• results in regulatory matters, the adoption of new legislation or regulations (including healthcare and increased costs associated with compliance with new laws and regulations), more aggressive enforcement of existing legislation or regulations, or a change in the interpretation of existing legislation or regulations

• our leverage and debt service obligations, including the effect of certain covenants in our borrowing agreements, access to capital and increases in interest rates

• continued pressure on margins resulting from client demands for lower prices or different pricing approaches, enhanced service offerings and/or higher service levels

• costs and uncertainties of adverse results in litigation, including a number of pending class action cases that challenge certain of our business practices

• the possible loss, or adverse modification of the terms, of contracts with pharmacies in our retail pharmacy network

• the possible termination or nonrenewal of, or unfavorable modification to, contracts with key clients or providers, some of which could have a material impact on our financial results

• our ability to maintain growth rates, or to control operating or capital costs, including the impact of declines in prescription drug utilization resulting from the current economic environment

• competition in the Pharmacy Benefit Management ("PBM") industry, and our ability to consummate contract negotiations with prospective clients, as well as competition from new competitors offering services that may in whole or in part replace services that we now provide to our customers

• changes in industry pricing benchmarks such as average wholesale price ("AWP") and average manufacturer price ("AMP"), which could have the effect of reducing prices and margins

• increased compliance risk relating to our contracts with the Department of Defense ("DoD") TRICARE Management Activity and various state governments and agencies

• uncertainties and risks regarding the Medicare Part D prescription drug benefit, including the financial impact to us to the extent we participate in the program on a risk-bearing basis, uncertainties of client or member losses to other providers under Medicare Part D, implementation of regulations that adversely affect our profitability or cash flow, and increased regulatory risk

• the possible loss, or adverse modification of the terms, of relationships with pharmaceutical manufacturers, or changes in pricing, discount or other practices of pharmaceutical manufacturers or interruption of the supply of any pharmaceutical products

• in connection with our specialty pharmacy business, the possible loss, or adverse modification of the terms of our contracts with a limited number of biopharmaceutical companies from whom we acquire specialty pharmaceuticals

• the use and protection of the intellectual property, data, and tangible assets that we use in our business, the misuse of our data by others, or the infringement or alleged infringement by us of intellectual property claimed by others

• general developments in the healthcare industry, including the impact of increases in healthcare costs, government programs to control healthcare costs, changes in drug utilization and cost patterns and introductions of new drugs

• increase in credit risk relative to our clients due to adverse economic trends or other factors

• other risks described from time to time in our filings with the SEC

See the more comprehensive description of risk factors under the captions "Forward Looking Statements and Associated Risks" contained in Item 1 - "Business" and Item 1A - "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the SEC on February 25, 2009, as revised and filed with the SEC on Form 8-K on June 2, 2009, and Item 1A - "Risk Factors" of this Quarterly Report on Form 10-Q.
OVERVIEW
As one of the largest full-service pharmacy benefit management companies in North America, we provide healthcare management and administration services on behalf of our clients, which include health maintenance organizations, health insurers, third-party administrators, employers, union-sponsored benefit plans, workers' compensation plans, and government health programs. Our integrated PBM services include network claims processing, home delivery services, patient care and direct specialty home delivery to patients, benefit design consultation, drug utilization review, formulary management, drug data analysis services, distribution of injectable drugs to patient homes and physicians' offices, bio-pharma services, and fulfillment of prescriptions to low-income patients through manufacturer-sponsored patient assistance programs and company-sponsored generic patient assistance programs.
Through our Emerging Markets ("EM") segment, we provide services including:
distribution of pharmaceuticals and medical supplies to providers and clinics, distribution of sample units to physicians and verification of practitioner licensure, fertility services to providers and patients, and healthcare account administration and implementation of consumer-directed healthcare solutions.
Revenue generated by our segments can be classified as either tangible product revenue or service revenue. We earn tangible product revenue from the sale of prescription drugs by retail pharmacies in our retail pharmacy networks and from dispensing prescription drugs from our home delivery and specialty pharmacies. Service revenue includes administrative fees associated with the administration of retail pharmacy networks contracted by certain clients, market research programs, medication counseling services, certain specialty distribution services, and sample fulfillment and accountability services. Tangible product revenue generated by our PBM and EM segments represented 98.6% of revenues for both the three months and nine months ended September 30, 2009 and for the same period of 2008.
During 2008, we established the Center for Cost-Effective Consumerism (the "Center") which meets the challenge of enabling better health and value by applying an advanced study of behavior to how the pharmacy benefit is used, and developing innovative tools that effect positive change. The Center combines our industry-leading research capabilities with insights from a multidisciplinary advisory board of national experts in the science of human behavior and decision making. Using work done by the Center, we equip plan sponsors to achieve lowest cost drug mix (e.g., generics and lower-cost brands), maximum therapy adherence in key classes, greatest use of the most cost-effective delivery channel, uncompromising safety standards and increasing member engagement and satisfaction.
EXECUTIVE SUMMARY AND TREND FACTORS AFFECTING THE BUSINESS Our results in the first nine months of 2009 reflect the successful execution of our business model, which emphasizes the alignment of our financial interests with those of our clients through greater use of generics and low-cost brands, home delivery and specialty pharmacy. In the first nine months of 2009 we benefited from better management of ingredient costs through renegotiation of supplier contracts, increased competition among generic manufacturers, higher generic fill rate (67.9% compared to 65.7% in the same period of 2008) and other actions which helped to reduce ingredient costs. In addition, through the research performed by the Center, as described above, we are providing our clients with additional tools designed to generate higher generic fill rates and further increase the use of our home delivery and specialty pharmacy services.

We believe our pending acquisition of WellPoint's NextRx PBM Business and our related proposed alliance with WellPoint is a solid strategic fit for advancing healthcare. While we expect to incur expenses of $50-60 million in the fourth quarter of 2009 prior to the closing of the acquisition, we believe our aligned business model creates significant opportunities for accelerated growth. The two organizations share a commitment to improving health outcomes and driving out waste. As healthcare costs continue to be a concern, we remain focused on initiatives that keep health benefits affordable while enhancing the healthcare value we bring to clients and patients.
While we believe we are well positioned from a business and financial perspective, we are subject to the current adverse economic environment. These conditions could affect our business in a number of direct and indirect ways.
We believe the positive trends in gross profit we see in the first nine months of 2009, including lower drug purchasing costs and increased generic usage, should continue to offset the negative impact of various economic and marketplace forces affecting pricing and plan structure, among other factors, and thus continue to generate improvements in our results of operations in the future.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions which affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates and assumptions are based upon a combination of historical information and various other assumptions believed to be reasonable under the particular circumstances. Actual results may differ from our estimates. We changed our reportable segments to PBM and EM during the first quarter of 2009 (see Note 10). For a full description of our accounting policies, please refer to the notes to the consolidated financial statements filed with the SEC on Current Report Form 8-K on June 2, 2009.

RESULTS OF OPERATIONS
PBM OPERATING INCOME

                                          Three Months Ended            Nine Months Ended
                                             September 30,                September 30,
 (in millions)                            2009         2008(1)         2009         2008(1)

 Product revenues
 Network revenues(2)                    $ 3,288.8     $ 3,181.3     $  9,772.3     $  9,759.0
 Home delivery and specialty revenues     1,892.7       1,831.5        5,541.3        5,398.0
 Other revenues                              22.4          14.8           58.5           38.9
 Service revenues                            67.1          63.9          200.8          191.9

 Total PBM revenues                       5,271.0       5,091.5       15,572.9       15,387.8
 Cost of PBM revenues(2)                  4,672.8       4,583.4       13,875.2       13,945.7

 PBM gross profit                           598.2         508.1        1,697.7        1,442.1
 PBM SG&A expenses                          243.4         178.8          614.2          506.1

 PBM operating income                   $   354.8     $   329.3     $  1,083.5     $    936.0

                                       Three Months Ended           Nine Months Ended
                                         September 30,                September 30,
     (in millions)                     2009         2008(1)         2009        2008(1)

     Network                              95.2          91.5          284.1        285.8
     Home delivery and specialty          10.3          10.6           30.4         31.6
     Other                                 0.8           0.7            2.1          2.1

     Total PBM Claims                    106.3         102.8          316.6        319.5

     Total adjusted PBM Claims(3)        126.3         123.4          375.8        380.6

(1) Includes the July 22, 2008 acquisition of MSC.

(2) Includes retail pharmacy co-payments of $708.4 million and $733.7 million for the three months ended September 30, 2009 and 2008, respectively, and $2,252.2 million and $2,445.5 million for the nine months ended September 30, 2009 and 2008, respectively.

(3) Total adjusted claims reflect home delivery claims multiplied by 3, as home delivery claims are typically 90 day claims.

Product Revenues for the three months ended September 30, 2009: Network pharmacy revenues increased by $107.5 million, or 3.4%, in the three months ended September 30, 2009 over the same period of 2008. This is primarily due to higher claims volume partially offset by decreases in price. The increase in our claims volume was primarily due to new clients. Changes in price are affected by inflation and the mix of prescription drugs processed at our network pharmacies. As our generic fill rate increases, price decreases, which is offset by inflation. Our generic fill rate increased to 69.6% of total network claims in the third quarter of 2009 as compared to 67.3% in the same period of 2008.
Home delivery and specialty revenues increased $61.2 million, or 3.3%, in the three months ended September 30, 2009 from the same period in 2008. The increase is primarily due to increases in price of our specialty products due to inflation, offset by lower home delivery claims volume from the loss of low margin clients and the impact of the higher generic fill rate. Our generic fill rate increased to 58.3% of home delivery claims in the three months ended September 30, 2009 as compared to 57.2% in the same period of 2008.
Product Revenues for the nine months ended September 30, 2009: Network pharmacy revenues increased by $13.3 million, or 0.1%, in the nine months ended September 30, 2009 over the same period of 2008. This is primarily due to increases in price which were partially offset by lower claims volume. Changes in price are affected by inflation and the mix of prescriptions processed at network pharmacies. As our generic fill rate increases, price decreases, which is offset by inflation. Our generic fill rate increased to 69.2% of total network claims in the first nine months of 2009 as compared to 66.9% in the same period of 2008. The decrease in our claims volume was primarily due to the loss of low margin clients partially offset by new clients.
Home delivery and specialty revenues increased $143.3 million, or 2.7%, in the nine months ended September 30, 2009 from the same period in 2008. The increase is primarily due to increases in price of our specialty products due to inflation, offset by lower home delivery claims volume from the loss of low margin clients and the impact of the higher generic fill rate. Our generic fill rate increased to 57.5% of home delivery claims in the nine months ended September 30, 2009 as compared to 56.0% in the same period of 2008.
Cost of PBM revenues increased $89.4 million, or 2.0%, in the three months ended September 30, 2009 from the same period of 2008 due primarily to a 2.4% increase in adjusted claims volume and inflation, partially offset by better management of ingredient costs and improvements in aggregate generic fill rate. Cost of PBM revenues decreased $70.5 million, or 0.5%, in the nine months ended September 30, 2009 from the same period of 2008 primarily due to better management of ingredient costs, a 1.3% decrease in adjusted claims volume and improvements in aggregate generic fill rate, partially offset by inflation.
Our PBM gross profit increased $90.1 million, or 17.7%, and $255.6 million, or 17.7%, for the three months and nine months ended September 30, 2009 as compared to the same periods of 2008. Better management of ingredient costs and client cost savings from the increase in the aggregate generic fill rate were partially offset by margin pressures arising from ingredient cost inflation and the current competitive environment.

Selling, general and administrative expense ("SG&A") for our PBM segment for the three months ended September 30, 2009 increased by $64.6 million, or 36.1%, as compared to the same period of 2008 primarily as a result of the following factors:
• Expenses of $35.0 million relating to an accrual for the settlement of a legal matter in October 2009 (see Note 9 - Contingencies for further discussion),

• Investments of $27.1 million to improve technological infrastructure which enhances product and services capabilities; along with other strategic initiatives,

• Costs of $9.6 million related to the NextRx transaction,

• Increases in employee compensation of $4.3 million due to growth and incentives tied to corporate financial results, in addition to the effect of inflation.

• These increases were partially offset by a charge related to internally developed software in the third quarter of 2008.

Selling, general and administrative expense ("SG&A") for our PBM segment for the nine months ended September 30, 2009 increased by $108.1 million, or 21.4%, as compared to the same period of 2008 primarily as a result of the following factors:
• Investments of $61.5 million to improve technological infrastructure which enhances product and services capabilities; along with other strategic initiatives,

• Expenses of $35.0 million relating to an accrual for the settlement of a legal matter in October 2009 (see Note 9 - Contingencies for further discussion),

• Costs of $21.3 million related to the NextRx transaction,

• Increases in employee compensation of $19.1 million due to growth and incentives tied to corporate financial results, in addition to the effect of inflation,

• These increases were partially offset by a $15.0 million benefit related to an insurance recovery for previously incurred litigation costs, and

• A charge related to internally developed software in the third quarter of 2008.

PBM operating income increased $25.5 million, or 7.7% and $147.5 million, or 15.8%, for the three months and nine months ended September 30, 2009 as compared to the same periods of 2008, based on the various factors described above.

EM OPERATING INCOME

                                   Three Months Ended          Nine Months Ended
                                      September 30,              September 30,
           (in millions)            2009          2008         2009         2008

           Product revenues      $    339.5      $ 348.4     $  943.9     $ 1,051.3
           Service revenues             8.9         10.6         28.7          33.0

           Total EM revenues          348.4        359.0        972.6       1,084.3
           Cost of EM revenues        334.0        346.7        929.6       1,037.3

           EM gross profit             14.4         12.3         43.0          47.0
           EM SG&A expenses            10.7         10.9         32.5          41.0

           EM operating income   $      3.7      $   1.4     $   10.5     $     6.0

EM Continuing Operations. EM revenues decreased $10.6 million, or 3.0%, and $111.7 million, or 10.3%, respectively, in the three months and nine months ended September 30, 2009 over the same periods of 2008. This is primarily due to decreased revenue in our Specialty Distribution line of business due to a reduction in sales volume of a few specific drugs.

EM cost of revenues decreased $12.7 million, or 3.7%, and $107.7 million, or 10.4%, respectively, in the three months and nine months ended September 30, 2009 over the same periods of 2008 primarily due to the reduction in sales volume discussed above and a charge to inventory in the third quarter of 2008. This resulted in an increase in gross profit of $2.1 million, or 17.1%, in the three months ended September 30, 2009 over the same period in 2008. Gross profit decreased $4.0 million, or 8.5%, in the nine months ended September 30, 2009, over the same period of 2008 primarily due to a reduction in sales volume as discussed above.
SG&A for our EM segment decreased by $8.5 million, or 20.7%, for the nine months ended September 30, 2009 primarily due to non-recurring bad debt expense, severance charges, and site closure costs incurred by the Specialty Distribution line of business in 2008.
EM income from continuing operations increased by $2.3 million, or 164.3%, and $4.5 million, or 75.0%, for the three months and nine months ended September 30, 2009 from the same periods of 2008, respectively, based on the factors described above.
OTHER (EXPENSE) INCOME
Net interest expense increased $32.4 million in the three months ended September 30, 2009 as compared to the same period in 2008 primarily due to the additional interest expense we incurred for the debt issuance (see "Liquidity and Capital Resources"), partially offset by a lower weighted average interest rate on debt outstanding under our credit facility (see Note 6 - Financing). Net interest expense increased $93.3 million in the nine months ended September 30, 2009 as compared to the same period in 2008 primarily due to fees of $56.3 million we incurred related to the termination of the bridge loan for the financing of the Next Rx acquisition, as well as additional interest expense we incurred for the debt issuance.
PROVISION FOR INCOME TAXES
Our effective tax rate from continuing operations was 37.0% and 36.8% for the three months and nine months ended September 30, 2009, respectively, as compared to 35.6% and 35.9% for the same periods of 2008. The three months and nine months ended September 30, 2009 reflect an increase in certain state income tax rates due to enacted law changes. The three months and nine months ended September 30, 2008 include discrete tax adjustments resulting in net tax benefit of $2.7 million and $5.2 million, respectively, attributable to lapses in the applicable statutes of limitations, favorable audit resolutions, and changes in our unrecognized tax benefits.
NET INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX Net income (loss) from discontinued operations, net of tax, increased $1.8 million and $4.7 million for the three months and nine months ended September 30, 2009, respectively, compared to the same periods of 2008 (see Note 4).
NET INCOME AND EARNINGS PER SHARE
Net income for the three months and nine months ended September 30, 2009 decreased $4.3 million, or 2.1%, and increased $35.0 million, or 6.1%, respectively, over the same period of 2008 due to factors discussed above.
Additionally, basic and diluted earnings per share decreased 12.2% and 12.3%, respectively, for the three months ended September 30, 2009 over the same period of 2008 due to an increase in the number of shares outstanding as a result of the public offering in June 2009 (see Note 7) and operating results as described above. For the nine months ended September 30, 2009, basic and diluted earnings per share increased 2.2% and 2.7%, respectively, over the same period of 2008. This increase is primarily due to improved operating results, partially offset by an increase in shares outstanding as a result of the public offering in June 2009 (see Note 7).

LIQUIDITY AND CAPITAL RESOURCES
OPERATING CASH FLOW, CAPITAL EXPENDITURES AND FINANCING
For the nine months ended September 30, 2009, net cash provided by continuing operations increased $186.3 million to $913.4 million. The increase was primarily impacted by net cash inflows of $56.3 million related to the write-off of deferred financing fees, net inflows of $47.9 million related to an increase in accrued interest expense primarily for our Senior Notes, a $35.0 million dollar increase in accrued expenses in the third quarter of 2009 related to the settlement of a legal matter in October 2009, the $30.3 million increase in net income from continuing operations as compared to the same period of 2008 due to the factors described above, and net inflows of $12.3 million related to a decrease in inventory due to large purchases of inventory at discounted prices at the end of 2008. These net inflows were partially offset by other net cash outflows, none of which were material. Net cash provided by discontinued operations increased $11.2 million to $13.1 million for the nine months ended September 30, 2009, primarily due to the utilization of a tax benefit in the third quarter of 2009.
Our capital expenditures for the nine months ended September 30, 2009 increased $30.6 million compared to the same period of 2008 primarily due to planned expenditures related to technology infrastructure. We intend to continue to invest in infrastructure and technology that we believe will provide efficiencies in operations and facilitate growth and enhance the service we provide to our clients. Anticipated capital expenditures will be funded primarily from operating cash flow or, to the extent necessary, with borrowings under our revolving credit facility, discussed below.
Net cash provided by financing activities was $3,765.9 million for the nine months ended September 30, 2009 compared to net cash used of $606.1 million in the same period of 2008. On June 9, 2009, we issued Senior Notes resulting in net proceeds of $2,478.3 million which includes original issue discount of $8.4 million and financing costs of $13.3 million. In addition, on June 10, 2009, we completed a public offering of 26.45 million shares of common stock which resulted in net proceeds of $1,569.1 million after giving effect to the underwriting discount and issuance costs of $44.4 million. Proceeds of $1,199.5 million are invested in U.S. treasury bills with maturities over three months and are classified as short-term investment on the unaudited consolidated balance sheet. The remaining proceeds of $2,847.9 million are invested in AAA-rated money market mutual funds with weighted average maturities of less than 90 days. Most of these mutual funds invest solely in U.S. Government securities. We intend to use the net proceeds to finance a portion of the $4.675 billion purchase price for the acquisition of WellPoint's NextRx pharmacy benefit business. Offsetting these proceeds were financing fees of $56.3 million for the committed credit facility (see Note 6).
INVESTMENTS
As of September 30, 2009, short-term investments includes our investment in the Reserve Primary Fund (the "Primary Fund"), which is a money market fund. The estimated fair value of our investment in the Primary Fund was $2.9 million as . . .