2006, the registrant had 293,425,628 shares of common stock, $0.01 par value, issued and outstanding.



---



---

##### Table of Contents

MEDCO HEALTH SOLUTIONS, INC.

QUARTERLY REPORT ON FORM 10-Q

INDEX



|           |  |                                                                                                                                           |  |   
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------------------- |  | --
|           |  | PART I  FINANCIAL INFORMATION                                                                                                            |  |   
|           |  |                                                                                                                                          
|Item 1.    |  | Financial Statements                                                                                                                      |  |   
|           |  |                                                                                                                                          
|           |  | Condensed Consolidated Balance Sheets (Unaudited)  September 30, 2006 and December 31, 2005                                              |  | 1 
|           |  |                                                                                                                                          
|           |  | Condensed Consolidated Statements of Income (Unaudited)  Fiscal Quarters and Nine Months Ended September 30, 2006 and September 24, 2005 |  | 2 
|           |  |                                                                                                                                          
|           |  | Condensed Consolidated Statement of Stockholders Equity (Unaudited)  Fiscal Nine Months Ended September 30, 2006                        |  | 3 
|           |  |                                                                                                                                          
|           |  | Condensed Consolidated Statements of Cash Flows (Unaudited)  Fiscal Nine Months Ended September 30, 2006 and September 24, 2005          |  | 4 
|           |  |                                                                                                                                          
|           |  | Notes to Condensed Consolidated Financial Statements (Unaudited)                                                                          |  | 5 
|           |  |                                                                                                                                          
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                     |  | 21
|           |  |                                                                                                                                          
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                |  | 38
|           |  |                                                                                                                                          
|Item 4.    |  | Controls and Procedures                                                                                                                   |  | 38
|           |  |                                                                                                                                          
|           |  | PART II  OTHER INFORMATION                                                                                                               |  |   
|           |  |                                                                                                                                          
|Item 1.    |  | Legal Proceedings                                                                                                                         |  | 40
|           |  |                                                                                                                                          
|Item 1A.   |  | Risk Factors                                                                                                                              |  | 40
|           |  |                                                                                                                                          
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                                               |  | 40
|           |  |                                                                                                                                          
|Item 3.    |  | Defaults Upon Senior Securities                                                                                                           |  | 41
|           |  |                                                                                                                                          
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                                                       |  | 41
|           |  |                                                                                                                                          
|Item 5.    |  | Other Information                                                                                                                         |  | 41
|           |  |                                                                                                                                          
|Item 6.    |  | Exhibits                                                                                                                                  |  | 43
|           | 
|SIGNATURES |  | 44                                                                                                                                       



---

##### Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

MEDCO HEALTH SOLUTIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In millions, except for share data)



|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------ | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                                             |  | September 30, 2006 |          |   | December 31, 2005 |  
|ASSETS                                                                                                                                                       |  |                    |          |   |                   |   |          |  
|Current assets:                                                                                                                                              |  |                    |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                                    |  | $                  | 458.8    |   |                   | $ | 888.2    |  
|Short-term investments                                                                                                                                       |  |                    | 60.4     |   |                   |   | 56.6     |  
|Accounts receivable, net                                                                                                                                     |  |                    | 2,460.2  |   |                   |   | 2,008.1  |  
|Inventories, net                                                                                                                                             |  |                    | 1,616.8  |   |                   |   | 1,527.1  |  
|Prepaid expenses and other current assets                                                                                                                    |  |                    | 303.3    |   |                   |   | 259.9    |  
|Deferred tax assets                                                                                                                                          |  |                    | 195.7    |   |                   |   | 321.0    |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|Total current assets                                                                                                                                         |  |                    | 5,095.2  |   |                   |   | 5,060.9  |  
|Income taxes receivable                                                                                                                                      |  |                    | 202.5    |   |                   |   |         |  
|Property and equipment, net                                                                                                                                  |  |                    | 626.9    |   |                   |   | 672.3    |  
|Goodwill                                                                                                                                                     |  |                    | 5,116.8  |   |                   |   | 5,152.3  |  
|Intangible assets, net                                                                                                                                       |  |                    | 2,577.7  |   |                   |   | 2,741.6  |  
|Other noncurrent assets                                                                                                                                      |  |                    | 51.2     |   |                   |   | 75.9     |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|Total assets                                                                                                                                                 |  | $                  | 13,670.3 |   |                   | $ | 13,703.0 |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                         |  |                    |          |   |                   |   |          |  
|Current liabilities:                                                                                                                                         |  |                    |          |   |                   |   |          |  
|Claims and other accounts payable                                                                                                                            |  | $                  | 2,708.5  |   |                   | $ | 2,678.6  |  
|Accrued expenses and other current liabilities                                                                                                               |  |                    | 775.7    |   |                   |   | 556.7    |  
|Short-term debt                                                                                                                                              |  |                    | 450.0    |   |                   |   | 450.0    |  
|Current portion of long-term debt                                                                                                                            |  |                    | 75.4     |   |                   |   | 75.5     |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|Total current liabilities                                                                                                                                    |  |                    | 4,009.6  |   |                   |   | 3,760.8  |  
|Long-term debt, net                                                                                                                                          |  |                    | 885.5    |   |                   |   | 943.9    |  
|Deferred tax liabilities                                                                                                                                     |  |                    | 1,166.2  |   |                   |   | 1,213.8  |  
|Other noncurrent liabilities                                                                                                                                 |  |                    | 60.3     |   |                   |   | 60.3     |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|Total liabilities                                                                                                                                            |  |                    | 6,121.6  |   |                   |   | 5,978.8  |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|Commitments and contingencies (See Note 12)                                                                                                                  |  |                    |          |   |                   |   |          |  
|                                                                                                                                                             |  |                   
|Stockholders equity:                                                                                                                                        |  |                    |          |   |                   |   |          |  
|Preferred stock, par value $0.01authorized: 10,000,000 shares; issued and outstanding: 0                                                                    |  |                    |         |   |                   |   |         |  
|Common stock, par value $0.01authorized: 1,000,000,000 shares; issued: 317,185,066 shares at September 30, 2006 and 312,000,754
shares at December 31, 2005 |  |                    | 3.2      |   |                   |   | 3.1      |  
|Accumulated other comprehensive income (loss)                                                                                                                |  |                    |         |   |                   |   |         |  
|Additional paid-in capital                                                                                                                                   |  |                    | 7,122.4  |   |                   |   | 6,913.3  |  
|Unearned compensation                                                                                                                                        |  |                    |         |   |                   |   | (39.8    | )
|Retained earnings                                                                                                                                            |  |                    | 1,656.3  |   |                   |   | 1,254.9  |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|                                                                                                                                                             |  |                    | 8,781.9  |   |                   |   | 8,131.5  |  
|Treasury stock, at cost: 22,834,836 shares at September 30, 2006 and 7,743,113 shares at December 31, 2005                                                   |  |                    | (1,233.2 | ) |                   |   | (407.3   | )
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|Total stockholders equity                                                                                                                                   |  |                    | 7,548.7  |   |                   |   | 7,724.2  |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  
|Total liabilities and stockholders equity                                                                                                                   |  | $                  | 13,670.3 |   |                   | $ | 13,703.0 |  
|                                                                                                                                                             |  |                    |          |   |                   |   |          |  

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



1



---

##### Table of Contents

MEDCO HEALTH SOLUTIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(In millions, except for
per share data)



|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | -------- | ------------------ | - | ------------------ |  | ------------------ | -------- |  | - | --------
|                                                                                                                                                                                  |  | Quarters Ended     |          | Nine Months Ended 
|                                                                                                                                                                                  |  | September 30, 2006 |          | September 24, 2005 |   | September 30, 2006 |  | September 24, 2005
|Product net revenues (Includes retail co-payments of $1,779 and $1,802 in the third quarters of 2006 and 2005, and $5,539 and $5,434 in the
nine months of 2006 and 2005)         |  | $                  | 10,334.8 |                    | $ | 9,223.7            |  | $                  | 31,237.1 |  | $ | 26,786.3
|Service revenues                                                                                                                                                                  |  |                    | 126.3    |                    |   | 101.7              |  |                    | 376.4    |  |   | 281.1   
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Total net revenues                                                                                                                                                                |  |                    | 10,461.1 |                    |   | 9,325.4            |  |                    | 31,613.5 |  |   | 27,067.4
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Cost of operations:                                                                                                                                                               |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Cost of product net revenues (Includes retail co-payments of $1,779 and $1,802 in the third quarters of 2006 and 2005, and $5,539 and $5,434
in the nine months of 2006 and 2005) |  |                    | 9,840.8  |                    |   | 8,839.5            |  |                    | 29,809.2 |  |   | 25,629.2
|Cost of service revenues                                                                                                                                                          |  |                    | 26.8     |                    |   | 22.8               |  |                    | 89.0     |  |   | 72.3    
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Total cost of revenues                                                                                                                                                            |  |                    | 9,867.6  |                    |   | 8,862.3            |  |                    | 29,898.2 |  |   | 25,701.5
|Selling, general and administrative expenses                                                                                                                                      |  |                    | 222.9    |                    |   | 186.4              |  |                    | 857.9    |  |   | 536.8   
|Amortization of intangibles                                                                                                                                                       |  |                    | 54.6     |                    |   | 48.1               |  |                    | 163.9    |  |   | 138.0   
|Interest and other (income) expense, net                                                                                                                                          |  |                    | 20.9     |                    |   | 10.6               |  |                    | 49.8     |  |   | 27.1    
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Total cost of operations                                                                                                                                                          |  |                    | 10,166.0 |                    |   | 9,107.4            |  |                    | 30,969.8 |  |   | 26,403.4
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Income before provision for income taxes                                                                                                                                          |  |                    | 295.1    |                    |   | 218.0              |  |                    | 643.7    |  |   | 664.0   
|Provision for income taxes                                                                                                                                                        |  |                    | 109.3    |                    |   | 61.3               |  |                    | 242.3    |  |   | 238.7   
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Net income                                                                                                                                                                        |  | $                  | 185.8    |                    | $ | 156.7              |  | $                  | 401.4    |  | $ | 425.3   
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Basic earnings per share:                                                                                                                                                         |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Weighted average shares outstanding                                                                                                                                               |  |                    | 294.1    |                    |   | 291.0              |  |                    | 299.1    |  |   | 281.5   
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Earnings per share                                                                                                                                                                |  | $                  | 0.63     |                    | $ | 0.54               |  | $                  | 1.34     |  | $ | 1.51    
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Diluted earnings per share:                                                                                                                                                       |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Weighted average shares outstanding                                                                                                                                               |  |                    | 298.7    |                    |   | 296.5              |  |                    | 303.5    |  |   | 286.9   
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         
|Earnings per share                                                                                                                                                                |  | $                  | 0.62     |                    | $ | 0.53               |  | $                  | 1.32     |  | $ | 1.48    
|                                                                                                                                                                                  |  |                    |          |                    |   |                    |  |                    |          |  |   |         

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



2



---

##### Table of Contents

MEDCO HEALTH SOLUTIONS, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

(UNAUDITED)

($ in millions,
except for per share data)

(Shares in thousands)



|                                                                           |  |                               |  |                          |  |                              |     |                                               |   |                            |  |   |                       |   |  |                   |       |                |  |   |         |  |   |          |   |  |   |         |  
|-------------------------------------------------------------------------- |  | ----------------------------- |  | ------------------------ |  | ---------------------------- | --- | --------------------------------------------- | - | -------------------------- |  | - | --------------------- | - |  | ----------------- | ----- | -------------- |  | - | ------- |  | - | -------- | - |  | - | ------- | -
|                                                                           |  | Shares of Common Stock Issued |  | Shares of Treasury Stock |  | $0.01 Par Value Common
Stock |     | Accumulated Other Comprehensive Income (Loss) |   | Additional Paid-in Capital |  |   | Unearned Compensation |   |  | Retained Earnings |       | Treasury Stock |  |   | Total   | 
|Balances at December 31, 2005                                              |  | 312,001                       |  | 7,743                    |  | $                            | 3.1 |                                               | $ |                           |  | $ | 6,913.3               |   |  | $                 | (39.8 | )              |  | $ | 1,254.9 |  | $ | (407.3   | ) |  | $ | 7,724.2 |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |   |                            |  |   |                       |   |  |                   |       |                |  |   |         |  |   |          |   |  |   |         |  
|Net income                                                                 |  |                              |  |                         |  |                              |    |                                               |   |                           |  |   |                      |   |  |                   |      |                |  |   | 401.4   |  |   |         |   |  |   | 401.4   |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |   |                            |  |   |                       |   |  |                   |       |                |  |   |         |  |   |          |   |  |   |         |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |  
|Total comprehensive income                                                 |  |                              |  |                         |  |                              |    |                                               |   |                           |  |   |                      |   |  |                   |      |                |  |   | 401.4   |  |   |         |   |  |   | 401.4   |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |  
|Issuance of common stock for options exercised, including tax benefit      |  | 4,949                         |  |                         |  |                              | 0.1 |                                               |   |                           |  |   | 170.7                 |   |  |                   |      |                |  |   |        |  |   |         |   |  |   | 170.8   |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |  
|Issuance of common stock under employee stock purchase plans               |  | 144                           |  |                         |  |                              |    |                                               |   |                           |  |   | 7.6                   |   |  |                   |      |                |  |   |        |  |   |         |   |  |   | 7.6     |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |  
|Restricted stock and restricted stock unit activity, including tax benefit |  | 91                            |  |                         |  |                              |    |                                               |   |                           |  |   | 21.5                  |   |  |                   |      |                |  |   |        |  |   |         |   |  |   | 21.5    |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |  
|Reversal of unearned compensation                                          |  |                              |  |                         |  |                              |    |                                               |   |                           |  |   | (39.8                 | ) |  |                   | 39.8  |                |  |   |        |  |   |         |   |  |   |        |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |  
|Stock-based compensation related to options                                |  |                              |  |                         |  |                              |    |                                               |   |                           |  |   | 49.1                  |   |  |                   |      |                |  |   |        |  |   |         |   |  |   | 49.1    |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |  
|Treasury stock acquired                                                    |  |                              |  | 15,092                   |  |                              |    |                                               |   |                           |  |   |                      |   |  |                   |      |                |  |   |        |  |   | (825.9   | ) |  |   | (825.9  | )
|                                                                           |  |                               |  |                          |  |                              |     |                                               |   |                            |  |   |                       |   |  |                   |       |                |  |   |         |  |   |          |   |  |   |         |  
|Balances at September 30, 2006                                             |  | 317,185                       |  | 22,835                   |  | $                            | 3.2 |                                               | $ |                           |  | $ | 7,122.4               |   |  | $                 |      |                |  | $ | 1,656.3 |  | $ | (1,233.2 | ) |  | $ | 7,548.7 |  
|                                                                           |  |                               |  |                          |  |                              |     |                                               |   |                            |  |   |                       |   |  |                   |       |                |  |   |         |  |   |          |   |  |   |         |  

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



3



---

##### Table of Contents

MEDCO HEALTH SOLUTIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In millions)



|                                                                                  |  |                    |        |   |                    |   |          |  
|--------------------------------------------------------------------------------- |  | ------------------ | ------ | - | ------------------ | - | -------- | -
|                                                                                  |  | Nine Months Ended  |       
|                                                                                  |  | September 30, 2006 |        |   | September 24, 2005 |  
|Cash flows from operating activities:                                             |  |                    |        |   |                    |   |          |  
|Net income                                                                        |  | $                  | 401.4  |   |                    | $ | 425.3    |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                    |        |   |                    |   |          |  
|Depreciation                                                                      |  |                    | 133.2  |   |                    |   | 121.5    |  
|Amortization of intangibles                                                       |  |                    | 163.9  |   |                    |   | 138.0    |  
|Deferred income taxes                                                             |  |                    | (72.7  | ) |                    |   | (85.0    | )
|Stock-based compensation on employee stock plans                                  |  |                    | 74.5   |   |                    |   |         |  
|Tax benefit on employee stock plans                                               |  |                    | 57.7   |   |                    |   | 80.1     |  
|Excess tax benefits from stock-based compensation arrangements                    |  |                    | (32.1  | ) |                    |   |         |  
|Other                                                                             |  |                    | 32.2   |   |                    |   | 22.5     |  
|Net changes in assets and liabilities (net of acquisition effects, 2005 only):    |  |                    |        |   |                    |   |          |  
|Accounts receivable                                                               |  |                    | (482.1 | ) |                    |   | 4.6      |  
|Inventories                                                                       |  |                    | (89.7  | ) |                    |   | 132.1    |  
|Prepaid expenses and other current assets                                         |  |                    | (43.0  | ) |                    |   | (21.0    | )
|Deferred income taxes                                                             |  |                    | 152.6  |   |                    |   |         |  
|Income taxes receivable                                                           |  |                    | (202.5 | ) |                    |   |         |  
|Other noncurrent assets                                                           |  |                    | 20.6   |   |                    |   | 40.4     |  
|Current liabilities and other noncurrent liabilities                              |  |                    | 247.8  |   |                    |   | 43.0     |  
|                                                                                  |  |                    |        |   |                    |   |          |  
|Net cash provided by operating activities                                         |  |                    | 361.8  |   |                    |   | 901.5    |  
|                                                                                  |  |                    |        |   |                    |   |          |  
|Cash flows from investing activities:                                             |  |                    |        |   |                    |   |          |  
|Cash paid for Accredo, net of cash acquired                                       |  |                    |       |   |                    |   | (989.1   | )
|Capital expenditures                                                              |  |                    | (87.8  | ) |                    |   | (77.4    | )
|Purchases of securities and other investments                                     |  |                    | (72.4  | ) |                    |   | (53.3    | )
|Proceeds from sale of securities and other investments                            |  |                    | 69.6   |   |                    |   | 53.3     |  
|                                                                                  |  |                    |        |   |                    |   |          |  
|Net cash used by investing activities                                             |  |                    | (90.6  | ) |                    |   | (1,066.5 | )
|                                                                                  |  |                    |        |   |                    |   |          |  
|Cash flows from financing activities:                                             |  |                    |        |   |                    |   |          |  
|Proceeds from long-term debt                                                      |  |                    |       |   |                    |   | 750.0    |  
|Repayments on long-term debt                                                      |  |                    | (56.6  | ) |                    |   | (1,046.4 | )
|Proceeds under accounts receivable financing facility                             |  |                    | 150.0  |   |                    |   | 450.0    |  
|Repayments under accounts receivable financing facility                           |  |                    | (150.0 | ) |                    |   |         |  
|Debt issuance costs                                                               |  |                    | (0.4   | ) |                    |   | (2.4     | )
|Purchase of treasury stock                                                        |  |                    | (825.9 | ) |                    |   | (69.1    | )
|Excess tax benefits from stock-based compensation arrangements                    |  |                    | 32.1   |   |                    |   |         |  
|Proceeds from employee stock plans                                                |  |                    | 150.2  |   |                    |   | 263.7    |  
|                                                                                  |  |                    |        |   |                    |   |          |  
|Net cash (used by) provided by financing activities                               |  |                    | (700.6 | ) |                    |   | 345.8    |  
|                                                                                  |  |                    |        |   |                    |   |          |  
|Net (decrease) increase in cash and cash equivalents                              |  |                    | (429.4 | ) |                    |   | 180.8    |  
|Cash and cash equivalents at beginning of period                                  |  |                    | 888.2  |   |                    |   | 1,145.5  |  
|                                                                                  |  |                    |        |   |                    |   |          |  
|Cash and cash equivalents at end of period                                        |  | $                  | 458.8  |   |                    | $ | 1,326.3  |  
|                                                                                  |  |                    |        |   |                    |   |          |  

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



4



---

##### Table of Contents

MEDCO HEALTH SOLUTIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial statements of Medco Health Solutions, Inc. and subsidiaries
(Medco or the Company) have been prepared pursuant to the Securities and Exchange Commissions (SEC) rules and regulations for reporting on Form 10-Q. Accordingly, certain information and disclosures required
by accounting principles generally accepted in the United States for complete consolidated financial statements are not included herein. In the opinion of the Companys management, all adjustments, which include adjustments of a normal
recurring nature necessary for a fair statement of the financial position, results of operations and cash flows at the dates and for the periods presented, have been included. The results of operations for any interim period are not necessarily
indicative of the results of operations for the full year. The unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto as of December 31, 2005
included in the Companys Annual Report on Form 10-K. The Companys fiscal quarters for 2006 and 2005 each consisted of 13 weeks and ended on September 30, 2006 and September 24, 2005, respectively.

The most recent assessment of goodwill impairment for each of the designated reporting units was performed as of September 30, 2006, and the
recorded goodwill was determined not to be impaired. Additionally, changes in goodwill for the nine months ended September 30, 2006 primarily result from converted option activity associated with the acquisition of Accredo Health, Incorporated
(Accredo).

Certain reclassifications have been made to prior period amounts to conform to current period presentation.

2. RECENTLY ADOPTED FINANCIAL ACCOUNTING STANDARD

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment, (SFAS 123R) which requires the
measurement and recognition of compensation expense for all stock-based compensation awards made to employees and directors including employee stock options and employee stock purchase plans. SFAS 123R supersedes the Companys previous
accounting under APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), for periods subsequent to December 31, 2005. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB
107) which provides interpretative guidance in applying the provisions of SFAS 123R. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R.

The Company adopted SFAS 123R using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Companys 2006 fiscal
year. The Companys unaudited interim condensed consolidated financial statements as of and for the fiscal quarter and nine months ended September 30, 2006 reflect the impact of SFAS 123R. In accordance with the modified prospective
transition method, the Companys consolidated financial statements for periods prior to January 1, 2006 have not been restated to reflect, and do not include, the impact of SFAS 123R as the Company did not record stock-based compensation
expense related to employee stock options and employee stock purchase plans. Stock-based compensation expense related to employee stock options and employee stock purchase plans recognized under SFAS 123R for the fiscal quarter and nine months ended
September 30, 2006 amounted to $14.8 million pre-tax and $50.4 million pre-tax, respectively. See Note 5, Stock-Based Compensation, for additional information.

SFAS 123R requires companies to estimate the fair value of stock-based awards on the date of grant using an option-pricing model. The portion of the
value that is ultimately expected to vest is recognized as expense over the requisite service period. Prior to the adoption of SFAS 123R, the Company accounted for stock-based awards using the intrinsic value method in accordance with APB 25 as
allowed under SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123). Under the intrinsic value method, no stock-based compensation expense had been recognized related to options because the exercise price of
the Companys stock options granted equaled the fair market value of the underlying stock at the date of the grant.



5



---

##### Table of Contents

SFAS 123R also requires the benefits of realized tax deductions in excess of tax benefits on compensation
expense to be reported as a component of cash flows from financing activities rather than as an operating cash flow, as previously required. The reported excess amounts to $32.1 million for the nine months ended September 30, 2006. In
accordance with SAB 107, the Company classifies stock-based compensation within cost of product net revenues and selling, general and administrative expenses to correspond with the line items in which cash compensation paid to employees and
directors is recorded.

Stock-based compensation expense recognized in the Companys unaudited interim condensed consolidated
statements of income for the fiscal quarter and nine months ended September 30, 2006 includes compensation expense for stock-based compensation awards granted prior to, but not yet vested as of December 31, 2005, based on the grant-date
fair value estimated in accordance with the pro forma provisions of SFAS 123. Additionally, the Companys unaudited interim condensed consolidated statements of income for the fiscal quarter and nine months ended September 30, 2006 include
compensation expense for the stock-based compensation awards granted subsequent to December 31, 2005 based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. In conjunction with the adoption of SFAS 123R, the
Company changed its method of attributing the value of stock-based compensation to expense from the accelerated multiple-option approach under Financial Accounting Standards Board (FASB) Interpretation No. 28, Accounting for
Stock Appreciation Rights and Other Variable Stock Option or Award Plans (FIN 28) to the straight-line single option method.

As stock-based compensation expense recognized in the Companys unaudited interim condensed consolidated statements of income is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123R
requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company estimates forfeitures in the same manner under SFAS 123R as it did prior to its
adoption.

3. LEGAL SETTLEMENTS CHARGE

On October 23, 2006, the Company entered into settlement agreements with the Department of Justice on the following three previously-disclosed matters handled by the U.S. Attorneys Office for the Eastern District of Pennsylvania.
The three settlement agreements do not include any finding or admission of wrongdoing on the part of the Company.

The first matter was a
Consolidated Action pending in the Eastern District of Pennsylvania. The Consolidated Action included a government complaint-in-intervention filed in September 2003 and two pending qui tam, or whistleblower, complaints filed in 2000. The
complaints alleged violations of the False Claims Act and various other state statutes. Additional legal claims were added in an amended complaint-in-intervention filed in December 2003, including a count alleging a violation of the Public Contracts
Anti-Kickback Act. This Consolidated Action has been settled for $137.5 million.

The second matter was a qui tam that remains under
seal in the Eastern District of Pennsylvania. The U.S. Attorneys Office had informed the Company that the Complaint alleges violations of the federal False Claims Act, that the Company and other defendants inflated manufacturers
best price to Medicare and Medicaid, and that the Company and other defendants offered and paid kickbacks to third parties to induce the placement on formularies and promotion of certain drugs. This matter has been settled for $9.5
million.

The third matter was an investigation that began with a letter the Company received from the U.S. Attorneys Office for the
Eastern District of Pennsylvania in January 2005 requesting information and representations regarding the Companys Medicare Part B coordination of benefits recovery program. This matter was settled for $8.0 million. The Company had previously
recorded reserves for these items, including a $162.6 million pre-tax charge in selling, general and administrative expenses to cover these settlement charges and fees paid to the plaintiffs attorneys. Based on the current facts and
circumstances, the Company believes it is probable that the settlement amounts will be tax deductible.



6



---

##### Table of Contents

Contemporaneous with the three above-referenced settlement agreements, the Company entered into a
Corporate Integrity Agreement with the Department of Health and Human Services and the Office of Personnel Management. This five-year agreement is designed to ensure that the Companys compliance program meets certain requirements. In
connection with the ongoing negotiations with the Department of Justice, the Company established a separate money market fund account associated with the legal settlement. On August 22, 2006, the Company purchased for such money market fund
account that number of shares with an aggregate net asset value of $155 million (Settlement Amount). On October 24, 2006, the Company paid $156.4 million, representing the Settlement Amount plus accrued interest of $1.4 million, to
the Department of Justice.

See Note 12, Commitments and Contingencies, for additional information on various lawsuits, claims
proceedings and investigations that are pending against the Company and certain of its subsidiaries.

4. ACQUISITION OF ACCREDO

The results of operations of Accredo are included in the accompanying unaudited interim condensed consolidated financial statements beginning on
August 18, 2005. The pro forma results of operations of the Company and Accredo for the quarter and nine months ended September 24, 2005, as if the Accredo acquisition had occurred at the beginning of fiscal 2005, were as follows ($ in
millions, except for per share amounts):



|                                                      |  |                                  |         |                                      |   |         
|----------------------------------------------------- |  | -------------------------------- | ------- | ------------------------------------ | - | --------
|                                                      |  | Quarter Ended September 24, 2005 |         | Nine Months Ended September 24, 2005
|Pro forma total net revenues                          |  | $                                | 9,525.4 |                                      | $ | 28,108.8
|Pro forma net income                                  |  | $                                | 151.2   |                                      | $ | 416.3   
|                                                      |  |                                 
|Pro forma basic weighted average shares outstanding   |  |                                  | 304.7   |                                      |   | 302.2   
|Pro forma basic earnings per common share             |  | $                                | 0.50    |                                      | $ | 1.38    
|Pro forma diluted weighted average shares outstanding |  |                                  | 311.0   |                                      |   | 308.2   
|Pro forma diluted earnings per common share           |  | $                                | 0.49    |                                      | $ | 1.35    

The pro forma financial information above is not necessarily indicative of what the Companys
consolidated results of operations actually would have been if the Accredo acquisition had been completed at the beginning of fiscal 2005. In addition, the pro forma information above does not attempt to project the Companys future results of
operations.

5. STOCK-BASED COMPENSATION

The Compensation Committee of the Companys Board of Directors regularly reviews the Companys compensation structure and practices, including the timing of its stock-based awards. The Audit Committee of the Companys Board
of Directors also reviews the Companys option-granting practices from time to time. The Company grants options to employees and directors to purchase shares of Medco common stock at the fair market value on the date of grant. The options
generally vest over three years and expire within 10 years from the date of the grant. Under the terms of the Medco Health Solutions, Inc. 2002 Stock Incentive Plan, as of September 30, 2006, 19.8 million shares of the Companys
common stock are available for awards. As of September 30, 2006, under the terms of the Accredo Health, Incorporated 2002 Long-Term Incentive Plan as amended and restated on August 18, 2005, there are 0.5 million shares of the
Companys common stock available for awards.

On January 1, 2006, the Company adopted SFAS 123R, which requires the measurement
and recognition of compensation expense for all stock-based compensation awards made to the Companys employees and directors, including stock options and employee stock purchases related to employee stock purchase plans, based on estimated
fair values. Prior to the adoption of SFAS 123R, the Company accounted for employee options to purchase stock, and for employee participation in employee stock purchase plans, under the intrinsic value method of expense recognition in APB 25, as
permitted by SFAS 123. See Note 2, Recently Adopted Financial Accounting Standard, for a discussion of SFAS 123R, which revised SFAS No. 123 and superseded APB 25 and its related implementation guidance.



7



---

##### Table of Contents

If the fair value method of accounting had been applied to stock options and the employee stock purchase
plans in 2005, net income in 2005 would have been reduced. The fair value method requires recognition of compensation expense ratably over the requisite service period. The employee stock purchase plans value under the fair value method
represents a 15% discount provided to eligible employees.

The fair value of options granted is estimated on the date of grant using the
Black-Scholes option-pricing model. As the Company has limited public trading history, the Medco volatility assumption is based on the volatility of the largest public companies within the pharmacy benefit management (PBM) industry,
combined with the Companys stock price volatility for the period the Company has been publicly traded. The Company uses historical data to estimate the expected option life. The expected option life represents the period of time that options
granted are expected to be outstanding. Groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant.
The weighted average fair value of options granted for the nine months ended September 30, 2006 and September 24, 2005 was $20.79 and $18.41, respectively. The weighted average assumptions utilized for options granted during the periods
presented are as follows:



|                                                                  |  |                    |   |  |                    |   |  |                    |   |  |                    |  
|----------------------------------------------------------------- |  | ------------------ | - |  | ------------------ | - |  | ------------------ | - |  | ------------------ | -
|                                                                  |  | Quarters Ended     |   |  | Nine Months Ended  |  
|                                                                  |  | September 30, 2006 |   |  | September 24, 2005 |   |  | September 30, 2006 |   |  | September 24, 2005 |  
|Medco stock options Black-Scholes assumptions (weighted average): |  |                    |   |  |                    |   |  |                    |   |  |                    |  
|Expected dividend yield                                           |  | 0                  | % |  | 0                  | % |  | 0                  | % |  | 0                  | %
|Risk-free interest rate                                           |  | 4.9                | % |  | 4.0                | % |  | 4.6                | % |  | 4.0                | %
|Expected volatility                                               |  | 32.0               | % |  | 35.0               | % |  | 32.0               | % |  | 35.0               | %
|Expected life (years)                                             |  | 4.0                |   |  | 4.5                |   |  | 5.1                |   |  | 5.6                |  

Stock-based compensation expense related to stock options and employee stock purchase plans
recognized for the quarter and nine months ended September 30, 2006 as a result of the adoption of SFAS 123R was comprised as follows ($ in millions, except for per share data):



|                                                  |  |                                  |      |   |                                      |   |       |  
|------------------------------------------------- |  | -------------------------------- | ---- | - | ------------------------------------ | - | ----- | -
|                                                  |  | Quarter Ended September 30, 2006 |      |   | Nine Months Ended September 30, 2006 |  
|Cost of product net revenues                      |  | $                                | 2.5  |   |                                      | $ | 8.3   |  
|Selling, general and administrative expenses      |  |                                  | 12.3 |   |                                      |   | 42.1  |  
|                                                  |  |                                  |      |   |                                      |   |       |  
|Stock-based compensation expense, before taxes    |  |                                  | 14.8 |   |                                      |   | 50.4  |  
|Related income tax benefits                       |  |                                  | (5.8 | ) |                                      |   | (19.7 | )
|                                                  |  |                                  |      |   |                                      |   |       |  
|Stock-based compensation expense, net of taxes(1) |  | $                                | 9.0  |   |                                      | $ | 30.7  |  
|                                                  |  |                                  |      |   |                                      |   |       |  
|Earnings per share effect:                        |  |                                  |      |   |                                      |   |       |  
|Basic                                             |  | $                                | 0.03 |   |                                      | $ | 0.10  |  
|Diluted                                           |  | $                                | 0.03 |   |                                      | $ | 0.10  |  

---

|(1) | Stock-based compensation expense for the quarter and
nine months ended September 30, 2006 includes stock option expense of $8.7 million ($14.3 million pre-tax) and $29.9 million ($49.1 million pre-tax), respectively, and employee stock purchase plan expense of $0.3 million ($0.5 million pre-tax)
and $0.8 million ($1.3 million pre-tax), respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The pro forma net income and earnings per share for the
quarter and nine months ended September 24, 2005, which reflect results as if the Company had applied the fair value method for recognizing employee stock-based compensation to the stock options and the employee stock purchase plan, are as
follows ($ in millions, except for per share data):



8



---

##### Table of Contents

|                                                                                                         |  |                                  |       |   |                                      |   |       |  
|-------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ----- | - | ------------------------------------ | - | ----- | -
|                                                                                                         |  | Quarter Ended September 24, 2005 |       |   | Nine Months Ended September 24, 2005 |  
|Net income, as reported                                                                                  |  | $                                | 156.7 |   |                                      | $ | 425.3 |  
|Stock-based compensation expense related to options and the employee stock purchase plan, net of tax (1) |  |                                  | (14.2 | ) |                                      |   | (46.5 | )
|                                                                                                         |  |                                  |       |   |                                      |   |       |  
|Pro forma net income, including stock-based compensation expense                                         |  | $                                | 142.5 |   |                                      | $ | 378.8 |  
|                                                                                                         |  |                                  |       |   |                                      |   |       |  
|Basic earnings per share:                                                                                |  |                                  |       |   |                                      |   |       |  
|As reported                                                                                              |  | $                                | 0.54  |   |                                      | $ | 1.51  |  
|Pro forma                                                                                                |  | $                                | 0.49  |   |                                      | $ | 1.35  |  
|Diluted earnings per share:                                                                              |  |                                  |       |   |                                      |   |       |  
|As reported                                                                                              |  | $                                | 0.53  |   |                                      | $ | 1.48  |  
|Pro forma                                                                                                |  | $                                | 0.48  |   |                                      | $ | 1.32  |  

---

|(1) | Pro forma stock-based compensation expense for the
quarter and nine months ended September 24, 2005 includes stock option expense of $14.0 million ($23.4 million pre-tax) and $46.0 million ($76.5 million pre-tax), respectively, and employee stock purchase plan expense of $0.2 million ($0.3
million pre-tax) and $0.5 million ($0.9 million pre-tax), respectively.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Stock Option Plans.Summarized information related to stock options held by the Companys employees and directors is as follows:



|                                  |  |                                 |   |  |                                 |       |                                             |      |                                         |   |      
|--------------------------------- |  | ------------------------------- | - |  | ------------------------------- | ----- | ------------------------------------------- | ---- | --------------------------------------- | - | -----
|                                  |  | Number of Shares (in thousands) |   |  | Weighted Average Exercise Price |       | Weighted Average Remaining Contractual Term |      | Aggregate Intrinsic Value (in millions)
|Outstanding at January 1, 2006    |  | 18,392.3                        |   |  | $                               | 33.13 |                                             |      |                                         |   |      
|Granted                           |  | 2,886.7                         |   |  |                                 | 56.52 |                                             |      |                                         |   |      
|Exercised                         |  | (4,963.6                        | ) |  |                                 | 29.20 |                                             |      |                                         |   |      
|Forfeited                         |  | (485.0                          | ) |  |                                 | 42.48 |                                             |      |                                         |   |      
|                                  |  |                                 |   |  |                                 |       |                                             |      |                                         |   |      
|Outstanding at September 30, 2006 |  | 15,830.4                        |   |  | $                               | 38.34 |                                             | 7.28 |                                         | $ | 339.2
|                                  |  |                                 |   |  |                                 |       |                                             |      |                                         |   |      
|Exercisable at September 30, 2006 |  | 8,443.9                         |   |  | $                               | 31.07 |                                             | 6.61 |                                         | $ | 242.3
|                                  |  |                                 |   |  |                                 |       |                                             |      |                                         |   |      

The total intrinsic value of options exercised during the nine months ended September 30,
2006 was $146.4 million. The total intrinsic value of options exercised during the nine months ended September 24, 2005 was $202.8 million.

As of September 30, 2006, there was $76.6 million of total unrecognized compensation cost related to stock options granted. That cost is expected to be recognized over a weighted-average period of 2.1 years. The total fair value of
shares vested during the nine months ended September 30, 2006 was $72.6 million. The total fair value of shares vested during the nine months ended September 24, 2005 was $89.0 million. The Company expects the majority of outstanding
nonvested options to vest. The activity related to nonvested options is as follows:



|                                |  |                                 |   |  |                                        |      
|------------------------------- |  | ------------------------------- | - |  | -------------------------------------- | -----
|                                |  | Number of Shares (in thousands) |   |  | Weighted Average Grant-Date Fair Value
|                                | 
|Nonvested at January 1, 2006    |  | 10,002.4                        |   |  | $                                      | 15.55
|Granted                         |  | 2,886.7                         |   |  |                                        | 20.79
|Vested                          |  | (5,154.8                        | ) |  |                                        | 14.11
|Forfeited                       |  | (347.8                          | ) |  |                                        | 16.56
|                                |  |                                 |   |  |                                        |      
|Nonvested at September 30, 2006 |  | 7,386.5                         |   |  | $                                      | 18.56
|                                |  |                                 |   |  |                                        |      



9



---

##### Table of Contents

Restricted Stock Units and Restricted Stock Plans. The Company grants restricted stock
units and restricted shares to employees and directors, which generally vest over two or three years. The fair value of the restricted stock units and restricted shares is determined by the product of the number of shares granted and the grant-date
market price of the Companys common stock. The fair value of the restricted stock units and restricted shares is expensed on a straight-line basis over the requisite service period. Net income, as reported, includes stock-based compensation
expense related to restricted stock and restricted stock units for the quarter and nine months ended September 30, 2006 of $5.3 million ($8.7 million pre-tax) and $14.6 million ($24.1 million pre-tax). Net income, as reported, includes
stock-based compensation expense related to restricted stock and restricted stock units for the quarter and nine months ended September 24, 2005 of $3.0 million ($4.9 million pre-tax) and $7.3 million ($12.1 million pre-tax), respectively.

Upon vesting, certain employees and directors may defer conversion of the restricted stock units to common stock. Summarized information
related to restricted stock units and restricted stock held by the Companys employees and directors is as follows:



|                                          |  |                                 |   |  |                                         |      
|----------------------------------------- |  | ------------------------------- | - |  | --------------------------------------- | -----
|Restricted Stock Units                    |  | Number of Shares (in thousands) |   |  | Aggregate Intrinsic Value (in millions)
|Outstanding at January 1, 2006            |  | 1,329.1                         |   |  |                                         |      
|Granted                                   |  | 892.4                           |   |  |                                         |      
|Converted                                 |  | (103.9                          | ) |  |                                         |      
|Forfeited                                 |  | (52.8                           | ) |  |                                         |      
|                                          |  |                                 |   |  |                                         |      
|Outstanding at September 30, 2006         |  | 2,064.8                         |   |  | $                                       | 123.4
|                                          |  |                                 |   |  |                                         |      
|Vested and deferred at September 30, 2006 |  | 164.3                           |   |  | $                                       | 9.8  
|                                          |  |                                 |   |  |                                         |      
|                                          |  |                                
|Restricted Stock                          |  | Number ofShares (in thousands)  |   |  | Aggregate Intrinsic Value (in millions)
|Outstanding at January 1, 2006            |  | 113.0                           |   |  |                                         |      
|Granted                                   |  |                                |   |  |                                         |      
|Converted                                 |  | (34.1                           | ) |  |                                         |      
|Forfeited                                 |  |                                |   |  |                                         |      
|                                          |  |                                 |   |  |                                         |      
|Outstanding at September 30, 2006         |  | 78.9                            |   |  | $                                       | 4.7  
|                                          |  |                                 |   |  |                                         |      

The weighted average grant-date fair value of restricted stock units granted during the nine
months ended September 30, 2006 and September 24, 2005 was $56.69 and $44.36, respectively. The weighted average grant-date fair value of restricted stock granted during the nine months ended September 24, 2005 was $49.62. Restricted
stock was not granted during the nine months ended September 30, 2006. The total intrinsic value of restricted stock units and restricted stock converted during the nine months ended September 30, 2006 was $6.3 million and $2.1 million,
respectively. The total intrinsic value of restricted stock units converted during the nine months ended September 24, 2005 was $3.7 million.



|                                 |  |                                 |   |  |                                        |      
|-------------------------------- |  | ------------------------------- | - |  | -------------------------------------- | -----
|Nonvested Restricted Stock Units |  | Number of Shares (in thousands) |   |  | Weighted Average Grant-Date Fair Value
|Nonvested at January 1, 2006     |  | 1,201.1                         |   |  | $                                      | 42.63
|Granted                          |  | 892.4                           |   |  |                                        | 56.69
|Vested                           |  | (140.2                          | ) |  |                                        | 30.40
|Forfeited                        |  | (52.8                           | ) |  |                                        | 48.67
|                                 |  |                                 |   |  |                                        |      
|Nonvested at September 30, 2006  |  | 1,900.5                         |   |  | $                                      | 49.96
|                                 |  |                                 |   |  |                                        |      



10



---

##### Table of Contents

|                                |  |                                 |   |  |                                        |      
|------------------------------- |  | ------------------------------- | - |  | -------------------------------------- | -----
|Nonvested Restricted Stock      |  | Number of Shares (in thousands) |   |  | Weighted Average Grant-Date Fair Value
|Nonvested at January 1, 2006    |  | 113.0                           |   |  | $                                      | 49.68
|Granted                         |  |                                |   |  |                                        |     
|Vested                          |  | (34.1                           | ) |  |                                        | 49.62
|Forfeited                       |  |                                |   |  |                                        |     
|                                |  |                                 |   |  |                                        |      
|Nonvested at September 30, 2006 |  | 78.9                            |   |  | $                                      | 49.71
|                                |  |                                 |   |  |                                        |      

As of September 30, 2006, there was $63.2 million of total unrecognized compensation cost
related to nonvested restricted stock units and restricted stock grants. That cost is expected to be recognized over a weighted average period of 2.1 years. The total grant-date fair value of restricted stock units vested during the nine months
ended September 30, 2006 and September 24, 2005 was $4.3 million and $4.2 million, respectively. The Company expects the majority of nonvested restricted stock units and restricted stock shares to vest.

6. EARNINGS PER SHARE (EPS)

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



|                                                                       |  |                    |  |                    |  |                    |  |                   
|---------------------------------------------------------------------- |  | ------------------ |  | ------------------ |  | ------------------ |  | ------------------
|                                                                       |  | Quarters Ended     |  | Nine Months Ended 
|                                                                       |  | September 30, 2006 |  | September 24, 2005 |  | September 30, 2006 |  | September 24, 2005
|Weighted average shares outstanding                                    |  | 294.1              |  | 291.0              |  | 299.1              |  | 281.5             
|Dilutive common stock equivalents:                                     |  |                    |  |                    |  |                    |  |                   
|Outstanding stock options, restricted stock units and restricted stock |  | 4.6                |  | 5.5                |  | 4.4                |  | 5.4               
|                                                                       |  |                    |  |                    |  |                    |  |                   
|Weighted average shares outstanding assuming dilution                  |  | 298.7              |  | 296.5              |  | 303.5              |  | 286.9             
|                                                                       |  |                    |  |                    |  |                    |  |                   

SFAS No. 128, Earnings per Share, (SFAS 128) requires that stock
options and restricted stock units granted by the Company be treated as potential common shares outstanding in computing diluted earnings per share. Under the treasury stock method, the amount the employee or director must pay for exercising the
award, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefit that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to
repurchase shares. For the quarter and nine months ended September 30, 2006, there were outstanding options to purchase 3.7 million and 4.0 million shares of Medco stock, respectively, which were not dilutive to the EPS calculations.
These outstanding options may be dilutive to future EPS calculations. For the quarter and nine months ended September 24, 2005, there were outstanding options to purchase 1.0 million shares of Medco stock where the exercise price of the
options exceeded the average stock price, which were not dilutive to the EPS calculations. The increase in the weighted average shares outstanding and diluted weighted average shares outstanding reflect approximately 24 million shares issued in
August 2005 in connection with the Accredo acquisition, as well as the issuance of stock under employee stock plans and the dilutive effect of outstanding stock options, partially offset by share repurchases. In accordance with SFAS 128, treasury
shares, on a weighted average basis, are not considered part of the basic or diluted shares outstanding for the quarter and nine months ended September 30, 2006.

7. ACCOUNTS RECEIVABLE, NET

As of September 30, 2006 and December 31, 2005, total unbilled
receivables from clients, manufacturers, and other payors amounted to $1,622.5 million and $2,182.6 million, respectively, reflecting the timing of billing cycles. As of September 30, 2006 and December 31, 2005, identified specialty
pharmacy accounts receivable from payors and patients amounted to $402.1 million and $399.6 million, respectively. Accounts receivable are presented net of allowance for doubtful accounts of $72.0 million at September 30, 2006 and $67.3 million
at December 31, 2005, including $65.0 million and $62.0 million, respectively, for specialty pharmacy. The relatively higher allowance for specialty pharmacy reflects a different credit risk profile than the PBM business, characterized by
reimbursement through medical coverage, including government agencies, and higher patient co-payments. See Note 11, Segment Reporting, for more information on the Specialty Pharmacy segment.



11



---

##### Table of Contents

8. INTANGIBLE ASSETS, NET

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



|                            |  |                      |         |                          |   |         |  |                      |         |                          |   |         |  |   |         |  |   |        
|--------------------------- |  | -------------------- | ------- | ------------------------ | - | ------- |  | -------------------- | ------- | ------------------------ | - | ------- |  | - | ------- |  | - | -------
|                            |  | September 30, 2006   |         | December 31, 2005       
|                            |  | Gross Carrying Value |         | Accumulated Amortization |   | Net     |  | Gross Carrying Value |         | Accumulated Amortization |   | Net    
|Intangible assets:          |  |                      |         |                          |   |         |  |                      |         |                          |   |         |  |   |         |  |   |        
|PBM client relationships(1) |  | $                    | 3,172.2 |                          | $ | 1,346.5 |  | $                    | 1,825.7 |                          | $ | 3,172.2 |  | $ | 1,211.5 |  | $ | 1,960.7
|Accredo(2)                  |  |                      | 793.5   |                          |   | 41.5    |  |                      | 752.0   |                          |   | 793.5   |  |   | 12.6    |  |   | 780.9  
|                            |  |                      |         |                          |   |         |  |                      |         |                          |   |         |  |   |         |  |   |        
|Total                       |  | $                    | 3,965.7 |                          | $ | 1,388.0 |  | $                    | 2,577.7 |                          | $ | 3,965.7 |  | $ | 1,224.1 |  | $ | 2,741.6
|                            |  |                      |         |                          |   |         |  |                      |         |                          |   |         |  |   |         |  |   |        

---

|(1) | Principally comprised of the recorded value of
Medcos client relationships at the time of the acquisition of the Company by Merck & Co., Inc.(Merck) in 1993 and, to a significantly lesser extent, the Companys acquisition of ProVantage Health Services, Inc. in
2000.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Represents the Specialty Pharmacy segment, primarily
reflecting the portion of the excess of the Accredo purchase price over tangible net assets acquired.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------

Aggregate
intangible asset amortization expense in each of the five succeeding fiscal years is estimated to be approximately $218 million. The weighted average useful life of intangible assets subject to amortization is 23 years in total and by major
intangible asset class are approximately 23 years for the PBM client relationships and approximately 22 years for the Accredo acquired intangible assets.

9. PENSION AND OTHER POSTRETIREMENT BENEFITS

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



|                                     |  |                    |      |   |                    |   |      |                    |  |   |                    |   |  |   |      |  
|------------------------------------ |  | ------------------ | ---- | - | ------------------ | - | ---- | ------------------ |  | - | ------------------ | - |  | - | ---- | -
|                                     |  | Quarters Ended     |      |   | Nine Months Ended  |  
|                                     |  | September 30, 2006 |      |   | September 24, 2005 |   |      | September 30, 2006 |  |   | September 24, 2005 |  
|Service cost                         |  | $                  | 4.3  |   |                    | $ | 4.1  |                    |  | $ | 12.8               |   |  | $ | 12.2 |  
|Interest cost                        |  |                    | 1.6  |   |                    |   | 1.4  |                    |  |   | 4.8                |   |  |   | 4.4  |  
|Expected return on plan assets       |  |                    | (2.3 | ) |                    |   | (2.0 | )                  |  |   | (6.9               | ) |  |   | (6.0 | )
|Net amortization of actuarial losses |  |                    | 0.1  |   |                    |   | 0.1  |                    |  |   | 0.3                |   |  |   | 0.2  |  
|                                     |  |                    |      |   |                    |   |      |                    |  |   |                    |   |  |   |      |  
|Net pension cost                     |  | $                  | 3.7  |   |                    | $ | 3.6  |                    |  | $ | 11.0               |   |  | $ | 10.8 |  
|                                     |  |                    |      |   |                    |   |      |                    |  |   |                    |   |  |   |      |  

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



|                                             |  |                    |      |   |                    |   |      |                    |  |   |                    |   |  |   |      |  
|-------------------------------------------- |  | ------------------ | ---- | - | ------------------ | - | ---- | ------------------ |  | - | ------------------ | - |  | - | ---- | -
|                                             |  | Quarters Ended     |      |   | Nine Months Ended  |  
|                                             |  | September 30, 2006 |      |   | September 24, 2005 |   |      | September 30, 2006 |  |   | September 24, 2005 |  
|Service (credit) cost                        |  | $                  | (0.3 | ) |                    | $ | 0.4  |                    |  | $ | 0.6                |   |  | $ | 1.3  |  
|Interest (credit) cost                       |  |                    | (0.4 | ) |                    |   | 0.6  |                    |  |   | 0.5                |   |  |   | 1.4  |  
|Amortization of prior service costs          |  |                    | (1.1 | ) |                    |   | (1.1 | )                  |  |   | (3.2               | ) |  |   | (3.2 | )
|Net amortization of actuarial (gains) losses |  |                    | (0.3 | ) |                    |   | 0.4  |                    |  |   | 0.5                |   |  |   | 1.3  |  
|                                             |  |                    |      |   |                    |   |      |                    |  |   |                    |   |  |   |      |  
|Net postretirement benefit (credit) cost     |  | $                  | (2.1 | ) |                    | $ | 0.3  |                    |  | $ | (1.6               | ) |  | $ | 0.8  |  
|                                             |  |                    |      |   |                    |   |      |                    |  |   |                    |   |  |   |      |  

The Company amended the postretirement healthcare benefit plan in 2003, which reduced and capped
benefit obligations, the effect of which is reflected in the amortization of the prior service costs component of the net postretirement benefit cost. The activity for the quarter and nine months ended September 30, 2006 reflects a change in
assumption regarding retiree participation based on recent plan experience under the amended plan design.



12



---

##### Table of Contents

10. TAXES ON INCOME

The Companys effective tax rate was 37.0% and 37.6% for the quarter and nine months ended September 30, 2006, respectively, compared to 28.1% and 35.9% for the same periods in 2005. The 2006 third
quarter rate reflects a net $6.6 million non-recurring benefit, which includes $4.1 million of interest income associated with the IRS approval of a favorable accounting method change for the timing of the deductibility of certain rebates passed
back to clients, which is accounted for as a reduction in provision for income taxes. In addition, the 2006 third quarter rate includes the favorable closure of state tax exposures in the amount of $3.0 million resulting from the expiration of the
statute of limitations in certain states, partially offset by increases in the Companys net deferred tax liabilities resulting from certain state law changes. During the third quarter of 2006, the Company recorded income taxes receivable of
$202.5 million associated with the aforementioned IRS approval of an accounting method change for the timing of the deductibility of certain rebates passed back to clients.

The 2006 year-to-date rate reflects a second quarter benefit of $16.3 million, including $9.1 million from the favorable resolution of income taxes
payable provided for prior to the spin-off from Merck, $4.0 million from the favorable closure of a state income tax audit, and a $3.2 million benefit from the adjustment of the Companys net deferred tax liabilities due to the enactment of a
state income tax law change. These benefits were partially offset by a $10.4 million increase in the second quarter 2006 provision relating to increases in the overall state marginal income tax rate due to various state law changes, including a
corresponding increase to the Companys net deferred tax liabilities.

The 2005 income tax rates reflect a $25.7 million non-recurring
tax benefit recorded in the third quarter associated with a reduction in the Companys marginal state income tax rate resulting primarily from an enacted change in a state income tax law and the receipt of a favorable state income tax ruling. A
reduction in the Companys marginal state income tax rate creates a benefit via a corresponding reduction of the Companys net deferred tax liabilities, principally on its net intangible assets, partially offset by deferred tax assets
primarily from client rebates payable and other accruals.

The Company may achieve additional state income tax savings in future quarters,
some of which relate to state income taxes payable provided for prior to the spin-off date from Merck. To the extent that these state tax savings are realized, they will be recorded as a reduction to the provision for income taxes at the time
approval is received from the respective state taxing jurisdiction or when the applicable statute of limitations has expired.

11. SEGMENT REPORTING

Reportable Segments

As a result of the Companys acquisition of Accredo on August 18, 2005, the Company has two reportable segments, PBM and Specialty Pharmacy. The PBM segment involves sales of traditional prescription drugs to the Companys
clients and members, either through the Companys network of contractually affiliated retail pharmacies or the Companys mail-order pharmacies. The Specialty Pharmacy segment, which was formed upon the Accredo acquisition, includes the
sale of higher margin specialty pharmacy products and services for the treatment of chronic and potentially life-threatening diseases. The results of Accredo are included in the Specialty Pharmacy segment results and the consolidated statements of
income effective with the August 18, 2005 acquisition. The Specialty Pharmacy segment also includes the specialty pharmacy activity previously included within Medcos PBM business.

The Company defines the Specialty Pharmacy segment based on a product set and associated services, broadly characterized to include drugs that are
high-cost, usually developed by biotechnology companies and often injectable, and which require elevated levels of patient support. When dispensed, these products frequently require a significant amount of ancillary administration equipment, special
packaging, and a much higher degree of patient-oriented customer service than is required in the traditional PBM business model. In addition, specialty pharmacy products and services are often covered through medical benefit programs with the
primary payors being insurance companies and government programs, along with patients, as well as PBM clients as payors.



13



---

##### Table of Contents

Factors Used to Identify Reportable Segments

The Specialty Pharmacy segment was formed as a result of the Accredo acquisition on August 18, 2005 in response to a management desire to manage the
acquired business together with Medcos pre-existing specialty pharmacy activity as a separate business from Medcos PBM operations. This acquisition complemented the pre-existing Medco specialty pharmacy operation, which was evolving in
2005. Prior to the acquisition, results for the specialty pharmacy business were neither prepared nor provided to the chief operating decision maker as he managed Medco on a consolidated entity level.

During 2005, Medco established procedures and controls and implemented system solutions in order to identify discrete financial information on a
prospective basis for the specialty pharmacy activities in anticipation of the combination of those activities with Accredo into a separate segment, effective with the closing of the Accredo acquisition. Until these procedures, controls and systems
were implemented during 2005, the complexity of the Companys manufacturer and client contracts, determining the appropriate cost of inventory and retail reimbursement, as well as the shared costs between the PBM and specialty pharmacy
activities prevented Medco from preparing detailed separate profitability financial results for specialty pharmacy for periods prior to the formation of the segment in August of 2005.

Selected Segment Income and Asset Information

Total net revenues and operating income are the measures used by the chief operating decision maker to assess the performance of each of the Companys operating segments. As described above, the Companys acquisition of Accredo
resulted in the establishment of the Specialty Pharmacy segment, hence the Specialty Pharmacy segment activity commenced with the Accredo acquisition date. For the third quarters and nine months of 2006 and 2005, Medco identified the revenues
associated with Medcos pre-existing specialty pharmacy business based on a data extract of sales for the specialty product set. Additionally, Medco has calculated the estimated operating income for the third quarter and nine months of 2005
based on the best information available for the pre-acquisition period and the detailed post-acquisition segment results.

The following
table presents selected financial information about the Companys reportable segments, including a reconciliation of operating income to income before provision for income taxes ($ in millions):



|                                                              |  |                                  |         |                                  |   |         |  |        |          |                       |   |         |  |   |       |  |   |        
|------------------------------------------------------------- |  | -------------------------------- | ------- | -------------------------------- | - | ------- |  | ------ | -------- | --------------------- | - | ------- |  | - | ----- |  | - | -------
|Quarterly Results:                                            |  | Quarter Ended September 30, 2006 |         | Quarter Ended September 24, 2005
|                                                              |  | PBM                              |         | Specialty Pharmacy               |   | Total   |  | PBM(1) |          | Specialty Pharmacy(2) |   | Total  
|Product net revenues                                          |  | $                                | 8,996.6 |                                  | $ | 1,338.2 |  | $      | 10,334.8 |                       | $ | 8,781.2 |  | $ | 442.5 |  | $ | 9,223.7
|Total service revenues                                        |  |                                  | 113.4   |                                  |   | 12.9    |  |        | 126.3    |                       |   | 96.6    |  |   | 5.1   |  |   | 101.7  
|                                                              |  |                                  |         |                                  |   |         |  |        |          |                       |   |         |  |   |       |  |   |        
|Total net revenues                                            |  |                                  | 9,110.0 |                                  |   | 1,351.1 |  |        | 10,461.1 |                       |   | 8,877.8 |  |   | 447.6 |  |   | 9,325.4
|Total cost of revenues                                        |  |                                  | 8,618.8 |                                  |   | 1,248.8 |  |        | 9,867.6  |                       |   | 8,451.6 |  |   | 410.7 |  |   | 8,862.3
|Selling, general and administrative expenses                  |  |                                  | 174.4   |                                  |   | 48.5    |  |        | 222.9    |                       |   | 169.4   |  |   | 17.0  |  |   | 186.4  
|Amortization of intangibles                                   |  |                                  | 45.0    |                                  |   | 9.6     |  |        | 54.6     |                       |   | 45.0    |  |   | 3.1   |  |   | 48.1   
|                                                              |  |                                  |         |                                  |   |         |  |        |          |                       |   |         |  |   |       |  |   |        
|Operating income                                              |  | $                                | 271.8   |                                  | $ | 44.2    |  | $      | 316.0    |                       | $ | 211.8   |  | $ | 16.8  |  | $ | 228.6  
|Reconciling item to income before provision for income taxes: |  |                                  |         |                                  |   |         |  |        |          |                       |   |         |  |   |       |  |   |        
|Interest and other (income) expense, net                      |  |                                  |         |                                  |   |         |  |        | 20.9     |                       |   |         |  |   |       |  |   | 10.6   
|                                                              |  |                                  |         |                                  |   |         |  |        |          |                       |   |         |  |   |       |  |   |        
|Income before provision for income taxes                      |  |                                  |         |                                  |   |         |  | $      | 295.1    |                       |   |         |  |   |       |  | $ | 218.0  
|                                                              |  |                                  |         |                                  |   |         |  |        |          |                       |   |         |  |   |       |  |   |        
|Capital expenditures                                          |  | $                                | 25.1    |                                  | $ | 6.4     |  | $      | 31.5     |                       | $ | 24.2    |  | $ | 1.5   |  | $ | 25.7   

---

|(1) | Includes eight weeks of specialty pharmacy activity
previously included in Medcos PBM business.
|--- | ------------------------------------------------------------------------------------------------

|(2) | The Specialty Pharmacy segment commenced on
August 18, 2005, the date of the Accredo acquisition. If the Company had owned Accredo for the full fiscal quarter ended September 24, 2005, it is estimated that the Specialty Pharmacy segment net revenues would represent approximately 12%
of total Medco net revenues.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14



---

##### Table of Contents

|                                                              |  |                                      |          |                         |   |         |  |     |          |                    |   |          |  |   |         |  |   |         
|------------------------------------------------------------- |  | ------------------------------------ | -------- | ----------------------- | - | ------- |  | --- | -------- | ------------------ | - | -------- |  | - | ------- |  | - | --------
|Year-To-Date Results:                                         |  | Nine Months Ended September 30, 2006 |          |                         |   |         |  |    
|                                                              |  | PBM                                  |          | Specialty Pharmacy      |   | Total   |  |     |          |                    |   |         
|Product net revenues                                          |  | $                                    | 27,264.4 |                         | $ | 3,972.7 |  | $   | 31,237.1 |                    |   |          |  |   |         |  |   |         
|Total service revenues                                        |  |                                      | 335.5    |                         |   | 40.9    |  |     | 376.4    |                    |   |          |  |   |         |  |   |         
|                                                              |  |                                      |          |                         |   |         |  |     |          |                    |   |          |  |   |         |  |   |         
|Total net revenues                                            |  |                                      | 27,599.9 |                         |   | 4,013.6 |  |     | 31,613.5 |                    |   |          |  |   |         |  |   |         
|Total cost of revenues                                        |  |                                      | 26,197.9 |                         |   | 3,700.3 |  |     | 29,898.2 |                    |   |          |  |   |         |  |   |         
|Selling, general and administrative expenses                  |  |                                      | 711.3    |                         |   | 146.6   |  |     | 857.9    |                    |   |          |  |   |         |  |   |         
|Amortization of intangibles                                   |  |                                      | 134.9    |                         |   | 29.0    |  |     | 163.9    |                    |   |          |  |   |         |  |   |         
|                                                              |  |                                      |          |                         |   |         |  |     |          |                    |   |          |  |   |         |  |   |         
|Operating income                                              |  | $                                    | 555.8    |                         | $ | 137.7   |  | $   | 693.5    |                    |   |          |  |   |         |  |   |         
|Reconciling item to income before provision for income taxes: |  |                                      |          |                         |   |         |  |     |          |                    |   |          |  |   |         |  |   |         
|Interest and other (income) expense, net                      |  |                                      |          |                         |   |         |  |     | 49.8     |                    |   |          |  |   |         |  |   |         
|                                                              |  |                                      |          |                         |   |         |  |     |          |                    |   |          |  |   |         |  |   |         
|Income before provision for income taxes                      |  |                                      |          |                         |   |         |  | $   | 643.7    |                    |   |          |  |   |         |  |   |         
|                                                              |  |                                      |          |                         |   |         |  |     |          |                    |   |          |  |   |         |  |   |         
|Capital expenditures                                          |  | $                                    | 68.5     |                         | $ | 19.3    |  | $   | 87.8     |                    |   |          |  |   |         |  |   |         
|                                                              |  |                                     
|Identifiable Assets:                                          |  | As of September 30, 2006             |          | As of December 31, 2005
|                                                              |  | PBM                                  |          | Specialty Pharmacy      |   | Total   |  | PBM |          | Specialty Pharmacy |   | Total   
|Total identifiable assets                                     |  | $                                    | 11,529.4 |                         | $ | 2,140.9 |  | $   | 13,670.3 |                    | $ | 11,526.0 |  | $ | 2,177.0 |  | $ | 13,703.0

Medcos operating results for the third quarter and nine months of 2005, excluding the effect
of the Accredo acquisition, would have reflected $9,173.0 million and $26,915.0 million in net revenues, respectively, and $218.5 million and $681.0 million in operating income, respectively. For the third quarter and nine months of 2005, the
Company estimates that the specialty pharmacy results of operations, including the effect of the pre-existing Medco specialty pharmacy results of operations, reflect approximately $0.9 billion and $2.2 billion in total net revenues, respectively,
with operating income estimated at $28 million and $50 million, respectively.

12. COMMITMENTS AND CONTINGENCIES

Various lawsuits, claims, proceedings and investigations are pending against the Company and certain of its subsidiaries. The most significant of these
matters are described below. There can be no assurance that there will not be an increase in the scope of these matters or that any future lawsuits, claims, proceedings or investigations will not be material. In accordance with SFAS No. 5,Accounting for Contingencies, the Company records accruals for such contingencies when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated.

Government Proceedings and Requests for Information. On December 22, 2003, the Board of the State Teachers Retirement System of Ohio
(STRS), a former client, filed a complaint against Merck and the Company in the Ohio Court of Common Pleas, alleging, among other things, violations of the contract between STRS and Medco and other state law claims. This case was tried
before a jury in November and December 2005. The jury did not reach a verdict on whether Medco violated its contract with STRS. It rendered a verdict in favor of STRS on two counts for a total of $7.8 million. It rendered a verdict in favor of Merck
on a claim of tortious interference with the contract. Medco has accrued for the amount of the jury verdict and plans to appeal the unfavorable components of the verdict.

The Company is aware of the existence of two sealed qui tam matters. The first action is filed in the Eastern District of Pennsylvania. It appears to allege that the Company billed government payors using
invalid or out-of-date national drug codes (NDCs). The second action is filed in the District of New Jersey and appears to allege that the Company charged government payors a different rate than it reimbursed pharmacies; engaged in
duplicate billing; refilled prescriptions too soon; and billed government payors for prescriptions written by unlicensed physicians and physicians with invalid Drug Enforcement Agency authorizations. The Department of Justice has not yet made any
decision as to whether it will intervene in either of these matters. The matters are under seal and U.S. District Court orders prohibit the Company from answering inquiries about the complaints. The Company was notified of the existence of the two
new qui tam matters during recent settlement negotiations with the Department of Justice. The Company does not know the identities of the relators or the other defendants in either of these matters. The two new qui tam matters
were not considered in the Companys recent settlement with the Department of Justice.



15



---

##### Table of Contents

The Company continues to believe that its business practices comply in all material respects with
applicable laws and regulations and it will continue to vigorously defend itself in these actions. See Note 3, Legal Settlements Charge, for further information on government proceedings.

ERISA and Similar Litigation. In December 1997, a lawsuit captionedGruer v. Merck-Medco Managed Care, L.L.C. was filed in the U.S.
District Court for the Southern District of New York against Merck and the Company. The suit alleges that the Company should be treated as a fiduciary under the provisions of ERISA (the Employee Retirement Income Security Act of 1974)
and that the Company has breached fiduciary obligations under ERISA in a variety of ways. After theGruer case was filed, a number of other cases were filed in the same court asserting similar claims. In December 2002, Merck and the Company
agreed to settle theGruer series of lawsuits on a class action basis for $42.5 million, and agreed to certain business practice changes, to avoid the significant cost and distraction of protracted litigation. The release of claims under the
settlement applies to plans for which the Company has administered a pharmacy benefit at any time between December 17, 1994 and the date of final approval. It does not involve the release of any potential antitrust claims. The plaintiff in one
of the cases discussed above,Blumenthal v. Merck-Medco Managed Care, L.L.C., et al., has elected to opt out of the settlement. In May 2004, the district court granted final approval to the settlement and a Final Judgment was entered in June
2004. The settlement becomes final only after all appeals have been exhausted. Two appeals are pending.

Similar ERISA-based complaints
against the Company and Merck were filed in eight additional actions by ERISA plan participants, purportedly on behalf of their plans, and, in some of the actions, similarly situated self-funded plans. The ERISA plans themselves, which were not
parties to these lawsuits, had elected to participate in the settlement discussed above and, accordingly, seven of these actions had been dismissed pursuant to the Final Judgment discussed above. The plaintiff in another action,Betty Jo Jones v.
Merck-Medco Managed Care, L.L.C., et al., has filed a Second Amended Complaint, in which she seeks to represent a class of all participants and beneficiaries of ERISA plans that required such participants to pay a percentage co-payment on
prescription drugs. The effect of the release under the settlement discussed above on theJones action has not yet been litigated. In addition to these cases, a proposed class action complaint against Merck and the Company has been filed by
trustees of another benefit plan, the United Food and Commercial Workers Local Union No. 1529 and Employers Health and Welfare Plan Trust, in the U.S. District Court for the Northern District of California. This plan has elected to opt out of
the settlement. TheUnited Food action has been transferred and consolidated in the U.S. District Court for the Southern District of New York by order of the Judicial Panel on Multidistrict Litigation.

In April 2003, a lawsuit captionedPeabody Energy Corporation (Peabody) v. Medco Health Solutions, Inc., et al. was filed in the U.S. District
Court for the Eastern District of Missouri. The complaint, filed by one of the Companys former clients, relies on allegations similar to those in the ERISA cases discussed above, in addition to allegations relating specifically to Peabody,
which has elected to opt out of the settlement described above. In December 2003, Peabody filed a similar action against Merck in the U.S. District Court for the Eastern District of Missouri. Both of these actions have been transferred to the U.S.
District Court for the Southern District of New York to be consolidated with the ERISA cases pending against Merck and the Company in that court.

In September 2002, a lawsuit captionedMiles v. Merck-Medco Managed Care, L.L.C., based on allegations similar to those in the ERISA cases discussed above, was filed against Merck and the Company in the Superior Court of California.
The theory of liability in this action is based on a California law prohibiting unfair business practices. TheMiles case was removed to the U.S. District Court for the Southern District of California and was later transferred to the U.S.
District Court for the Southern District of New York and consolidated with the ERISA cases pending against Merck and the Company in that court.

In October 2002, the Company filed a declaratory judgment action, captionedMedco Health Solutions, Inc. v. West Virginia Public Employees Insurance Agency, in the Circuit Court of Kanawha County, West Virginia, asserting the
Companys right to retain certain cost savings in accordance with the Companys written agreement with the West Virginia Public Employees Insurance Agency, or PEIA. In November 2002, the State of West Virginia and PEIA filed a separate
lawsuit against Merck and the Company in the same court. This action was premised on several state law theories, including violations of the West Virginia Consumer Credit and Protection Act, conspiracy, tortious interference, unjust enrichment,
accounting, fraud and breach of contract. PEIA later filed a counterclaim in the declaratory judgment



16



---

##### Table of Contents

action and the State of West Virginia, which was joined as a party, filed a third-party complaint against the Company and
Merck. This case continues with a variety of motions and rulings by the court, including dismissal of some of PEIAs and the States claims. Fact discovery is proceeding.

In July 2003, a lawsuit captionedGroup Hospitalization and Medical Services v. Merck-Medco Managed Care, L.L.C., et al. was filed against the
Company in the Superior Court of New Jersey. In this action, the Companys former client, CareFirst Blue Cross Blue Shield, asserts claims for violation of fiduciary duty under state law; breach of contract; negligent misrepresentation; unjust
enrichment; violations of certain District of Columbia laws regarding consumer protection and restraint of trade; and violation of a New Jersey law prohibiting racketeering. The plaintiff demands compensatory damages, punitive damages, treble
damages for certain claims, and restitution.

The Company does not believe that it is a fiduciary, and believes that its business practices
comply with all applicable laws and regulations. The Company has denied all allegations of wrongdoing and is vigorously defending all of the lawsuits described above, although the Company has proposed to settle some of them as described above.

Antitrust and Related Litigation. In August, 2003, a lawsuit captionedBrady Enterprises, Inc., et al. v. Medco Health
Solutions, Inc., et al. was filed in the U.S. District Court for the Eastern District of Pennsylvania against Merck and the Company. The plaintiffs, who seek to represent a national class of retail pharmacies that had contracted with the
Company, allege that the Company has conspired with, acted as the common agent for, and used the combined bargaining power of plan sponsors to restrain competition in the market for the dispensing and sale of prescription drugs. The plaintiffs
allege that, through the alleged conspiracy, the Company has engaged in various forms of anticompetitive conduct, including, among other things, setting artificially low reimbursement rates to such pharmacies. The plaintiffs assert claims for
violation of the Sherman Act and seek treble damages and injunctive relief. The plaintiffs motion for class certification is currently pending.

In October 2003, a lawsuit captionedNorth Jackson Pharmacy, Inc., et al. v. Medco Health Solutions, Inc., et al. was filed in the U.S. District Court for the Northern District of Alabama against Merck and the
Company. In their Second Amended Complaint, the plaintiffs allege that Merck and the Company have engaged in price fixing and other unlawful concerted actions with others, including other PBMs, to restrain trade in the dispensing and sale of
prescription drugs to customers of retail pharmacies who participate in programs or plans that pay for all or part of the drugs dispensed, and have conspired with, acted as the common agent for, and used the combined bargaining power of plan
sponsors to restrain competition in the market for the dispensing and sale of prescription drugs. The plaintiffs allege that, through such concerted action, Merck and the Company have engaged in various forms of anticompetitive conduct, including,
among other things, setting reimbursement rates to such pharmacies at unreasonably low levels. The plaintiffs assert claims for violation of the Sherman Act and seek treble damages and injunctive relief. The plaintiffs motion for class
certification has been granted.

In December 2005, a lawsuit captionedMikes Medical Center Pharmacy, et al. v. Medco Health
Solutions, Inc., et al. was filed against the Company and Merck in the U.S. District Court for the Northern District of California. The plaintiffs seek to represent a class of all pharmacies and pharmacists that had contracted with the Company
and California pharmacies that had indirectly purchased prescription drugs from Merck and make factual allegations similar to those in theAlameda Drug Company action discussed below. The plaintiffs assert claims for violation of the Sherman
Act, California antitrust law, and California law prohibiting unfair business practices. The plaintiffs demand, among other things, treble damages, restitution, disgorgement of unlawfully obtained profits, and injunctive relief.

In April 2006, theBrady plaintiffs filed a petition to transfer and consolidate various antitrust actions against PBMs, including North
Jackson, Brady, andMikes Medical Center before a single federal judge. The motion was granted on August 24, 2006. These actions are now consolidated for pretrial purposes in the U.S. District Court for the Eastern District of
Pennsylvania. The consolidated action is known as In re Pharmacy Benefit Managers Antitrust Litigation.

In January 2004, a lawsuit
captionedAlameda Drug Company, Inc., et al. v. Medco Health Solutions, Inc., et al. was filed against the Company and Merck in the Superior Court of California. The plaintiffs, which seek to represent a class of all California pharmacies
that had contracted with the Company and that had indirectly purchased prescription drugs from Merck, allege, among other things, that since the expiration of a 1995 consent injunction entered by the U.S. District



17



---

##### Table of Contents

Court for the Northern District of California, if not earlier, the Company has failed to maintain an Open Formulary (as
defined in the consent injunction), and that the Company and Merck had failed to prevent nonpublic information received from competitors of Merck and the Company from being disclosed to each other. The complaint also copies verbatim many of the
allegations in the amended complaint-in-intervention filed by the U.S. Attorney for the Eastern District of Pennsylvania, discussed in Note 3, Legal Settlements Charge. The plaintiffs further allege that, as a result of these alleged
practices, the Company has been able to increase its market share and artificially reduce the level of reimbursement to the retail pharmacy class members, and that the prices of prescription drugs from Merck and other pharmaceutical manufacturers
that do business with the Company had been fixed and raised above competitive levels. The plaintiffs assert claims for violation of California antitrust law and California law prohibiting unfair business practices. The plaintiffs demand, among other
things, compensatory damages, restitution, disgorgement of unlawfully obtained profits, and injunctive relief. In the complaint, the plaintiff further alleges, among other things, that the Company acts as a purchasing agent for its plan sponsor
customers, resulting in a system that serves to suppress competition.

In February 2006, a lawsuit captionedChelsea Family Pharmacy,
PLLC v. Medco Health Solutions, Inc., was filed in the U.S. District Court for the Northern District of Oklahoma. The plaintiff, which seeks to represent a class of Oklahoma pharmacies that had contracted with the Company within the last three
years, alleges, among other things, that the Company has contracted with retail pharmacies at rates that are less than the prevailing rates paid by ordinary consumers and has denied consumers their choice of pharmacy by placing restrictions on the
plaintiffs ability to dispense pharmaceutical goods and services. The plaintiff asserts that the Companys activities violate the Oklahoma Third Party Prescription Act, and seeks, among other things, compensatory damages, attorneys
fees, and injunctive relief. On June 12, 2006, the Company filed a motion to stay the action pending arbitration. That motion is pending.

Contract Litigation. In September 2004, the Companys former client, Horizon Blue Cross Blue Shield of New Jersey (Horizon), filed an action in the Superior Court of New Jersey, Bergen County, alleging, among other
things, that the Company breached its contract with Horizon in various respects. The Company has denied Horizons allegations and is vigorously defending itself in this action. The Company has filed counterclaims against Horizon. Trial is
scheduled for 2007.

The Company denies all allegations of wrongdoing and intends to vigorously defend these cases.

Accredo. Accredo and an 80%-owned subsidiary of Accredo (the Joint Venture) provided contract pharmacy and related billing services to
a third-party pharmacy (the Local Pharmacy) that is the subject of a certain state agency audit. On January 20, 2006, the agency issued a preliminary assessment of its findings, which included allegations of overbilling and false
claims. Since that time, Accredo has been involved in a dialogue with the agency and is in the process of providing additional information and documents for the agency to consider in connection with its ultimate findings. Although the Joint
Venture is not currently involved with the audit, the contract pharmacy relationship is implicated, and the Local Pharmacy is seeking indemnification from the Joint Venture for any payments that the Local Pharmacy is required to pay to the
state agency.

Accredo, a former Accredo officer and a former Accredo officer who is a current Medco director are defendants in a class
action lawsuit filed in the United States District Court for the Western District of Tennessee. Certain former officers and former directors of Accredo are defendants in a related stockholders derivative suit filed in the Circuit Court of Shelby
County, Tennessee. Plaintiffs in the class action lawsuit allege that the actions and omissions of the current Medco director and former Accredo officer constitute violations of various sections of the Securities Exchange Act of 1934. Plaintiffs in
the derivative suit allege that the former officers and former directors have breached their fiduciary duty to Accredo.

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

The Company is also involved in various claims and legal proceedings of a nature considered normal to the Companys business, principally employment
and commercial matters.



18



---

##### Table of Contents

The various lawsuits described above arise in an environment of rising costs for prescription drugs and
heightened public scrutiny of the pharmaceutical industry, including the PBM and specialty pharmacy industries and their practices. This public scrutiny is characterized by extensive press coverage, ongoing attention in various state and federal
government branches, and investigations and public statements by government officials. These factors contribute to the uncertainty regarding the possible course and outcome of the proceedings discussed above. An adverse outcome in any one of the
lawsuits described above could result in material fines and damages; changes to the Companys business practices; loss of (or litigation with) clients; and other penalties. Moreover, an adverse outcome in any one of these lawsuits could have a
material adverse effect on the Companys business, financial condition, liquidity and operating results. The Company is vigorously defending each of the pending lawsuits described above.

Although the range of loss for many of the unresolved matters above is not subject to reasonable estimation and it is not feasible to predict or
determine the final outcome of any of the above proceedings with certainty, the Companys management does not believe that they will have a material adverse effect on the Companys financial position or liquidity, either individually or in
the aggregate. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially adversely affected by the ultimate resolutions of one or more of these matters, or changes in the
Companys assumptions or its strategies related to these proceedings. The Company believes that most of the claims made in these legal proceedings and government investigations would not likely be covered by insurance.

Purchase Obligations. The Company has entered into agreements with certain biopharmaceutical manufacturers and a brand-name pharmaceutical
manufacturer that contain minimum purchasing volume commitments. As of September 30, 2006, these purchase obligations amounted to $151.8 million for the remainder of 2006 and $69.1 million for 2007, the majority of which is associated with
Accredo.

13. RECENT ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB released FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement 109 (FIN 48 or the Interpretation), which clarifies the
accounting for uncertainty in income taxes recognized in companies financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is recognition
whereby companies must determine whether it is more likely than not that a tax position will be sustained upon examination. The second step is measurement whereby a tax position that meets the more-likely-than-not recognition threshold is measured
to determine the amount of benefit to recognize in the financial statements. The Interpretation also provides guidance on derecognition of recognized tax benefits, classification, interest and penalties, accounting in interim periods, disclosure and
transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Earlier adoption is only permitted at the beginning of a companys fiscal year, provided that interim financial statements for that fiscal year have not
yet been issued. As a result, the Company expects to adopt the new requirements in the first quarter of 2007 and is currently evaluating the impact that such adoption will have on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines fair
value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value
measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. The Companys adoption of SFAS 157 is not expected to have a material impact on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plansan
amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS 158), which requires employers to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement
of financial position and to recognize changes in that funded status in the year in which the



19



---

##### Table of Contents

changes occur through other comprehensive income. The Company is required to adopt SFAS 158 as of the fiscal year ending
after December 15, 2006. The Company will adopt the new requirements as of December 30, 2006, but does not expect such adoption to have a material impact on its consolidated financial statements.



20



---

##### Table of Contents

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

This
Quarterly Report on Form 10-Q contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause results to differ
materially from those set forth in the statements. No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statement, whether as
a result of new information, future events or otherwise. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about the business and future financial results of
the pharmacy benefit management (PBM) and specialty pharmacy industries, and other legal, regulatory and economic developments. We use words such as anticipates, believes, plans, expects,
projects, future, intends, may, will, should, could, estimates, predicts, potential, continue and similar expressions
to identify these forward-looking statements. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors. These factors include:



| |  |  | Risks associated with our acquisition of Accredo Health, Incorporated (Accredo), including integration risks, and an increase in credit risk resulting from the payment
streams associated with specialty pharmacy accounts receivable;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Governmental investigations, and governmental, qui tam and other liability claims asserted against us, and any associated mandatory changes to our business practices;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Competition in the PBM and specialty pharmacy industries and in the broader healthcare industry;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | Pressure on discounts and rebates from pharmaceutical manufacturers and margins in the PBM industry;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | Our ability to obtain new clients and the possible termination of, or unfavorable modification to, contracts with key clients;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Risks and uncertainties regarding the implementation and ongoing execution of the Medicare Part D prescription drug benefit;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | Possible regulatory changes affecting pricing, rebates, discounts or other practices of pharmaceutical manufacturers;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | Risks associated with the secure storage and transmission of personal health information and other confidential data;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | Developments in the healthcare industry, including the effect of increases in overall healthcare costs, changes in drug utilization and cost patterns and the introduction of new
brand-name and/or generic drugs;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | New or existing governmental regulations or legislation and changes in, or the failure to comply with, governmental regulations or legislation;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The possibility of a material non-cash charge to income if our recorded intangible assets are impaired or require accelerated amortization from a change in the remaining useful
life;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Risks associated with our indebtedness and debt service obligations; and
| | - |  | ------------------------------------------------------------------------



| |  |  | General economic and business conditions.
| | - |  | -----------------------------------------

The foregoing
list of factors is not exhaustive. You should carefully consider the foregoing factors and the other uncertainties and potential events described in our Annual Report on Form 10-K and other documents filed from time to time with the Securities and
Exchange Commission (SEC).

Overview

We are one of the nations largest pharmacy benefit managers, and we provide sophisticated traditional and specialty pharmacy benefit programs and services for our clients, members of client-funded benefit plans
or those served by the Medicare Part D Prescription Drug Program, and individual patients. Our business model requires collaboration with retail pharmacies, physicians, Medicare, and particularly in specialty pharmacy, collaboration with Medicaid
and other payors such as insurers. Our programs and services help control the cost and enhance the quality of the prescription drug benefit. We accomplish this by providing PBM services through our national networks of retail pharmacies and our own
mail-order pharmacies, as well as through our specialty pharmacy operation, which became the nations largest specialty



21



---

##### Table of Contents

pharmacy based on revenues with the acquisition of Accredo on August 18, 2005 (the Accredo acquisition).
When the term mail order is used, we mean Medcos traditional pharmacy mail-order operations, and subsequent to the Accredo acquisition, we mean Medcos traditional pharmacy mail-order operations, as well as Accredos
specialty pharmacy operations. We have a large number of clients in each of the major industry categories, including Blue Cross/Blue Shield plans; managed care organizations; insurance carriers; third-party benefit plan administrators; employers;
federal, state and local government agencies; and union-sponsored benefit plans. Our clients are generally entities that provide a pharmacy benefit to their underlying membership, such as members of their plan or their employees.

We operate in a competitive market as clients and other payors seek to control the growth in the cost of providing prescription drug benefits.
Prescription drug costs have risen considerably over the past several years, largely as a result of inflation on brand-name drugs and increases in the number of prescriptions utilized, including the introduction of new products from brand-name
pharmaceutical and biopharmaceutical manufacturers. These prescription drug cost increases, known as drug trend, have garnered significant attention throughout the United States as they contribute to the rise in the national cost of healthcare. Our
business model is designed to reduce this rate of drug trend for our PBM clients. Specialty drug spending is growing at approximately 20% each year and provides us with further opportunity to reduce overall drug trend for our clients and specialty
payors.

The complicated environment in which we operate presents us with opportunities, challenges and risks. Our clients and membership
are paramount to our success; the retention and winning of new clients and members poses the greatest opportunity, and the loss thereof represents an ongoing risk. The preservation of our relationships with pharmaceutical manufacturers,
biopharmaceutical manufacturers and retail pharmacies is very important to the execution of our business strategies. Our future success will hinge on our ability to drive an increase in generic utilization from the nearly $45 billion in brand-name
drug patent expirations expected to occur beginning in 2006 through 2010, our ability to continue to provide innovative and competitive clinical and other services to clients and patients, including our active participation in the Medicare Part D
benefit and the rapidly growing specialty pharmacy industry.

On August 18, 2005, we acquired all of the outstanding common stock of
Accredo, as described in Note 3, Acquisitions of Businesses, to our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Key Indicators Reviewed by Management

Management
reviews the following indicators in analyzing our consolidated financial performance: net revenues, with a particular focus on mail-order revenue; adjusted prescription volume; generic dispensing rate; gross margin percentage; diluted earnings per
share; Specialty Pharmacy segment operating income; Earnings before Interest Income/Expense, Taxes, Depreciation, and Amortization (EBITDA); and EBITDA per adjusted prescription. See EBITDA further below for a
definition and calculation of EBITDA and EBITDA per adjusted prescription. We believe these measures highlight key business trends and are important in evaluating our overall performance. These measures are also reflective of the success of our
execution of strategic objectives.

Financial Performance Summary for the Quarter and Nine Months Ended September 30, 2006

In the third quarter of 2006, our net income was $185.8 million and diluted earnings per share were $0.62. In the nine months of 2006, our net income was
$401.4 million and diluted earnings per share were $1.32. These year-to-date results reflect a one-time pre-tax legal settlements charge of $162.6 million recorded in the first quarter, with a $99.9 million after-tax effect, or $0.33 per diluted
share. The one-time legal settlements charge reflected an agreement with the U.S. Attorneys Office for the Eastern District of Pennsylvania to settle three previously disclosed pending federal legal matters. The settlement agreements for these
three matters were signed and approved by the District Court on October 23, 2006.

The $185.8 million in third quarter net income
represents an 18.6% increase over the third quarter of 2005. Diluted earnings per share of $0.62 in the third quarter of 2006 increased 17.0% over 2005, including an increase of approximately 2.2 million in diluted shares outstanding. The
$401.4 million in 2006 year-to-date net income represents a 5.6% decline from 2005. Excluding the one-time legal settlements charge, our net income increased 17.9% to $501.3 million for the nine months of 2006, and diluted earnings per share of
$1.65 increased 11.5%.



22



---

##### Table of Contents

The diluted weighted average shares outstanding were 298.7 million and 303.5 million for the
third quarter and nine months of 2006, respectively, and 296.5 million and 286.9 million for the third quarter and nine months of 2005, respectively, representing increases of 0.7% for the quarter and 5.8% for the nine months. These
increases result from the shares issued in connection with the August 2005 Accredo acquisition and the effect of share issuances in connection with stock option exercises, partially offset by the purchase of 22.8 million shares of stock in
connection with our share repurchase program since its inception in the third quarter of 2005. Shares repurchased during the third quarter and nine months of 2006 were approximately 1.2 million shares and approximately 15.1 million shares,
respectively.

As a result of the adoption of the Statement of Financial Accounting Standards No. 123R, Share-Based
Payment (SFAS 123R) in the first quarter of 2006, we have recorded stock option expenses in 2006. Stock option expenses are not recorded in the 2005 results. Total stock option expense reflected in net income before provision for
income taxes amounted to $14.8 million in the third quarter of 2006 and $50.4 million for the nine months of 2006, compared to a pro forma equivalent of $23.7 million in the third quarter of 2005 and $77.4 million for the nine months of 2005. The
majority of the 2006 stock option expenses are recorded in selling, general and administrative (SG&A) expenses.

Net
revenues increased 12.2% to $10,461 million in the third quarter of 2006, and 16.8% to $31,614 million in the nine months of 2006, compared to the same periods in the prior year. These increases reflect higher prices charged by pharmaceutical
manufacturers including the effect of new and higher-cost brand-name drugs, higher volumes including Accredos incremental results and new business, partially offset by higher generic dispensing rates and higher levels of rebate sharing with
clients. The revenue growth reflects a full quarter and nine months of Accredo in 2006, compared to a five-week period in both the third quarter and nine months of 2005.

Total prescription volume, adjusted for the difference in days supply between mail and retail, increased 3.3% to 179.2 million for the third quarter of 2006, and 4.4% to 542.3 million for the nine months of
2006, primarily as a result of higher volumes from new clients. The mail-order penetration rate on an adjusted basis increased slightly to 37.1% for the third quarter of 2006 compared to 37.0% for the third quarter of 2005. For the nine months, the
mail-order penetration rate on an adjusted basis was consistent in both years at 36.5%.

Our overall generic dispensing rate increased to
56.0% in the third quarter and 54.5% in the nine months of 2006, compared to 51.5% in the third quarter and 51.1% in the nine months of 2005, as a result of drugs that have lost patent protection in the third quarter and first nine months of 2006,
as well as at the end of 2005. The higher generic dispensing rates, which contribute to lower costs for clients and members, resulted in a reduction of approximately $530 million in net revenues for the third quarter of 2006 and approximately $1,125
million for the nine months of 2006.

Earned brand-name pharmaceutical rebates of $808 million for the third quarter of 2006 and $2,540
million for the nine months of 2006 were consistent with the third quarter of 2005, and 6.4% higher than the nine months of 2005. The consistent level of rebates for the quarter reflects improved formulary management and patient compliance, offset
by brand-name drugs that have recently lost patent protection. The increase for the nine months reflects improved formulary management and patient compliance, and favorable pharmaceutical manufacturer rebate contract revisions, partially offset by
brand-name drugs that have lost patent protection. The percentage of rebates retained by Medco decreased to approximately 18.3% in the third quarter and 20.3% for the nine months of 2006, compared to approximately 25.8% in the third quarter and
27.9% in the nine months of 2005. These percentage decreases primarily relate to a higher representation of clients participating in pricing arrangements whereby a greater portion of rebates are shared in exchange for other elements of pricing,
including higher claims processing administrative fees, which are reflected in service revenues. Our service revenues increased 24.2% to $126.3 million in the third quarter of 2006, and increased 33.9% to $376.4 million for the nine months of 2006.

The overall gross margin was 5.7% in the third quarter and 5.4% for the nine months of 2006, compared to 5.0% for both the third quarter
and nine months of 2005, driven by our increased generic dispensing rate and higher gross margin experienced in our specialty pharmacy business reflecting the inclusion of a full quarter and nine months of Accredo results.



23



---

##### Table of Contents

SG&A expenses increased 19.6% to $222.9 million when compared to the third quarter of 2005, and
amounted to $857.9 million for the nine months of 2006, which includes the $162.6 million one-time pre-tax legal settlements charge recorded in the first quarter of 2006. Excluding the one-time charge from the nine months of 2006, SG&A expenses
increased 29.5% to $695.3 million when compared to the nine months of 2005. The increases for the third quarter and nine months primarily result from the incremental Accredo expenses, and stock option expenses recorded in 2006.

Amortization of intangible assets for the third quarter and the nine months of 2006 increased $6.5 million and $25.9 million, respectively, when compared
to the third quarter and nine months of 2005, principally associated with the intangible assets acquired in the Accredo acquisition. Interest and other (income) expense, net, increased $10.3 million for the third quarter and $22.7 million for the
nine months of 2006, compared to the same periods in 2005. The variances primarily reflect higher interest expense from elevated average debt levels related to the Accredo acquisition, higher interest rates on floating rate debt, and increased
short-term borrowing levels in the third quarter of 2006.

Our effective tax rate (defined as the percentage relationship of provision for
income taxes to income before provision for income taxes) was 37.0% for the third quarter of 2006 and 37.6% for the nine months of 2006, compared to 28.1% in the third quarter of 2005 and 35.9% for the nine months of 2005. The 2006 third quarter
rate includes a net $6.6 million non-recurring benefit, primarily reflecting interest income associated with the IRS approval of a favorable accounting method change for the timing of the deductibility of certain rebates passed back to clients,
which is accounted for as a reduction in provision for income taxes.

The 2006 year-to-date rate also reflects a net $5.9 million
non-recurring benefit recorded in the second quarter, including the impact of changes in our marginal state income tax rate, the favorable resolution of income taxes payable provided for prior to the spin-off date from Merck & Co., Inc.
(Merck), and the closure of a state income tax audit. The 2005 rates reflect a $25.7 million non-recurring tax benefit recorded in the third quarter, associated with a reduction in our marginal state income tax rate resulting primarily
from an enacted change in a state income tax law and the receipt of a favorable state income tax ruling.

Key Financial Statement Components

Consolidated Statements of Income. Our net revenues are comprised primarily of product net revenues and are derived from
the sale of prescription drugs through our networks of contractually affiliated retail pharmacies and through our mail-order pharmacies, and are recorded net of certain discounts, rebates and guarantees payable to clients and members. The majority
of our product net revenues are derived on a fee-for-service basis. Specialty pharmacy product net revenues represent revenues from the sale of primarily biopharmaceutical drugs and are reported at the net amount billed to third-party payors and
patients.

Our product net revenues also include premiums associated with our Medicare Part D Prescription Drug Program (PDP)
product offering. This product involves prescription dispensing for members covered under the Center for Medicare & Medicaid Services (CMS)-sponsored Medicare Part D benefit. Commencing January 1, 2006, we began serving as
a plan sponsor offering Medicare Part D prescription drug insurance coverage pursuant to two contracts by and between CMS and two of our insurance company subsidiaries. We provide a standard drug benefit that represents either (i) the minimum
level of benefits mandated by Congress, or (ii) enhanced coverage, on behalf of certain clients, which represents benefits in excess of the standard drug benefit in exchange for additional premiums.

The PDP premiums are determined based on our annual bid and related contractual arrangements with CMS. The PDP premiums are primarily comprised of
amounts received from CMS as part of a direct subsidy and an additional subsidy from CMS for low income member premiums, as well as premium payments received from members. These premiums are recognized ratably to product net revenues over the period
in which members are entitled to receive benefits. Premiums received in advance of the applicable benefit period are recorded in accrued expenses and other current liabilities on the consolidated balance sheets. There is a possibility that the
annual costs of drugs may be higher or lower than premium revenues. As a result, CMS provides a risk corridor adjustment for the standard drug benefit that compares our actual annual drug costs incurred to the targeted premiums in our CMS-approved
bid. Based on specific collars in the risk corridor, we will receive from CMS additional premium amounts or be required to refund to CMS



24



---

##### Table of Contents

previously received premium amounts. We calculate the risk corridor adjustment on a quarterly basis based on drug cost
experience to date and record an adjustment to product net revenues with a corresponding account receivable or payable to CMS reflected on the consolidated balance sheets. In the third quarter of 2006, premium revenues for our PDP product were $98
million, or approximately 1% of total net revenues of $10.5 billion. For the nine months of 2006, premium revenues were $364 million, or approximately 1% of total net revenues of $31.6 billion.

In addition to premiums, there are certain co-payments and deductibles (the cost share) due by members based on prescription orders by those
members, some of which are subsidized by CMS in cases of low income membership. The subsidy amounts received in advance are recorded in accrued expenses and other current liabilities on the consolidated balance sheets. At the end of the contract
term and based on actual annual drug costs incurred, subsidies are reconciled with actual costs and residual subsidy advance receipts are payable to CMS. The cost share is treated consistently as other co-payments derived from providing PBM
services, as a component of product net revenues in the consolidated statements of income where the requirements of Emerging Issues Task Force (EITF) No. 99-19, Reporting Gross Revenue as a Principal vs. Net as an Agent,
are met. For further details, see our critical accounting policies included in Use of Estimates and Critical Accounting Policies and Estimates and Note 2, Summary of Significant Accounting Policies, to our consolidated
financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Our agreements with CMS, as well
as applicable Medicare Part D regulations and federal and state laws, require us to, among other obligations: (i) comply with certain disclosure, filing, record-keeping and marketing rules; (ii) operate quality assurance, drug utilization
management and medication therapy management programs; (iii) support e-prescribing initiatives; (iv) implement grievance, appeals and formulary exception processes; (v) comply with payment protocols, which include the return of
overpayments to CMS and, in certain circumstances, coordination with state pharmacy assistance programs; (vi) use approved networks and formularies, and provide access to such networks to any willing pharmacy; (vii) provide emergency
out-of-network coverage; and (viii) adopt a comprehensive Medicare and Fraud, Waste and Abuse compliance program. Contractual or regulatory non-compliance may entail significant sanctions and monetary penalties.

Service revenues consist principally of administrative fees and clinical program fees earned from clients and other non-product related revenues, sales
of prescription services and data to pharmaceutical manufacturers and other parties, and performance-oriented fees paid by specialty pharmacy manufacturers. For further details see our critical accounting policies included in Use of
Estimates and Critical Accounting Policies and Estimates and Note 2, Summary of Significant Accounting Policies, to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31,
2005.

Cost of revenues is comprised primarily of cost of product net revenues and is principally attributable to the dispensing of
prescription drugs. Cost of product net revenues for prescriptions dispensed through our network of retail pharmacies includes the contractual cost of drugs dispensed by, and professional fees paid to, retail pharmacies in the networks. Our cost of
product net revenues relating to drugs dispensed by our mail-order pharmacies consists primarily of the cost of inventory dispensed and our costs incurred to process and dispense the prescriptions, including the associated fixed asset depreciation.
The operating costs of our call center pharmacies are also included in cost of product net revenues. In addition, cost of product net revenues includes a credit for rebates earned from brand-name pharmaceutical manufacturers whose drugs are included
in our formularies. These rebates generally take the form of formulary rebates, which are earned based on the volume of a specific drug dispensed, or market share rebates, which are earned based on the achievement of contractually specified market
share levels.

Our cost of product net revenues also includes the cost of drugs dispensed in our mail-order pharmacies or retail network
for members covered under our Medicare Part D PDP product offering and are recorded at cost as incurred. We receive a catastrophic reinsurance subsidy from CMS for approximately 80% of costs incurred by individual members in excess of the individual
annual out-of-pocket maximum of $3,600 (the threshold applicable for 2006). The subsidy is reflected as an offsetting credit in cost of product net revenues to the extent that catastrophic costs are incurred. Catastrophic reinsurance subsidy amounts
received in advance are recorded in accrued expenses and other current liabilities on the consolidated balance sheets. At the end of the contract term and based on actual annual drug costs incurred, residual subsidy advance receipts are payable to
CMS.



25



---

##### Table of Contents

Cost of service revenues consist principally of labor and operating costs for delivery of services
provided, costs associated with member communication materials, and certain information acquisition costs.

Selling, general and
administrative expenses reflect the costs of operations dedicated to overall corporate governance and general management, generating new sales, maintaining existing client relationships, managing clinical programs, enhancing technology capabilities,
directing pharmacy operations, performing reimbursement activities, finance, legal and other staff activities, and may also include the effect of legal settlements.

Interest and other (income) expense, net, primarily includes interest expense on our senior unsecured term loan facility, senior notes, and accounts receivable financing facility, net of interest on our interest rate
swap agreements on $200 million of the senior notes, partially offset by interest income generated by overnight deposits and short-term investments in marketable securities.

Consolidated Balance Sheets. Our key assets include cash and short-term investments, accounts receivable, inventories, fixed assets,
deferred tax assets, goodwill and intangibles. Cash reflects the accumulation of positive cash flows from our operations. Accounts receivable balances primarily include amounts due from brand-name pharmaceutical manufacturers for earned rebates and
other prescription services. The accounts receivable balances also represent amounts due from clients, other payors and patients for prescriptions dispensed from retail pharmacies in our networks or from our mail-order pharmacies, including fees due
to us, net of allowances for doubtful accounts, as well as contractual allowances and any applicable rebate liabilities or payments due to clients under guarantees. When rebates due to be passed back to clients are greater than the corresponding
client accounts receivable balances, the net liability is reclassified to claims and other accounts payable. Our accounts receivable also include premiums receivable, including the risk corridor adjustment, from CMS for our Medicare Part D PDP
product offering and premiums from members. Inventories reflect the cost of prescription products held for dispensing by our mail-order pharmacies and are recorded on a first-in, first-out basis, net of allowances for losses.

In addition, deferred tax assets primarily represent temporary differences between the financial statement basis and the tax basis of certain accrued
expenses, client rebate pass-back liabilities and stock-based compensation. Income taxes receivable at September 30, 2006 represents amounts due from the IRS associated with the approval of a favorable accounting method change received from the
IRS in the third quarter of 2006 for the timing of the deductibility of certain rebates passed back to clients. Fixed assets include investments in our corporate headquarters, mail-order pharmacies, call center pharmacies, account service offices,
and information technology, including capitalized software development. Goodwill and intangible assets are comprised primarily of the push-down of goodwill and intangibles related to our acquisition in 1993 by Merck, goodwill for the excess of the
Accredo purchase price over net assets acquired, and intangible assets recorded from our acquisition of Accredo.

Our primary liabilities
include claims and other accounts payable, accrued expenses and other current liabilities, debt and deferred tax liabilities. Claims and other accounts payable primarily consist of amounts payable to retail network pharmacies for prescriptions
dispensed and services rendered, amounts payable for mail-order prescription inventory purchases, and reclassified net client rebate pass-back liabilities. Accrued expenses and other current liabilities primarily consist of employee- and
facility-related cost accruals incurred in the normal course of business, as well as income taxes payable. Accrued expenses and other current liabilities also include certain premium and catastrophic reinsurance pre-payments from CMS for our
Medicare Part D PDP product offering. Our debt is primarily comprised of a senior unsecured term loan facility, senior notes and an accounts receivable financing facility. In addition, we have a net deferred tax liability primarily associated with
our recorded intangible assets. We do not have any off-balance sheet arrangements, other than purchase commitments and lease obligations. See  Contractual Obligations further below.

Our stockholders equity as of December 31, 2005 includes an offset for net unearned compensation, representing the market value at the time of
grant of restricted stock and restricted stock units granted to our employees and directors less the amount of compensation expense amortized over the associated vesting period. This amount was closed into additional paid-in capital in connection
with our adoption of SFAS 123R effective January 1, 2006. Stockholders equity also includes an offset for treasury stock purchases under our share repurchase program originally announced in August 2005.



26



---

##### Table of Contents

Consolidated Statements of Cash Flows. An important element of our operating cash flows is
the timing of billing cycles, which are two-week periods of accumulated billings for retail and mail-order prescriptions. We bill the cycle activity to clients on this biweekly schedule and generally collect from our clients before we pay our
obligations to the retail pharmacies for that same cycle. At the end of any given reporting period, unbilled PBM receivables can represent up to two weeks of dispensing activity and will fluctuate at the end of a fiscal month depending on the timing
of these billing cycles. A portion of the specialty pharmacy business includes reimbursement by payors, such as insurance companies, under a medical benefit, or by Medicare or Medicaid. These transactions involve higher patient co-payments than
experienced in the PBM business. As a result, this portion of the specialty pharmacy business, which yields a higher margin than the PBM business, experiences slower accounts receivable turnover than in the aforementioned PBM cycle. We also generate
operating cash flows associated with our Medicare Part D PDP product offering including premiums and various subsidies received from CMS.

We pay for our mail-order prescription drug inventory in accordance with payment terms offered by our suppliers to take advantage of appropriate discounts. Effective mail-order inventory management generates further positive cash flows.
Earned brand-name pharmaceutical manufacturers rebates are recorded monthly based upon prescription dispensing, with actual bills rendered on a quarterly basis and paid by the manufacturers within an agreed-upon term. Payments of rebates to
clients are generally made after our receipt of the rebates from the brand-name pharmaceutical manufacturers, although some clients may receive more accelerated rebate payments in exchange for other elements of pricing in their contracts.

Our cash primarily includes time deposits with banks or other financial institutions. Our short-term investments include U.S. government
securities that have average maturities of less than one year and that are held to satisfy statutory capital requirements for our insurance subsidiaries.

Ongoing cash outflows are associated with expenditures to support our mail-order, retail pharmacy network operations, call center pharmacies and other selling, general and administrative functions. The largest
components of these expenditures include mail-order inventory purchases, payments to retail pharmacies, rebate and guarantee payments to clients, employee payroll and benefits, facility operating expenses, capital expenditures including technology
investments, interest and principal payments on our outstanding debt, income taxes and share repurchases. Acquisitions will also generally result in cash outflows.

Client-Related Information

Revenues from UnitedHealth Group, which is currently our largest client, amounted to
approximately $2,200 million and $6,600 million, or 21% of our net revenues, in the third quarter and nine months of 2006, respectively, and $2,100 million and $6,200 million, or 22% and 23% of our net revenues, in the third quarter and nine months
of 2005, respectively. None of our other clients individually represented more than 10% of our net revenues in the third quarter or nine months of 2006 or 2005.

Segment Discussion

As a result of our acquisition of Accredo on August 18, 2005, we have two reportable segments, PBM
and Specialty Pharmacy. The PBM segment involves sales of traditional prescription drugs to our clients and their members, either through our networks of contractually affiliated retail pharmacies or our mail-order pharmacies. The Specialty Pharmacy
segment, which was formed upon the Accredo acquisition, includes the sale of higher margin specialty pharmacy products and services for the treatment of chronic and potentially life-threatening diseases. The results of Accredo are included in the
Specialty Pharmacy segment results and the consolidated statements of income effective with the August 18, 2005 acquisition. The Specialty Pharmacy segment also includes the specialty pharmacy activity previously included within our PBM
business. We define the Specialty Pharmacy segment based on a product set and associated services, broadly characterized to include drugs that are high-cost, usually developed by biotechnology companies and often injectable, and which require
elevated levels of patient support. When dispensed, these products frequently require a significant amount of ancillary administration equipment, special packaging, and a much higher degree of patient-oriented customer service than is required in
the traditional PBM business model. In addition, specialty pharmacy products and services are often covered through medical benefit programs with the primary payors being insurance companies and government programs, along with patients, as well as
PBM clients as payors.



27



---

##### Table of Contents

The Specialty Pharmacy segment was formed as a result of the Accredo acquisition on August 18, 2005
in response to a management desire to manage the acquired business together with our pre-existing specialty pharmacy activity as a separate business from our PBM operations. This acquisition complemented our pre-existing Medco specialty pharmacy
operation, which was evolving in 2005.

The PBM segment is measured and managed on an integrated basis, and there is no distinct
measurement that separates the performance and profitability of mail order and retail. We offer fully integrated PBM services to virtually all of our PBM clients and their members. The PBM services we provide to our clients are generally delivered
and managed under a single contract for each client. Both the PBM and the Specialty Pharmacy segments operate in one geographic region, which includes the United States and Puerto Rico.

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

Results of Operations

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



|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|----------------------------------- |  | -------------------------------- | -------- | - | ------------------- | - | ------- | ----------------------------------- |  | ---- | ------------------------------------ |  | - | ------------------- | - |  | --------------------------------------- | -------- | - |  | - | ------- | - |  | ---- | - |  | - | -------- | -
|                                    |  | Quarter Ended September 30, 2006 |          |   | Increase (Decrease) |   |         | Quarter Ended September 24, 2005(1) |  |      | Nine Months Ended September 30, 2006 |  |   | Increase (Decrease) |   |  | Nine Months Ended September 24, 2005(1) |         
|Net Revenues                        |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Retail product(2)                   |  | $                                | 6,334.5  |   |                     | $ | 590.7   |                                     |  | 10.3 | %                                    |  | $ | 5,743.8             |   |  | $                                       | 19,208.7 |   |  | $ | 2,205.5 |   |  | 13.0 | % |  | $ | 17,003.2 |  
|Mail-order product                  |  |                                  | 4,000.3  |   |                     |   | 520.4   |                                     |  | 15.0 | %                                    |  |   | 3,479.9             |   |  |                                         | 12,028.4 |   |  |   | 2,245.3 |   |  | 23.0 | % |  |   | 9,783.1  |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Total product(2)                    |  | $                                | 10,334.8 |   |                     | $ | 1,111.1 |                                     |  | 12.0 | %                                    |  | $ | 9,223.7             |   |  | $                                       | 31,237.1 |   |  | $ | 4,450.8 |   |  | 16.6 | % |  | $ | 26,786.3 |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Client and other service            |  |                                  | 85.0     |   |                     |   | 25.8    |                                     |  | 43.6 | %                                    |  |   | 59.2                |   |  |                                         | 246.0    |   |  |   | 83.9    |   |  | 51.8 | % |  |   | 162.1    |  
|Manufacturer service                |  |                                  | 41.3     |   |                     |   | (1.2    | )                                   |  | (2.8 | )%                                   |  |   | 42.5                |   |  |                                         | 130.4    |   |  |   | 11.4    |   |  | 9.6  | % |  |   | 119.0    |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Total service                       |  | $                                | 126.3    |   |                     | $ | 24.6    |                                     |  | 24.2 | %                                    |  | $ | 101.7               |   |  | $                                       | 376.4    |   |  | $ | 95.3    |   |  | 33.9 | % |  | $ | 281.1    |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Total net revenues(2)               |  | $                                | 10,461.1 |   |                     | $ | 1,135.7 |                                     |  | 12.2 | %                                    |  | $ | 9,325.4             |   |  | $                                       | 31,613.5 |   |  | $ | 4,546.1 |   |  | 16.8 | % |  | $ | 27,067.4 |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Cost of Revenues                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Product(2)                          |  | $                                | 9,840.8  |   |                     | $ | 1,001.3 |                                     |  | 11.3 | %                                    |  | $ | 8,839.5             |   |  | $                                       | 29,809.2 |   |  | $ | 4,180.0 |   |  | 16.3 | % |  | $ | 25,629.2 |  
|Service                             |  |                                  | 26.8     |   |                     |   | 4.0     |                                     |  | 17.5 | %                                    |  |   | 22.8                |   |  |                                         | 89.0     |   |  |   | 16.7    |   |  | 23.1 | % |  |   | 72.3     |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Total cost of revenues(2)           |  | $                                | 9,867.6  |   |                     | $ | 1,005.3 |                                     |  | 11.3 | %                                    |  | $ | 8,862.3             |   |  | $                                       | 29,898.2 |   |  | $ | 4,196.7 |   |  | 16.3 | % |  | $ | 25,701.5 |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Gross Margin(3)                     |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Product                             |  | $                                | 494.0    |   |                     | $ | 109.8   |                                     |  | 28.6 | %                                    |  | $ | 384.2               |   |  | $                                       | 1,427.9  |   |  | $ | 270.8   |   |  | 23.4 | % |  | $ | 1,157.1  |  
|Product gross margin percentage     |  |                                  | 4.8      | % |                     |   | 0.6     | %                                   |  |      |                                      |  |   | 4.2                 | % |  |                                         | 4.6      | % |  |   | 0.3     | % |  |      |   |  |   | 4.3      | %
|Service                             |  | $                                | 99.5     |   |                     | $ | 20.6    |                                     |  | 26.1 | %                                    |  | $ | 78.9                |   |  | $                                       | 287.4    |   |  | $ | 78.6    |   |  | 37.6 | % |  | $ | 208.8    |  
|Service gross margin percentage     |  |                                  | 78.8     | % |                     |   | 1.2     | %                                   |  |      |                                      |  |   | 77.6                | % |  |                                         | 76.4     | % |  |   | 2.1     | % |  |      |   |  |   | 74.3     | %
|Total gross margin                  |  | $                                | 593.5    |   |                     | $ | 130.4   |                                     |  | 28.2 | %                                    |  | $ | 463.1               |   |  | $                                       | 1,715.3  |   |  | $ | 349.4   |   |  | 25.6 | % |  | $ | 1,365.9  |  
|Gross margin percentage             |  |                                  | 5.7      | % |                     |   | 0.7     | %                                   |  |      |                                      |  |   | 5.0                 | % |  |                                         | 5.4      | % |  |   | 0.4     | % |  |      |   |  |   | 5.0      | %
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Volume Information                  |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Retail                              |  |                                  | 112.7    |   |                     |   | 3.5     |                                     |  | 3.2  | %                                    |  |   | 109.2               |   |  |                                         | 344.4    |   |  |   | 14.4    |   |  | 4.4  | % |  |   | 330.0    |  
|Mail-order                          |  |                                  | 22.3     |   |                     |   | 0.9     |                                     |  | 4.2  | %                                    |  |   | 21.4                |   |  |                                         | 66.4     |   |  |   | 3.2     |   |  | 5.1  | % |  |   | 63.2     |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Total volume                        |  |                                  | 135.0    |   |                     |   | 4.4     |                                     |  | 3.4  | %                                    |  |   | 130.6               |   |  |                                         | 410.8    |   |  |   | 17.6    |   |  | 4.5  | % |  |   | 393.2    |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Adjusted prescriptions(4)           |  |                                  | 179.2    |   |                     |   | 5.8     |                                     |  | 3.3  | %                                    |  |   | 173.4               |   |  |                                         | 542.3    |   |  |   | 22.7    |   |  | 4.4  | % |  |   | 519.6    |  
|                                    |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Adjusted mail-order penetration(5)  |  |                                  | 37.1     | % |                     |   | 0.1     | %                                   |  |      |                                      |  |   | 37.0                | % |  |                                         | 36.5     | % |  |   |        |   |  |      |   |  |   | 36.5     | %
|Generic Dispensing Rate Information |  |                                  |          |   |                     |   |         |                                     |  |      |                                      |  |   |                     |   |  |                                         |          |   |  |   |         |   |  |      |   |  |   |          |  
|Retail generic dispensing rate      |  |                                  | 57.9     | % |                     |   | 4.4     | %                                   |  |      |                                      |  |   | 53.5                | % |  |                                         | 56.6     | % |  |   | 3.7     | % |  |      |   |  |   | 52.9     | %
|Mail-order generic dispensing rate  |  |                                  | 46.3     | % |                     |   | 4.7     | %                                   |  |      |                                      |  |   | 41.6                | % |  |                                         | 43.9     | % |  |   | 2.4     | % |  |      |   |  |   | 41.5     | %
|Overall generic dispensing rate     |  |                                  | 56.0     | % |                     |   | 4.5     | %                                   |  |      |                                      |  |   | 51.5                | % |  |                                         | 54.5     | % |  |   | 3.4     | % |  |      |   |  |   | 51.1     | %

---

|(1) | The Accredo acquisition occurred in Medcos
fiscal August 2005 month-end. Accordingly, the 2005 results exhibited include Accredo for one five-week month (fiscal September 2005) only.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



28



---

##### Table of Contents

|(2) | Includes retail co-payments of $1,779 million and $1,802 million for the third quarters of 2006 and 2005, and $5,539 million
and $5,434 million for the nine months of 2006 and 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Defined as net revenues minus cost of revenues.
|--- | -----------------------------------------------

|(4) | Estimated adjusted prescription volume equals the majority of mail-order prescriptions multiplied by 3, plus retail
prescriptions. These mail-order prescriptions are multiplied by 3 to adjust for the fact that they include approximately 3 times the amount of product days supplied compared with retail prescriptions.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | The percentage of adjusted mail-order prescriptions
to total adjusted prescriptions.
|--- | ------------------------------------------------------------------------------------

Net Revenues. The $591 million increase in retail net
revenues for the third quarter is attributable to net price increases of $405 million driven by higher prices charged by pharmaceutical manufacturers, and net volume increases of $186 million primarily related to new business, partially offset by
client terminations. For the nine months, the increase in retail net revenues of $2,206 million is attributable to net price increases of $1,422 million, net volume increases of $739 million, as well as the favorable closure of a client rebate
matter of $19 million and settlement of a client audit matter of $10 million both recorded in the second quarter of 2006, and an additional client-related benefit of $16 million recorded in the first quarter of 2006. The aforementioned net price
variance includes the offsetting effect of price decreases of approximately $340 million for the third quarter and approximately $825 million for the nine months from a greater representation of generic drugs in 2006, as well as a reduction of $44
million for the third quarter and $198 million for the nine months related to higher levels of rebate sharing with clients, further discussed in the gross margin section.

The $520 million increase in mail-order net revenues for the third quarter of 2006 reflects volume increases of $371 million including new business and the incremental effect of Accredo, and net price increases of
$149 million. For the nine months, the $2,245 million increase in mail-order net revenues reflects volume increases of $1,555 million including new business and the incremental effect of Accredo, and net price increases of $690 million. The revenue
growth reflects a full quarter and nine months of Accredo in 2006, compared to a five-week period in both the third quarter and nine months of 2005. The net price increases are driven by higher prices charged by pharmaceutical manufacturers,
partially offset by higher levels of rebate sharing with clients resulting in reductions to mail-order revenue of $12 million for the third quarter and $103 million for the nine months. Also contributing as an offset within the net price increases
are decreases of approximately $190 million and approximately $300 million from a higher representation of generic drugs for the third quarter and nine months of 2006, respectively. Mail-order penetration on an adjusted basis was 37.1% for the third
quarter of 2006 and 36.5% for the nine months of 2006, slightly above the 37.0% for the third quarter of 2005 and consistent with the 36.5% for the nine months of 2005.

Our product net revenues were also favorably impacted by the commencement of our Medicare Part D PDP product offering. In the third quarter of 2006, premium revenues for our PDP product were $98 million, or
approximately 1% of total net revenues of $10.5 billion. For the nine months of 2006, premium revenues were $364 million, or approximately 1% of total net revenues of $31.6 billion.

Our overall generic dispensing rate increased to 56.0% for the third quarter of 2006 and to 54.5% for the nine months of 2006, compared to 51.5% for the
third quarter of 2005 and 51.1% for the nine months of 2005. Mail-order generic dispensing rates increased to 46.3% for the third quarter of 2006 and 43.9% for the nine months of 2006, compared to 41.6% and 41.5% for the third quarter and nine
months of 2005, respectively. Retail generic dispensing rates increased to 57.9% for the third quarter of 2006 and 56.6% for the nine months of 2006, compared to 53.5% and 52.9% for the third quarter and nine months of 2005, respectively. These
increases reflect the introduction of new generic products during these periods, the effect of client plan design changes promoting the use of lower-cost and more steeply discounted generics, and our programs designed to encourage generic
utilization.

Service revenues increased $24.6 million in the third quarter of 2006 and $95.3 million in the nine months of 2006, primarily
as a result of higher client and other service revenues of $25.8 million and $83.9 million, respectively. Higher manufacturer service revenues of $11.4 million also contributed to the increase in service revenues for the nine months. The higher
client and other service revenues reflect higher claims processing administrative fees for services including clinical programs and Medicare Part D-related support. The higher manufacturer revenues for the nine months result from Accredo
manufacturer service fees, partially offset by lower administrative fees earned as a result of a manufacturer contract revision.



29



---

##### Table of Contents

Gross Margin. Our client contracts include several pricing variables, such as price
discounts for brand-name drugs, generic drugs and specialty drugs, separate price discounts for mail-order and retail prescriptions, fees for various administrative and clinical services, and terms regarding levels of rebate sharing and other
guarantees. Clients have varied preferences regarding the pricing model best suited to their needs, and we negotiate these variables to generate an appropriate aggregate level of gross margin. As an example, certain clients may prefer a model
whereby more rebates are shared in exchange for higher fees or lower price discounts, while others may prefer steeper price discounts in exchange for lower rebates. We experienced a year-over-year decline in rebate retention reflecting changes in
the pricing composition within our contracts. Gross margin reflects these changes, as well as changes in the generic drug representation, mail or retail composition in our prescription base, specialty drug content, and Medicare Part D financial
performance.

Our product gross margin percentage was 4.8% for the third quarter of 2006 compared to 4.2% for the third quarter of 2005,
and 4.6% for the nine months of 2006 compared to 4.3% for the nine months of 2005, with 2006 including a full quarter and nine months of Accredo product gross margin, compared to a five-week period in 2005. The rate of change in cost of product net
revenues was consistent with the rate of change in product net revenues for the third quarter and nine months. The consistent rates reflect higher prescription prices charged by pharmaceutical manufacturers, partially offset by the greater
utilization of lower-cost generic products, as well as increased brand-name purchasing discounts and increased brand-name pharmaceutical rebates for the nine months. Our gross margin percentage also reflects the higher levels of rebate sharing with
our clients, which increased $56 million and $301 million for the third quarter and nine months of 2006, respectively.

Rebates from
brand-name pharmaceutical manufacturers, which are reflected as a reduction in cost of product net revenues, totaled $808 million in the third quarter of 2006 and $814 million in the third quarter of 2005, with formulary rebates representing 52.3%
and 50.4% of total rebates, respectively. Rebates totaled $2,540 million in the nine months of 2006 and $2,387 million in the nine months of 2005, with formulary rebates representing 52.3% and 50.6% of total rebates, respectively. For the third
quarter of 2006, the consistent level of rebates compared to the same quarter of 2005 reflects improved formulary management and patient compliance, offset by brand-name drugs that have recently lost patent protection. For the nine months of 2006,
the increase in rebates earned compared to the same period for 2005 reflects improved formulary management and patient compliance, and favorable pharmaceutical manufacturer rebate contract revisions, partially offset by the aforementioned brand-name
drugs that have lost patent protection. We retained approximately $148 million, or 18.3% of total rebates, in the third quarter of 2006, and $210 million, or 25.8% of total rebates, in the third quarter of 2005. For the nine months of 2006, we
retained approximately $517 million, or $20.3% of total rebates, compared to approximately $665 million, or 27.9% of total rebates, for the nine months of 2005. The gross margin effect of overall higher rebate sharing levels is partially mitigated
by other elements of pricing including higher claims processing, administrative and other client service fees, higher generic dispensing rates, and increased specialty drug volumes.

Service gross margin percentage improved to 78.8% in the third quarter of 2006 from 77.6% in the third quarter of 2005, and to 76.4% in the nine months
of 2006 from 74.3% in the nine months of 2005. This reflects the increase in service revenues of 24.2% for the third quarter and 33.9% for the nine months of 2006, driven by the aforementioned client and other service revenue increases, partially
offset by an increase in cost of service revenues of 17.5% for the third quarter and 23.1% for the nine months of 2006. The increase in cost of service revenues is primarily related to higher expenses of $2 million for the third quarter and $15
million for the nine months associated with enrollment-related activities for our Medicare Part D PDP product offering. Total enrollment-related activities for our Medicare Part D PDP product offering were $3 million and $25 million for the third
quarter and nine months, respectively.



30



---

##### Table of Contents

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



|                                             |  |                                  |       |                     |   |       |                                     |      |                                      |  |                     |       |  |                                         |         |  |   |       |   |  |      |    |  |   |        
|-------------------------------------------- |  | -------------------------------- | ----- | ------------------- | - | ----- | ----------------------------------- | ---- | ------------------------------------ |  | ------------------- | ----- |  | --------------------------------------- | ------- |  | - | ----- | - |  | ---- | -- |  | - | -------
|                                             |  | Quarter Ended September 30, 2006 |       | Increase (Decrease) |   |       | Quarter Ended September 24, 2005(1) |      | Nine Months Ended September 30, 2006 |  | Increase (Decrease) |       |  | Nine Months Ended September 24, 2005(1)
|Gross margin                                 |  | $                                | 593.5 |                     | $ | 130.4 |                                     | 28.2 | %                                    |  | $                   | 463.1 |  | $                                       | 1,715.3 |  | $ | 349.4 |   |  | 25.6 | %  |  | $ | 1,365.9
|Selling, general and administrative expenses |  |                                  | 222.9 |                     |   | 36.5  |                                     | 19.6 | %                                    |  |                     | 186.4 |  |                                         | 857.9   |  |   | 321.1 |   |  | 59.8 | %  |  |   | 536.8  
|Amortization of intangibles                  |  |                                  | 54.6  |                     |   | 6.5   |                                     | 13.5 | %                                    |  |                     | 48.1  |  |                                         | 163.9   |  |   | 25.9  |   |  | 18.8 | %  |  |   | 138.0  
|Interest and other (income) expense, net     |  |                                  | 20.9  |                     |   | 10.3  |                                     | 97.2 | %                                    |  |                     | 10.6  |  |                                         | 49.8    |  |   | 22.7  |   |  | 83.8 | %  |  |   | 27.1   
|                                             |  |                                  |       |                     |   |       |                                     |      |                                      |  |                     |       |  |                                         |         |  |   |       |   |  |      |    |  |   |        
|Income before provision for income taxes     |  |                                  | 295.1 |                     |   | 77.1  |                                     | 35.4 | %                                    |  |                     | 218.0 |  |                                         | 643.7   |  |   | (20.3 | ) |  | (3.1 | )% |  |   | 664.0  
|Provision for income taxes                   |  |                                  | 109.3 |                     |   | 48.0  |                                     | 78.3 | %                                    |  |                     | 61.3  |  |                                         | 242.3   |  |   | 3.6   |   |  | 1.5  | %  |  |   | 238.7  
|                                             |  |                                  |       |                     |   |       |                                     |      |                                      |  |                     |       |  |                                         |         |  |   |       |   |  |      |    |  |   |        
|Net income                                   |  | $                                | 185.8 |                     | $ | 29.1  |                                     | 18.6 | %                                    |  | $                   | 156.7 |  | $                                       | 401.4   |  | $ | (23.9 | ) |  | (5.6 | )% |  | $ | 425.3  
|                                             |  |                                  |       |                     |   |       |                                     |      |                                      |  |                     |       |  |                                         |         |  |   |       |   |  |      |    |  |   |        

---

|(1) | The Accredo acquisition occurred in Medcos
fiscal August 2005 month-end. Accordingly, the 2005 results exhibited include Accredo for one five-week month (fiscal September 2005) only.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Selling, General and Administrative Expenses. SG&A expenses of $223 million in the third quarter of 2006 increased from the third quarter of 2005 by $37 million, or 19.6%. This increase reflects
incremental Accredo expenses of $27 million, and stock option expense of $12 million.

SG&A expenses for the nine months of 2006
amounting to $858 million increased from the nine months of 2005 by $321 million, or 59.8%, which includes the aforementioned $162.6 million one-time pre-tax legal settlements charge. The one-time pre-tax legal settlements charge reflected an
agreement with the U.S. Attorneys Office for the Eastern District of Pennsylvania to settle three previously disclosed pending federal matters. The settlement agreements for these three matters were signed and approved by the District Court on
October 23, 2006. Excluding the one-time charge, SG&A expenses for the nine months of 2006 increased from 2005 by $159 million to $695 million, or 29.5%. This increase reflects incremental Accredo expenses of $112 million, as well as stock
option expense of $42 million and higher restricted stock unit expenses of $11 million, partially offset by other expense reductions of $6 million.

Amortization of Intangibles. Amortization of intangible assets of $54.6 million for the third quarter of 2006 and $163.9 million for the nine months of 2006 increased by $6.5 million from the third quarter of 2005 and $25.9
million from the nine months of 2005, primarily reflecting the additional amortization associated with the intangible assets acquired in the Accredo acquisition.

Interest and Other (Income) Expense, Net. Interest and other (income) expense, net, increased $10.3 million for the third quarter of 2006 and $22.7 million for the nine months of 2006 from the
same periods in 2005. The third quarter variance results from higher interest expense of $6.1 million and lower interest income of $4.2 million. The variance for the nine months of 2006 reflects higher interest expense of $21.7 million and lower
interest income of $1.0 million. The higher interest expense for the third quarter and nine months reflects elevated average debt levels from the debt refinancing in August 2005 related to the Accredo acquisition, higher interest rates on floating
rate debt, and increased short-term borrowing levels in the third quarter of 2006. The lower interest income for the third quarter and nine months reflect lower average daily cash balances, partially offset by the benefit of higher interest rates in
2006. The estimated weighted average interest rate on our indebtedness was approximately 6.5% for the third quarter of 2006 and 6.2% for the nine months of 2006, compared to 5.6% for the third quarter of 2005 and 5.8% for the nine months of 2005,
and reflects increases in floating interest rates on our term loans and accounts receivable financing facility.

Provision for Income
Taxes. Our effective tax rate (defined as the percentage relationship of provision for income taxes to income before provision for income taxes) was 37.0% and 37.6% for the quarter and nine months of 2006, respectively, compared to 28.1% and
35.9% for the same periods in 2005. The 2006 third quarter rate reflects a net $6.6 million non-recurring benefit, which includes $4.1 million in interest income associated with the IRS approval of a



31



---

##### Table of Contents

favorable accounting method change for the timing of the deductibility of certain rebates passed back to clients. In
addition, the 2006 third quarter rate includes the favorable closure of state tax exposures in the amount of $3.0 million resulting from the expiration of the statute of limitations in certain states, partially offset by increases in our net
deferred tax liabilities resulting from certain state law changes.

The 2006 year-to-date rate reflects a second quarter benefit of $16.3
million, including $9.1 million from the favorable resolution of income tax payables provided for prior to the spin-off from Merck, $4.0 million from the favorable closure of a state income tax audit, and a $3.2 million benefit from the adjustment
of our net deferred tax liabilities due to the enactment of a state income tax law change. These benefits were partially offset by a $10.4 million increase in the second quarter 2006 provision relating to increases in the overall state marginal
income tax rate due to various state law changes including a corresponding increase to our net deferred tax liabilities. The 2005 income tax rates reflect a $25.7 million non-recurring tax benefit recorded in the third quarter associated with a
reduction in our marginal state income tax rate resulting primarily from an enacted change in a state income tax law and the receipt of a favorable state income tax ruling.

Based on the current facts and circumstances associated with the one-time legal settlements charge, we believe it is probable the settlement amount will
be tax deductible. Accordingly, our nine month provision for income taxes reflects an estimated tax benefit of approximately $63 million associated with the one-time charge.

We may achieve additional state income tax savings in future quarters, some of which relate to state income tax payables provided for prior to the
spin-off date from Merck. To the extent that these state tax savings are realized, they will be recorded as a reduction to the provision for income taxes at the time approval is received from the respective state taxing jurisdiction or when the
applicable statute of limitations has expired.

Net Income and Earnings per Share. Net income as a percentage of net
revenues was 1.8% in the third quarter of 2006, and 1.3% in the nine months of 2006, which includes a 0.3% reduction resulting from the one-time legal settlements charge for the nine months. Excluding the one-time charge, net income as a percentage
of net revenues was 1.6% in the nine months of 2006.

Diluted earnings per share increased 17.0% to $0.62 for the third quarter of 2006 and
decreased 10.8% to $1.32 for the nine months of 2006, including the one-time legal settlements charge of $0.33 per share for the nine months. Excluding the one-time charge, diluted earnings per share increased 11.5% to $1.65 for the nine months of
2006. The diluted weighted average shares outstanding were 298.7 million and 303.5 million for the third quarter and nine months of 2006, respectively, and 296.5 million and 286.9 million for the third quarter and nine months of
2005, respectively.

The increases in the diluted weighted average shares outstanding reflect the issuance of stock under employee stock
plans and the dilutive effect of outstanding stock options, as well as approximately 24 million shares issued in August 2005 for the Accredo acquisition. These increases are partially offset by the repurchase of 22.8 million shares of
stock in connection with our share repurchase program since its inception in the third quarter of 2005, of which approximately 1.2 million and approximately 15.1 million were repurchased during the third quarter and nine months of 2006,
respectively.

Specialty Pharmacy Segment. For the third quarter and nine months of 2006 and 2005, we identified the revenues
associated with Medcos pre-existing specialty pharmacy business based on a data extract of sales for the specialty product set. We have also calculated the estimated operating income for the third quarter and nine months of 2005 based on the
best information available for the pre-acquisition period and the detailed post-acquisition segment results. For the third quarter and nine months of 2005, we estimate that the specialty pharmacy results of operations, including the effect of the
pre-existing Medco specialty pharmacy results of operations, reflect approximately $0.9 billion and $2.2 billion in total net revenues, respectively, with operating income estimated at $28 million and $50 million, respectively.

Specialty Pharmacy total net revenues of $1.4 billion for the third quarter of 2006 and $4.0 billion for the nine months of 2006 increased approximately
$0.5 billion and $1.8 billion compared to the estimated third quarter and nine months of 2005, respectively. The increase primarily results from the Accredo acquisition, as 2006 includes a full quarter and nine months of Accredo, compared to a
five-week period in 2005. The total net revenues include revenue for the seasonal drug, Synagis, of $2.6 million and $76.7 million for the third quarter and nine months of 2006, respectively.



32



---

##### Table of Contents

Operating income of $44 million for the third quarter of 2006 and $138 million for the nine months of 2006 increased
approximately $16 million and $88 million compared to the estimated operating income for the third quarter and nine months of 2005, respectively. The increase primarily results from the increased revenue, as well as the inclusion of incremental
higher-margin Accredo products as a result of the Accredo acquisition. Sequentially, operating income decreased from $50 million in the second quarter of 2006 to $44 million in the third quarter, with gross margin decreasing from 8.3% in the second
quarter to 7.6% in the third quarter, primarily due to the mix of products dispensed in the quarter.

Liquidity and Capital Resources

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



|                                                     |  |                                      |        |   |                     |   |          |                                      |  |   |          |  
|---------------------------------------------------- |  | ------------------------------------ | ------ | - | ------------------- | - | -------- | ------------------------------------ |  | - | -------- | -
|                                                     |  | Nine Months Ended
September 30, 2006 |        |   | Increase (Decrease) |   |          | Nine Months Ended
September 24, 2005 | 
|                                                     |  |                                     
|Net cash provided by operating activities            |  | $                                    | 361.8  |   |                     | $ | (539.7   | )                                    |  | $ | 901.5    |  
|Net cash used by investing activities                |  |                                      | (90.6  | ) |                     |   | 975.9    |                                      |  |   | (1,066.5 | )
|Net cash (used by) provided by financing activities  |  |                                      | (700.6 | ) |                     |   | (1,046.4 | )                                    |  |   | 345.8    |  
|                                                     |  |                                      |        |   |                     |   |          |                                      |  |   |          |  
|Net (decrease) increase in cash and cash equivalents |  |                                      | (429.4 | ) |                     |   | (610.2   | )                                    |  |   | 180.8    |  
|Cash and cash equivalents at beginning of period     |  |                                      | 888.2  |   |                     |   | (257.3   | )                                    |  |   | 1,145.5  |  
|                                                     |  |                                      |        |   |                     |   |          |                                      |  |   |          |  
|Cash and cash equivalents at end of period           |  | $                                    | 458.8  |   |                     | $ | (867.5   | )                                    |  | $ | 1,326.3  |  
|                                                     |  |                                      |        |   |                     |   |          |                                      |  |   |          |  

Operating Activities.The net cash provided by operating activities of $362
million for the nine months of 2006 reflects cash provided by operating activities from net income of $401 million, with adjustments for depreciation and amortization of $297 million. Additionally, there was an increase of $248 million in current
liabilities and other noncurrent liabilities, primarily resulting from unearned premiums and catastrophic reinsurance from CMS associated with our Medicare Part D PDP product offering and the one-time legal settlements liability that was recorded in
the first quarter of 2006. These increases were partially offset by a $482 million decrease in cash flows from accounts receivable, net, resulting from an increase in Medicare Part D receivables from CMS associated with the new product offering and
the timing of our client billing cycles. We collected over $468 million from our clients on the first business day of the fourth fiscal quarter of 2006. We also experienced a decrease in cash flows from inventory of $90 million resulting from the
timing of pharmaceutical purchases.

The decrease in net cash provided by operating activities in the first nine months of 2006 compared to
the first nine months of 2005 of $540 million substantially results from an increase in cash outflows of $487 million from accounts receivable, net, due to the aforementioned factors, and a decrease in cash flows from inventory of $222 million due
to higher inventory levels at the end of the third quarter of 2006 reflecting the timing of pharmaceutical purchases. These decreases were partially offset by an increase of $205 million in current liabilities and other noncurrent liabilities,
primarily resulting from the aforementioned components activity.

For the nine months ended September 30, 2006 and compared to
the first nine months of 2005, net cash provided by operating activities reflects a decrease resulting from income taxes receivable associated with the approval of a favorable accounting method change received from the IRS in the third quarter of
2006 for the timing of the deductibility of certain rebates passed back to clients. The decrease is offset within net cash provided by operating activities in the deferred income taxes and prepaid expenses and other current assets components.
Additionally, we established a separate money market fund account associated with the legal settlement with the U.S. Attorneys Office for the Eastern District of Pennsylvania. On August 22, 2006, we purchased for such money market fund
account that number of shares with an aggregate net asset value of $155 million (Settlement Amount). On October 24, 2006, we paid $156.4 million, representing the Settlement Amount plus accrued interest of $1.4 million, to the
Department of Justice.

Investing Activities. The net cash used by investing activities of $91 million for the nine
months of 2006 is primarily attributable to capital expenditures associated with capitalized software development in connection with our Medicare Part D PDP product offering, client-related programs, productivity initiatives, as well as investments
in customer service and pharmacy operations. We expect that our full year 2006 capital expenditures will not exceed $150 million. The increase in net cash used by investing activities for the nine months of 2006 compared to the prior year of $976
million is primarily due to $989 million paid, net of cash acquired, for the Accredo acquisition in the third quarter of 2005, as well as the timing of capital expenditures.



33



---

##### Table of Contents

Financing Activities. The net cash used by financing activities of $701 million for
the nine months of 2006 primarily results from $826 million in treasury stock repurchases, partially offset by proceeds from employee stock plans of $150 million. The increase in net cash used by financing activities for the nine months of 2006
compared with 2005 of $1,046 million is primarily due to an increase in treasury stock repurchases of $757 million, reflecting nine months of activity in 2006 compared to only one month of activity through September 2005. Also contributing to the
increase in net cash used by financing activities for 2006 compared with 2005 were lower net proceeds from debt of approximately $150 million as 2005 reflected financing for a portion of the Accredo purchase price. In addition, proceeds from
employee stock plans of decreased by $114 million.

Total cash and short-term investments as of September 30, 2006 were $519.2
million, including $458.8 million in cash and cash equivalents. Total cash and short-term investments as of December 31, 2005 were $944.8 million, including $888.2 million in cash and cash equivalents. The decrease of $425.6 million in cash and
short-term investments for the nine months of 2006 primarily reflects share repurchase activity, partially offset by cash flows from operations and employee stock plans.

Financing Facilities

Senior Bank Credit Facilities. We have a $1.25 billion senior
unsecured credit facility, comprised of a $750 million term loan and a $500 million revolving credit facility. There was $475 million outstanding under our term loan facility as of September 30, 2006. We had no amounts outstanding under our
revolving credit facility as of September 30, 2006. The credit facilities bear interest at the London Interbank Offered Rate (LIBOR) plus a 0.5% margin.

Accounts Receivable Financing Facility. Through a wholly-owned subsidiary, as of September 30, 2006, we have a $600 million, 364-day renewable accounts receivable financing facility that is
collateralized by our pharmaceutical manufacturer rebate accounts receivable. There was $450 million outstanding under this accounts receivable financing facility as of September 30, 2006. We pay interest on amounts borrowed under the agreement
based on the funding rates of the bank-related commercial paper programs that provide the financing, plus an applicable margin determined by our credit rating.

Effective July 31, 2006, the accounts receivable financing facility was increased from $500 million to $600 million. During the third quarter of 2006, we drew down and repaid $150 million under the facility.

Interest Rates and Covenants

The estimated weighted average annual interest rate on our indebtedness was approximately 6.5% and 6.2% for the third quarter and nine months of 2006,
respectively, and 5.6% and 5.8% for the third quarter and nine months of 2005, respectively. Several factors could change the weighted average annual interest rate, including but not limited to a change in reference rates used under our credit
facilities and swap agreements.

Our senior unsecured credit facility, senior notes and accounts receivable financing facility contain
covenants, including, among other items, minimum interest coverage, maximum leverage ratios, as well as restrictions on dividends, share repurchases, and asset sales and liens. We were in compliance with all financial covenants at September 30,
2006.

Debt Ratings

On August 9, 2006, Moodys Investors Service upgraded the credit ratings of Medco Health Solutions, Inc. to Baa3 (positive outlook) investment grade from Ba1 (positive outlook).



34



---

##### Table of Contents

Share Repurchase Program

On November 3, 2006, we announced that our Board of Directors had authorized the expansion of our share repurchase plan by an incremental $1 billion,
bringing the amount authorized under such share repurchase plan to a cumulative total of $2.5 billion. The original repurchase plan, which was approved in August 2005, authorized share repurchases of $500 million. The plan was increased by an
incremental $1 billion in December 2005. The expiration date of the plan has been extended through October 2008. We repurchased under the plan approximately 1.2 million shares at a cost of $71.8 million, and approximately 15.1 million
shares at a cost of $825 million during the third quarter and nine months of 2006, respectively. Inception-to-date repurchases through September 30, 2006 under this program total approximately 22.8 million shares at a cost of approximately
$1.2 billion. Our Board of Directors periodically reviews the program and approves trading parameters.

EBITDA

We calculate and use EBITDA and EBITDA per adjusted prescription as indicators of our ability to generate cash from our reported operating results. These
measurements are used in concert with net income and cash flows from operations, which measure actual cash generated in the period. In addition, we believe that EBITDA and EBITDA per adjusted prescription are supplemental measurement tools used by
analysts and investors to help evaluate overall operating performance and the ability to incur and service debt and make capital expenditures. EBITDA does not represent funds available for our discretionary use and is not intended to represent or to
be used as a substitute for net income or cash flows from operations data as measured under U.S. generally accepted accounting principles (GAAP). The items excluded from EBITDA but included in the calculation of our reported net income
are significant components of our consolidated statements of income, and must be considered in performing a comprehensive assessment of our overall financial performance. EBITDA, and the associated year-to-year trends, should not be considered in
isolation. Our calculation of EBITDA may not be consistent with calculations of EBITDA used by other companies. Additionally, we have calculated the nine-month 2006 EBITDA excluding the one-time legal settlements charge recorded in the first quarter
of 2006, as this is not considered an indicator of our ongoing performance.

EBITDA per adjusted prescription is calculated by dividing
EBITDA by the adjusted prescription volume for the period. This measure is used as an indicator of our EBITDA performance on a per-unit basis, providing insight into the cash-generating potential of each prescription. EBITDA per adjusted
prescription reflects the level of efficiency in the business and is affected by changes in prescription volumes between retail and mail order, as well as the relative representation of brand-name, generic and specialty drugs.

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



|                                                                                  |  |                    |       |                       |   |                    |  |   |                       |     |  |   |      
|--------------------------------------------------------------------------------- |  | ------------------ | ----- | --------------------- | - | ------------------ |  | - | --------------------- | --- |  | - | -----
|                                                                                  |  | Quarters Ended     |       | Nine Months Ended    
|                                                                                  |  | September 30, 2006 |       | September 24, 2005(1) |   | September 30, 2006 |  |   | September 24, 2005(1)
|Net income                                                                        |  | $                  | 185.8 |                       | $ | 156.7              |  | $ | 401.4                 |     |  | $ | 425.3
|Add:                                                                              |  |                    |       |                       |   |                    |  |   |                       |     |  |   |      
|Interest and other (income) expense, net(2)                                       |  |                    | 20.9  |                       |   | 10.6               |  |   | 49.8                  |     |  |   | 27.1 
|Provision for income taxes(3)                                                     |  |                    | 109.3 |                       |   | 61.3               |  |   | 242.3                 |     |  |   | 238.7
|Depreciation expense                                                              |  |                    | 42.3  |                       |   | 40.4               |  |   | 133.2                 |     |  |   | 121.5
|Amortization expense                                                              |  |                    | 54.6  |                       |   | 48.1               |  |   | 163.9                 |     |  |   | 138.0
|                                                                                  |  |                    |       |                       |   |                    |  |   |                       |     |  |   |      
|EBITDA                                                                            |  | $                  | 412.9 |                       | $ | 317.1              |  | $ | 990.6                 |     |  | $ | 950.6
|One-time legal settlements charge                                                 |  |                    |      |                       |   |                   |  |   | 162.6                 | (4) |  |   |     
|                                                                                  |  |                    |       |                       |   |                    |  |   |                       |     |  |   |      
|EBITDA, excluding the one-time legal settlements charge                           |  | $                  | 412.9 |                       | $ | 317.1              |  | $ | 1,153.2               |     |  | $ | 950.6
|                                                                                  |  |                    |       |                       |   |                    |  |   |                       |     |  |   |      
|Adjusted prescriptions(5)                                                         |  |                    | 179.2 |                       |   | 173.4              |  |   | 542.3                 |     |  |   | 519.6
|                                                                                  |  |                    |       |                       |   |                    |  |   |                       |     |  |   |      
|EBITDA per adjusted prescription                                                  |  | $                  | 2.30  |                       | $ | 1.83               |  | $ | 1.83                  |     |  | $ | 1.83 
|                                                                                  |  |                    |       |                       |   |                    |  |   |                       |     |  |   |      
|EBITDA per adjusted prescription, excluding the one-time legal settlements charge |  | $                  | 2.30  |                       | $ | 1.83               |  | $ | 2.13                  |     |  | $ | 1.83 
|                                                                                  |  |                    |       |                       |   |                    |  |   |                       |     |  |   |      

---

|(1) | The Accredo acquisition occurred in Medcos
fiscal August 2005 month-end. Accordingly, the 2005 results exhibited include Accredo for one five-week month (fiscal September 2005) only.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



35



---

##### Table of Contents

|(2) | 2005 includes a $1.7 million write-off in the third
quarter associated with the debt refinancing for the Accredo acquisition and a write-off of deferred debt issuance costs amounting to $0.7 million in the first quarter associated with accelerated term loan payments.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | 2006 includes a $6.6 million nonrecurring tax
benefit reflected in the third quarter, as well as a $12.5 million nonrecurring tax benefit reflected for the nine months. 2005 includes a $25.7 million nonrecurring tax benefit reflected in the third quarter and nine months.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | This represents the one-time pre-tax legal
settlements charge of $162.6 million recorded in the first quarter of 2006. This charge reflected an agreement with the U.S. Attorneys Office for the Eastern District of Pennsylvania to settle three previously disclosed pending federal legal
matters. The settlement agreements for these three matters were signed and approved by the District Court on October 23, 2006.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Estimated adjusted prescription volume equals the
majority of mail-order prescriptions multiplied by 3, plus retail prescriptions. These mail-order prescriptions are multiplied by 3 to adjust for the fact that they include approximately 3 times the amount of product days supplied compared with
retail prescriptions.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

EBITDA for the third quarter of 2006 increased 30.2% from the third quarter of 2005,
compared to a net income increase of 18.6%. Excluding the one-time legal settlements charge, EBITDA for the nine months of 2006 increased 21.3% from the nine months of 2005, compared to a net income increase of 17.9%. The higher rate of increase for
EBITDA compared with net income reflects the exclusions of the increased interest expense and intangible asset amortization associated with the Accredo acquisition, as well as the exclusion of the nonrecurring tax benefits, which were more
significant in 2005. EBITDA per adjusted prescription increased $0.47 or 25.7% to $2.30 in the third quarter of 2006 compared with $1.83 in the third quarter of 2005. For the nine months, EBITDA per adjusted prescription, excluding the one-time
legal settlements charge, increased $0.30, or 16.4%, to $2.13 compared to $1.83 in the nine months of 2005. The higher increase for the third quarter of 2006 compared to the nine months of 2006 largely reflects the increased mail-order generic
dispensing rate.

Contractual Obligations

The following table presents our contractual obligations as of September 30, 2006, as well as our long-term debt obligations, including the current portion of long-term debt ($ in millions):

Payments Due By Period



|                                                         |  |       |         |                   |   |           |  |           |       |            |   |       |  |   |      
|-------------------------------------------------------- |  | ----- | ------- | ----------------- | - | --------- |  | --------- | ----- | ---------- | - | ----- |  | - | -----
|                                                         |  | Total |         | Remainder of 2006 |   | 2007-2008 |  | 2009-2010 |       | Thereafter
|Long-term debt obligations, including current portion(1) |  | $     | 975.4   |                   | $ | 18.9      |  | $         | 150.3 |            | $ | 306.2 |  | $ | 500.0
|Interest expense on long-term debt obligations(2)        |  |       | 331.4   |                   |   | 16.3      |  |           | 120.3 |            |   | 99.6  |  |   | 95.2 
|Operating lease obligations(3)                           |  |       | 108.3   |                   |   | 8.8       |  |           | 54.8  |            |   | 35.5  |  |   | 9.2  
|Purchase obligations(4)                                  |  |       | 220.9   |                   |   | 151.8     |  |           | 69.1  |            |   |      |  |   |     
|                                                         |  |       |         |                   |   |           |  |           |       |            |   |       |  |   |      
|Total                                                    |  | $     | 1,636.0 |                   | $ | 195.8     |  | $         | 394.5 |            | $ | 441.3 |  | $ | 604.4
|                                                         |  |       |         |                   |   |           |  |           |       |            |   |       |  |   |      

---

|(1) | Long-term debt obligations exclude the $3.1 million
of unamortized discount on the senior notes and a fair value adjustment of $11.4 million associated with the interest rate swap agreements on $200 million of the senior notes.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | The variable component of interest expense for the
term loan facility is based on the third quarter 2006 LIBOR. The LIBOR fluctuates and may result in differences in the presented interest expense on long-term debt obligations.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Reflects contractual operating lease commitments to
lease pharmacy and call center pharmacy facilities, offices and warehouse space throughout the United States, as well as pill dispensing and counting devices and other operating equipment for use in our mail-order pharmacies and computer equipment
for use in our data centers.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Reflects contractual commitments to purchase
inventory from certain biopharmaceutical manufacturers and a brand-name pharmaceutical manufacturer.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------

As of September 30, 2006, we had letters of credit outstanding of approximately $14.9 million, of which approximately $13.9 million were issued
under our senior unsecured revolving credit facility.



36



---

##### Table of Contents

Recently Adopted Financial Accounting Standard

On January 1, 2006, we adopted SFAS 123R, which requires the measurement and recognition of compensation expense for all stock-based compensation
awards made to employees and directors including employee stock options and employee stock purchase plans. SFAS 123R supersedes our previous accounting under APB Opinion No. 25, Accounting for Stock Issued to Employees (APB
25), for periods subsequent to December 31, 2005. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) which provides interpretative guidance in applying the provisions of SFAS 123R. We have applied
the provisions of SAB 107 in our adoption of SFAS 123R.

We adopted SFAS 123R using the modified prospective transition method, which
requires the application of the accounting standard as of January 1, 2006, the first day of our 2006 fiscal year. Our unaudited interim condensed consolidated financial statements as of and for the fiscal quarter and nine months ended
September 30, 2006 reflect the impact of SFAS 123R. In accordance with the modified prospective transition method, our consolidated financial statements for periods prior to January 1, 2006 have not been restated to reflect, and do not
include, the impact of SFAS 123R as we did not record stock-based compensation expense related to employee stock options and employee stock purchase plans. Stock-based compensation expense related to employee stock options and employee stock
purchase plans recognized under SFAS 123R for the fiscal quarter and nine months ended September 30, 2006 amounted to $14.8 million pre-tax and $50.4 million pre-tax, respectively. See Note 5, Stock-Based Compensation, to the
accompanying unaudited interim condensed consolidated financial statements for additional information.

SFAS 123R requires companies to
estimate the fair value of stock-based awards on the date of grant using an option-pricing model. The portion of the value that is ultimately expected to vest is recognized as expense over the requisite service period. Prior to the adoption of SFAS
123R, we accounted for stock-based awards using the intrinsic value method in accordance with APB 25, as allowed under SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123). Under the intrinsic value method,
no stock-based compensation expense had been recognized related to options because the exercise price of our stock options granted equaled the fair market value of the underlying stock at the date of the grant.

SFAS 123R also requires the benefits of realized tax deductions in excess of tax benefits on compensation expense to be reported as a component of cash
flows from financing activities rather than as an operating cash flow, as previously required. The reported excess amounts to $32.1 million for the nine months ended September 30, 2006. In accordance with SAB 107, we classify stock-based
compensation within cost of product net revenues and selling, general and administrative expenses to correspond with the line items in which cash compensation paid to employees and directors is recorded.

Stock-based compensation expense recognized in our unaudited interim condensed consolidated statements of income for the fiscal quarter and nine months
ended September 30, 2006 include compensation expense for stock-based compensation awards granted prior to, but not yet vested as of December 31, 2005, based on the grant-date fair value estimated in accordance with the pro forma
provisions of SFAS 123. Additionally, our unaudited interim condensed consolidated statements of income for the fiscal quarter and nine months ended September 30, 2006 includes compensation expense for the stock-based compensation awards
granted subsequent to December 31, 2005 based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. In conjunction with the adoption of SFAS 123R, we changed our method of attributing the value of stock-based
compensation to expense from the accelerated multiple-option approach under Financial Accounting Standards Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans
(FIN 28) to the straight-line single option method.

As stock-based compensation expense recognized in our unaudited interim
condensed consolidated statements of income is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent
periods if actual forfeitures differ from those estimates. We estimate forfeitures in the same manner under SFAS 123R as we did prior to our adoption.



37



---

##### Table of Contents

Recent Accounting Pronouncements

In July 2006, the FASB released FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an Interpretation of FASB
Statement 109 (FIN 48 or the Interpretation), which clarifies the accounting for uncertainty in income taxes recognized in companies financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a
tax position in accordance with FIN 48 is a two-step process. The first step is recognition whereby companies must determine whether it is more likely than not that a tax position will be sustained upon examination. The second step is measurement
whereby a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The Interpretation also provides guidance on derecognition of recognized tax
benefits, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Earlier adoption is only permitted at the beginning of a
companys fiscal year, provided that interim financial statements for that fiscal year have not yet been issued. As a result, we expect to adopt the new requirements in the first quarter of 2007 and are currently evaluating
the impact that such adoption will have on our consolidated financial statements.

In September 2006, the FASB issued SFAS
No. 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.
SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. SFAS 157 is
effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Our adoption of SFAS 157 is not expected to have a material impact on our consolidated financial
statements.

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other
Postretirement Plansan amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS 158), which requires employers to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset
or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. We are required to adopt SFAS 158 as of the fiscal year ending after
December 15, 2006. We will adopt the new requirements as of December 30, 2006, but do not expect such adoption to have a material impact on our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We have floating rate debt with our
credit facilities and investments in marketable securities that are subject to interest rate volatility. In addition, in 2004, we entered into interest rate swap agreements on $200 million of the $500 million in 7.25% senior notes. As a result of
the interest rate swap agreements, the $200 million of senior notes is subject to interest rate volatility. A 25 basis point change in the weighted average annual interest rate relating to the credit facilities balances outstanding and
interest rate swap agreements as of September 30, 2006, which are subject to variable interest rates based on the LIBOR, and the accounts receivable financing facility, which is subject to the commercial paper rate, would yield a change of
approximately $2.8 million in annual interest expense. We have no plans to enter into further swap agreements. We do not expect our cash flows to be affected to any significant degree by a sudden change in market interest rates.

We operate our business within the United States and Puerto Rico and execute all transactions in U.S. dollars and, therefore, we have no foreign exchange
risk.

Item 4. Controls and Procedures

The Companys management, with the participation of its Chief
Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Quarterly Report on Form 10-Q, the
Companys Chief Executive Officer and Chief Financial



38



---

##### Table of Contents

Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended) are effective. There have been no changes in internal control over financial reporting for the period covered by this report that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.



39



---

##### Table of Contents

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Descriptions of certain legal proceedings to which the Company is a party are
contained in Note 3, Legal Settlements Charge, and Note 12, Commitments and Contingencies, to the unaudited interim condensed consolidated financial statements included in Part I of this Quarterly Report on Form 10-Q. Such
descriptions include the following recent developments:

On October 23, 2006, the Company entered into settlement agreements with the
Department of Justice with regard to the following three previously-disclosed matters handled by the U.S. Attorneys Office for the Eastern District of Pennsylvania. The three settlement agreements do not include any finding or admission of
wrongdoing on the part of the Company.

The first matter was a Consolidated Action pending in the Eastern District of Pennsylvania. The
Consolidated Action included a government complaint-in-intervention filed in September 2003 and two pending qui tam, or whistleblower, complaints filed in 2000. The complaints alleged violations of the False Claims Act and various other
statutes. Additional legal claims were added in an amended complaint-in-intervention filed in December 2003, including a count alleging a violation of the Public Contracts Anti-Kickback Act. This Consolidated Action has been settled for $137.5
million.

The second matter was a qui tamthat remains under seal in the Eastern District of Pennsylvania. The U.S. Attorneys
Office had informed the Company that the Complaint alleges violations of the federal False Claims Act, that the Company and other defendants inflated manufacturers best price to Medicare and Medicaid, and that the Company and other
defendants offered and paid kickbacks to third parties to induce the placement on formularies and promotion of certain drugs. This matter has been settled for $9.5 million.

The third matter was an investigation that began with a letter the Company received from the U.S. Attorneys Office for the Eastern District of
Pennsylvania in January 2005 requesting information and representations regarding the Companys Medicare Part B coordination of benefits recovery program. This matter was settled for $8.0 million.

Contemporaneously with the three above-referenced settlement agreements, the Company entered into a Corporate Integrity Agreement with the Department of
Health and Human Services and the Office of Personnel Management. This five-year agreement is designed to ensure that the Companys compliance program meets certain requirements.

Item 1A. Risk Factors

Reference is made to the risk factors set forth in Part I, Item 1A of our
Annual Report on Form 10-K for the fiscal year ended December 31, 2005. There have been no material changes with regard to the risk factors disclosed in such Form 10-K.

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

The following is a
summary of the Companys share repurchase activity for the three months ended September 30, 2006:



40



---

##### Table of Contents

|                                         |  |                  |  |                            |       |                                                                                             |            |                                                                                                  |   |          
|---------------------------------------- |  | ---------------- |  | -------------------------- | ----- | ------------------------------------------------------------------------------------------- | ---------- | ------------------------------------------------------------------------------------------------ | - | ---------
|Issuer Purchases of Equity
Securities(1)
|Fiscal Period                            |  | Shares purchased |  | Average price per share(2) |       | Total number of shares purchased as part of
a publicly announced program since inception(3) |            | Approximate dollar value of shares that may yet be purchased under the program(4)
(in thousands)
|Balances at July 1, 2006                 |  |                  |  |                            |       |                                                                                             | 21,597,876 |                                                                                                  | $ | 1,339,348
|                                         |  |                  |  |                            |       |                                                                                             |            |                                                                                                  |   |          
|Fiscal July 2006                         |  | 761,190          |  | $                          | 57.93 |                                                                                             | 761,190    |                                                                                                  | $ | 1,295,251
|Fiscal August 2006                       |  | 319,770          |  | $                          | 59.96 |                                                                                             | 319,770    |                                                                                                  | $ | 1,276,077
|Fiscal September 2006                    |  | 143,584          |  | $                          | 59.49 |                                                                                             | 143,584    |                                                                                                  | $ | 1,267,535
|                                         |  |                  |  |                            |       |                                                                                             |            |                                                                                                  |   |          
|Third quarter 2006 totals                |  | 1,224,544        |  | $                          | 58.64 |                                                                                             | 1,224,544  |                                                                                                  |   |          
|                                         |  |                  |  |                            |       |                                                                                             |            |                                                                                                  |   |          

---

|(1) | On November 3, 2006, the Company announced that
its Board of Directors had authorized the expansion of the Companys share repurchase plan by an incremental $1 billion, bringing the amount authorized under such repurchase plan to a cumulative total of $2.5 billion. The original share
repurchase plan, which was approved in August 2005, authorized share repurchases of $500 million. The plan was increased by an incremental $1 billion in December 2005. The expiration date of the plan has been extended through October 2008.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Dollar amounts include transaction costs. The total
average price paid per share in the table above represents the average price paid per share for repurchases initiated during the three months ended September 30, 2006. The average price paid per share for repurchases initiated since inception
is $54.00.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | The Company purchased all of the above-referenced
shares of its common stock through its publicly announced share repurchase program.
|--- | -------------------------------------------------------------------------------------------------------------------------------------

|(4) | The amounts in the table above reflect the remaining
authorized purchases based on the increase in the authorized repurchases approved on November 3, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

Item 3. Defaults Upon Senior Securities

Not applicable.

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

Not applicable.

Item 5. Other Information

Rule 10b5-1 Sales Plans

Medcos comprehensive compliance program includes a broad policy against insider trading. The procedures promulgated under that policy include
regularly scheduled blackout periods that apply to over 600 employees. Executive officers are prohibited from trading during the period that begins on the first day of the last month of the fiscal period and ends on the third trading day after the
release of earnings. In addition, executive officers are required to pre-clear all of their trades. Medcos executive officers are also subject to share ownership guidelines and retention requirements that further limit their ability to access
gain from stock option exercises.

To facilitate compliance with the ownership guidelines and retention requirements, the Board of
Directors authorized the use of prearranged trading plans under Rule 10b5-1 of the Securities and Exchange Act of 1934. Rule 10b5-1 permits insiders to adopt predetermined plans for selling specified amounts of stock or exercising stock options
under specified conditions and at specified times. Executive officers may only enter into a trading plan during an open trading window and they must not possess material nonpublic information regarding the company at the time they adopt the plan.
Using trading plans, insiders can diversify their investment portfolios while avoiding concerns about transactions occurring at a time when they might possess material nonpublic information. Under Medcos policy, sales instructions made
pursuant to a written trading plan may be executed during a blackout period. In addition, the use of trading plans provides Medco with a greater ability to monitor trading and compliance with its stock ownership guidelines.



41



---

##### Table of Contents

All trading plans adopted by Medco executives are reviewed and approved by the Office of the General
Counsel. For ease of administration, executives have been permitted to add new orders to existing plans rather than requiring the adoption of a new plan. Once modified, a plan cannot be changed for at least 90 days. Both new plans and modifications
are subject to a minimum two-week delay before the plan or modification can become effective. This mandatory waiting period is designed to safeguard the plans from manipulation or market timing.

The following table, which we are providing on a voluntary basis, sets forth the Rule 10b5-1 sales plans entered into by our executive officers and in
effect as of October 1, 2006(1):



|                                                                              |  |                                            |  |                                                                                                                                                                                                                                       |  |                                      |  |                                   
|----------------------------------------------------------------------------- |  | ------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ |  | ----------------------------------
|Name and Position                                                             |  | Number of Shares to be Sold
under the Plan |  | Timing of Sales Under the Plan                                                                                                                                                                                                        |  | Number of Shares Sold Under
the Plan |  | Projected Beneficial Ownership
(2)
|John Driscoll President, Insured and Emerging Markets                         |  | 40,900                                     |  | Option exercises in tranches of 20,400 and 20,500 shares shall be triggered if stock reaches specified prices.                                                                                                                        |  |                                      |  | 32,696                            
|                                                                              |  |                                            |  |                                                                                                                                                                                                                                      
|Robert Epstein Senior Vice President, Medical Affairs & Chief Medical Officer |  | 43,300                                     |  | Option exercise triggered if stock reaches a specified price and 20,800 previously acquired shares will be sold if stock reaches a specified price.                                                                                   |  |                                      |  | 51,825                            
|                                                                              |  |                                            |  |                                                                                                                                                                                                                                      
|Brian Griffin Group President, Health Plans                                   |  | 269,181                                    |  | Option exercises in tranches ranging from 10,010 to 62,610 shares shall be triggered if stock reaches specified prices.                                                                                                               |  |                                      |  | 81,829                            
|                                                                              |  |                                            |  |                                                                                                                                                                                                                                      
|Kenneth O. Klepper, President & Chief Operating Officer                       |  | 114,700                                    |  | Option exercises in tranches ranging from 9,300 to 43,500 shares shall be triggered if stock reaches specified prices; previously acquired shares shall be sold in two installments of 4,300
shares if specified prices are obtained. |  |                                      |  | 100,556                           
|                                                                              |  |                                            |  |                                                                                                                                                                                                                                      
|Arthur H. Nardin Senior Vice President, Pharmaceutical Contracting            |  | 13,200                                     |  | Sale of 6,800 previously acquired shares if stock reaches a specified price and exercise of option and sale of 6,400 shares acquired on exercise if stock reaches a specified
price.                                                  |  |                                      |  | 23,703                            
|                                                                              |  |                                            |  |                                                                                                                                                                                                                                      
|Karin Princivalle, Senior Vice President, Human Resources                     |  | 11,700                                     |  | Exercise of options and sale of 6,500 shares acquired on exercise and 5,200 previously acquired shares if stock reaches a specified price.                                                                                            |  |                                      |  | 19,674                            
|                                                                              |  |                                            |  |                                                                                                                                                                                                                                      
|JoAnn A. Reed, Senior Vice President, Finance & Chief Financial Officer       |  | 133,916                                    |  | Option exercises in tranches ranging from 20,110 to 63,013 shares shall be triggered if stock reaches specified prices.                                                                                                               |  |                                      |  | 344,915                           
|                                                                              |  |                                            |  |                                                                                                                                                                                                                                      
|Jack A. Smith Senior Vice President, Chief Marketing Officer                  |  | 22,700                                     |  | Option exercises in tranches of 7,500 and 15,200 shares shall be triggered if stock reaches specified prices.                                                                                                                         |  |                                      |  | 74,238                            
|                                                                              |  |                                            |  |                                                                                                                                                                                                                                      
|Glenn Taylor Group President, Key Accounts                                    |  | 39,900                                     |  | Sale of previously acquired shares if stock reaches a specified price.                                                                                                                                                                |  |                                      |  | 75,607                            

---

|(1) | This table does not include any trading plans entered into by any executive officer that has expired by its terms or has been fully executed. No plans entered into
by executive officers have been voluntarily terminated.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | This column reflects an estimate of the number of shares each identified executive officer will beneficially own following the sale of all shares under the Rule
10b5-1 sales plans currently in effect. This information reflects the beneficial ownership of our common stock as of October 1, 2006, and includes shares of our common stock subject to options or restricted stock units that were then vested or
exercisable and unvested options and restricted stock units that are included in a current trading plan for sales periods that begin after the applicable vesting date. Options cannot be exercised and restricted stock units cannot be converted prior
to vesting. The estimates do not reflect any changes to beneficial ownership that may have occurred since October 1, 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



42



---

##### Table of Contents

Item 6. Exhibits



|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  |                                                                                                                 
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------
|Number |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  | Method of Filing                                                                                                
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|10.1   |  | Settlement Agreement and Mutual Releases, dated as of October 23, 2006, entered into by and among the United States of America, acting through the United States Department of Justice, on behalf
of the Office of the Inspector General of the Department of Health and Human Services, the Office of Personnel Management, and the Department of Defense TRICARE Management Activity; Medco Health Solutions, Inc.; Diane M. Collins; and relators George
Bradford Hunt, Walter William Gauge and Joseph Percentile. |  | Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed October 27, 2006.
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|10.2   |  | Settlement Agreement and Mutual Releases, dated as of October 23, 2006, entered into by and among the United States of America, acting through the United States Department of Justice, on behalf
of the Office of the Inspector General of the Department of Health and Human Services and the Office of Personnel Management; Medco Health Solutions, Inc.; and relator Karl S. Schumann.                                                                                                                            |  | Incorporated by reference to Exhibit 10.2 to the Registrants Current Report on Form 8-K filed October 27, 2006.
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|10.3   |  | Settlement Agreement and Mutual Releases, dated as of October 23, 2006, entered into by and among the United States of America, acting through the United States Department of Justice, on behalf
of the Office of the Inspector General of the Department of Health and Human Services and Medco Health Solutions, Inc.                                                                                                                                                                                               |  | Incorporated by reference to Exhibit 10.3 to the Registrants Current Report on Form 8-K filed October 27, 2006.
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|10.4   |  | Corporate Integrity Agreement, dated as of October 23, 2006, between the Office of the Inspector General of the Department of Health and Human Services and the Office of the Inspector General of
the Office of Personnel Management and Medco Health Solutions, Inc.                                                                                                                                                                                                                                                 |  | Incorporated by reference to Exhibit 10.4 to the Registrants Current Report on Form 8-K filed October 27, 2006.
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|31.1   |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                                     |  | Filed with this document.                                                                                       
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|31.2   |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                                                                     |  | Filed with this document.                                                                                       
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|32.1   |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                      |  | Filed with this document.                                                                                       
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|32.2   |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                                                                                                                      |  | Filed with this document.                                                                                       



43



---

##### Table of Contents

Signatures

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



|                       |  |                              |  |                                   
|---------------------- |  | ---------------------------- |  | ----------------------------------
|                       |  | MEDCO HEALTH SOLUTIONS, INC.
|                       |  |                             
|Date: November 3, 2006 |  | By:                          |  | /s/ David B. Snow, Jr.            
|                       |  | Name:                        |  | David B. Snow, Jr.                
|                       |  | Title:                       |  | Chairman, and                     
|                       |  |                              |  | Chief Executive Officer           
|                       |  |                             
|Date: November 3, 2006 |  | By:                          |  | /s/ JoAnn A. Reed                 
|                       |  | Name:                        |  | JoAnn A. Reed                     
|                       |  | Title:                       |  | Senior Vice President, Finance and
|                       |  |                              |  | Chief Financial Officer           



44



---

##### Table of Contents

Index to Exhibits



|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|10.1   |  | Settlement Agreement and Mutual Releases, dated as of October 23, 2006, entered into by and among the United States of America, acting through the United States Department of Justice, on
behalf of the Office of the Inspector General of the Department of Health and Human Services, the Office of Personnel Management, and the Department of Defense TRICARE Management Activity; Medco Health Solutions, Inc.; Diane M. Collins; and relators
George Bradford Hunt, Walter William Gauger and Joseph Piacentile. Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on Form 8-K filed October 27, 2006.
|       | 
|10.2   |  | Settlement Agreement and Mutual Releases, dated as of October 23, 2006, entered into by and among the United States of America, acting through the United States Department of Justice, on
behalf of the Office of the Inspector General of the Department of Health and Human Services and the Office of Personnel Management; Medco Health Solutions, Inc.; and relator Karl S. Schumann. Incorporated by reference to Exhibit 10.2 to the
Registrants Current Report on Form 8-K filed October 27, 2006.                                                                                                                            
|       | 
|10.3   |  | Settlement Agreement and Mutual Releases, dated as of October 23, 2006, entered into by and among the United States of America, acting through the United States Department of Justice, on
behalf of the Office of the Inspector General of the Department of Health and Human Services and Medco Health Solutions, Inc. Incorporated by reference to Exhibit 10.3 to the Registrants Current Report on Form 8-K filed October 27,
2006.                                                                                                                                                                                               
|       | 
|10.4   |  | Corporate Integrity Agreement, dated as of October 23, 2006, between the Office of the Inspector General of the Department of Health and Human Services and the Office of the Inspector
General of the Office of Personnel Management and Medco Health Solutions, Inc. Incorporated by reference to Exhibit 10.4 to the Registrants Current Report on Form 8-K filed October 27, 2006.                                                                                                                                                                                                                                                 
|       | 
|31.1   |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|       | 
|31.2   |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|       | 
|32.1   |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|       | 
|32.2   |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.