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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002.
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: 0-20199
EXPRESS SCRIPTS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 43-1420563
(State of Incorporation) (I.R.S. employer identification no.)
13900 RIVERPORT DR.,
MARYLAND HEIGHTS, MISSOURI 63043
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (314) 770-1666
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
--- ---
Common stock outstanding as of October 31, 2002: 77,904,824 Shares
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EXPRESS SCRIPTS, INC.
INDEX
PAGE NUMBER
Part I Financial Information 3
Item 1. Financial Statements (unaudited)
a) Unaudited Consolidated Balance Sheet 3
b) Unaudited Consolidated Statement of Operations 4
c) Unaudited Consolidated Statement of Changes
in Stockholders' Equity 5
d) Unaudited Consolidated Statement of Cash Flows 6
e) Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosures About
Market Risks 33
Item 4. Controls and Procedure 33
Part II Other Information
Item 1. Legal Proceedings 34
Item 2. Changes in Securities and Use of Proceeds - (Not Applicable)
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 - (Not Applicable)
Item 6. Exhibits and Reports on Form 8-K 35
Signatures 36
Officer Certifications 37
Index to Exhibits 39
2
PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
EXPRESS SCRIPTS, INC.
UNAUDITED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, DECEMBER 31,
(IN THOUSANDS, EXCEPT SHARE DATA) 2002 2001
---------------- ----------------
Assets
Current assets:
Cash and cash equivalents $ 161,598 $ 177,715
Receivables, net 994,787 883,827
Inventories 123,671 122,375
Deferred taxes 26,102 16,368
Prepaid expenses and other current assets 11,358 12,918
---------------- ----------------
Total current assets 1,317,516 1,213,203
Property and equipment, net 156,647 165,263
Goodwill, net 1,381,833 942,280
Other intangible assets, net 251,926 165,349
Other assets 16,144 14,150
---------------- ----------------
Total assets $ 3,124,066 $ 2,500,245
================ ================
Liabilities and Stockholders' Equity
Current liabilities:
Claims and rebates payable $ 1,011,136 $ 910,360
Accounts payable 245,290 181,784
Accrued expenses 186,237 153,473
---------------- ----------------
Total current liabilities 1,442,663 1,245,617
Long-term debt 620,884 346,119
Other liabilities 89,741 76,512
---------------- ----------------
Total liabilities 2,153,288 1,668,248
---------------- ----------------
Stockholders' equity:
Preferred stock, $0.01 par value per share, 5,000,000 shares authorized,
and no shares issued and outstanding - -
Common Stock, $0.01 par value per share, 181,000,000 shares
authorized, and 79,817,000 and 79,230,000 shares issued and 798 792
outstanding, respectively
Additional paid-in capital 507,402 492,229
Unearned compensation under employee compensation plans (10,685) (15,452)
Accumulated other comprehensive income (5,122) (4,593)
Retained earnings 558,225 412,114
---------------- ----------------
1,050,618 885,090
Common Stock in treasury at cost, 1,619,000 and 1,199,000
shares, respectively (79,840) (53,093)
---------------- ----------------
Total stockholders' equity 970,778 831,997
---------------- ----------------
Total liabilities and stockholders' equity $ 3,124,066 $ 2,500,245
================ ================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
EXPRESS SCRIPTS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
---------------- ---------------- ---------------- ----------------
Revenues $ 3,426,198 $ 2,381,252 $ 9,577,905 $ 6,719,135
Cost of revenues 3,214,736 2,236,799 8,979,682 6,279,499
---------------- ---------------- ---------------- ----------------
Gross profit 211,462 144,453 598,223 439,636
Selling, general and administrative 112,162 84,222 329,860 266,610
---------------- ----------------
---------------- ----------------
Operating income 99,300 60,231 268,363 173,026
---------------- ---------------- ---------------- ----------------
Other (expense) income:
Undistributed loss from joint venture (1,224) (435) (3,294) (1,093)
Interest income 1,391 1,837 3,770 5,521
Interest expense (11,753) (8,417) (31,535) (26,190)
---------------- ---------------- ---------------- ----------------
(11,586) (7,015) (31,059) (21,762)
---------------- ---------------- ---------------- ----------------
Income before income taxes 87,714 53,216 237,304 151,264
Provision for income taxes 33,777 20,653 90,698 60,378
---------------- ---------------- ---------------- ----------------
Income before extraordinary item 53,937 32,563 146,606 90,886
Extraordinary item, net of tax (495) (372) (495) (372)
---------------- ---------------- ---------------- ----------------
Net income $ 53,442 $ 32,191 $ 146,111 $ 90,514
================ ================ ================ ================
Basic earnings per share:
Before extraordinary item $ 0.70 $ 0.41 $ 1.88 $ 1.16
Extraordinary item (0.01) - (0.01) -
---------------- ---------------- ---------------- ----------------
Net income $ 0.69 $ 0.41 $ 1.87 $ 1.16
================ ================ ================ ================
Weighted average number of common shares
Outstanding during the period - Basic EPS 77,829 78,382 77,962 77,978
================ ================ ================ ================
Diluted earnings per share:
Before extraordinary item $ 0.68 $ 0.40 $ 1.84 $ 1.13
Extraordinary item (0.01) - (0.01) -
---------------- ---------------- ---------------- ----------------
Net income $ 0.67 $ 0.40 $ 1.83 $ 1.13
================ ================ ================ ================
Weighted average number of common shares
Outstanding during the period - Diluted EPS 79,449 80,612 79,786 80,156
================ ================ ================ ================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
EXPRESS SCRIPTS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Number
of Amount
Shares
------- ---------------------------------------------------------------------------------------
Unearned
Compensation Accumulated
Additional Under Employee Other
Common Common Paid-in Compensation Comprehensive Retained Treasury
(IN THOUSANDS) Stock Stock Capital Plans Income Earnings Stock Total
- ------------------------------------------- --------- ----------- --------------- -------------- ----------- ---------- -----------
Balance at December 31, 2001 79,230 $ 792 $492,229 $ (15,452) $ (4,593) $ 412,114 $ (53,093) $ 831,997
-------- --------- ----------- --------------- -------------- ----------- ---------- -----------
Comprehensive income:
Net income 146,111 146,111
Other comprehensive income:
Foreign currency
translation adjustment (87) (87)
Realized and unrealized gains
on derivative financial
instruments, net of taxes (442) (442)
-------- --------- ----------- --------------- -------------- ----------- ---------- ------------
Comprehensive income (529) 146,111 145,582
Common stock issued under
employee plans 35 3,636 (596) 3,040
Amortization of unearned
compensation under
employee plans 5,363 5,363
Treasury stock acquired (66,840) (66,840)
Exercise of stock options (21,433) 40,093 18,660
Tax benefit relating to
employee stock options 11,310 11,310
Repurchase and cancellation
of shares - (Note 6) (4,734) (4,734)
Stock issued for NPA acquisition 552 6 26,394 26,400
-------- --------- ----------- --------------- -------------- ----------- ---------- -----------
Balance at September 30, 2002 79,817 $ 798 $507,402 $ (10,685) $ (5,122) $ 558,225 $ (79,840) $ 970,778
======== ========= =========== =============== ============== =========== ========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
EXPRESS SCRIPTS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
(IN THOUSANDS) 2002 2001
---------------- ----------------
Cash flows from operating activities:
Net income $ 146,111 $ 90,514
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 66,473 55,838
Non-cash adjustments to net income 54,625 54,182
Net changes in operating assets and liabilities 19,755 (35,482)
---------------- ----------------
Net cash provided by operating activities 286,964 168,052
---------------- ----------------
Cash flows from investing activities:
Purchases of property and equipment (32,472) (36,830)
Proceeds from the sale of property and equipment - 844
Acquisitions, net of cash acquired, and investment in joint venture (497,229) (19,582)
Other 655 (7,234)
---------------- ----------------
Net cash used in investing activities (529,046) (62,802)
---------------- ----------------
Cash flows from financing activities:
Proceeds from long-term debt 425,000 -
Repayment of long-term debt (150,000) (50,000)
Treasury stock acquired (66,840) (27,055)
Proceeds from employee stock plans 21,700 23,663
Other (3,885) -
---------------- ----------------
Net cash provided by (used in) financing activities 225,975 (53,392)
---------------- ----------------
Effect of foreign currency translation adjustment (10) (242)
---------------- ----------------
Net (decrease) increase in cash and cash equivalents (16,117) 51,616
Cash and cash equivalents at beginning of period 177,715 53,204
---------------- ----------------
Cash and cash equivalents at end of period $ 161,598 $ 104,820
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SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
EXPRESS SCRIPTS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Certain of our significant accounting policies are described below.
Other financial statement note disclosures, normally included in financial
statements prepared in conformity with generally accepted accounting principles,
have been omitted from this Form 10-Q pursuant to the Rules and Regulations of
the Securities and Exchange Commission. However, we believe that the disclosures
contained in this Form 10-Q are adequate to make the information presented not
misleading when read in conjunction with the notes to the consolidated financial
statements included in our Annual Report on Form 10-K for the year ended
December 31, 2001 filed with the Securities and Exchange Commission on March 8,
2002.
We believe that the accompanying unaudited consolidated financial
statements reflect all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the Unaudited Consolidated Balance
Sheet at September 30, 2002, the Unaudited Consolidated Statement of Operations
for the three months and nine months ended September 30, 2002 and 2001, the
Unaudited Consolidated Statement of Changes in Stockholders' Equity for the nine
months ended September 30, 2002, and the Unaudited Consolidated Statement of
Cash Flows for the nine months ended September 30, 2002 and 2001. Operating
results for the three months and nine months ended September 30, 2002 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2002.
REVENUE RECOGNITION
PBM revenues are derived from the following sources:
o Revenues from dispensing prescriptions from our mail
pharmacies, which include the co-payment received from our
members, are recorded when the prescription is shipped. At
this time our earnings process is complete as the obligations
of our customer to pay for the drugs is fixed, and due to the
nature of the product, the member may not return the drugs nor
receive a refund.
o Revenues from the sale of prescription drugs by retail
pharmacies in our nationwide network are recognized when the
claim is processed, and exclude co-payments that our members
pay to the retail pharmacy. When we independently have a
contractual obligation to pay our network pharmacy providers
for benefits provided to our clients' members, we include the
total payments from these clients as revenue, and payments to
the network pharmacy provider as cost of revenue (the "Gross
Basis"). These transactions require us to assume the credit
risk of our clients' ability to pay. In addition, under most
of our client contracts we may realize a positive or negative
margin represented by the difference between the negotiated
ingredient costs we will receive from our clients and
negotiated ingredient costs we will pay to our network
pharmacies. If we merely administer clients' network pharmacy
contracts in which we do not assume credit risk, we record
only our administrative or dispensing fees as revenue (the
"Net Basis") and do not realize a positive or negative margin.
At the end of a period, any unbilled revenues related to the
sale of prescription drugs by retail pharmacies are estimated
based on the amount to be paid to the pharmacies and
historical gross margin. Revenues are adjusted to actual at
the time of billing.
o We receive payments from drug manufacturers, including those
relating to the administration of manufacturer rebate and
discount programs. Revenues relating to these services, which
include manufacturer rebates and associated administrative
fees, are recognized as earned when the prescriptions covered
under contractual agreements with the manufacturers are
dispensed; these revenues are not dependent upon future
pharmaceutical sales. The portion of the rebate that is
payable to customers is treated as a reduction from revenues.
With respect to rebates that are based on market share
performance, we estimate rebates receivable from
pharmaceutical manufacturers on a quarterly basis based on our
estimate of the number of rebatable prescriptions and the
rebate per prescription. These estimates are adjusted to
actual when the number of rebatable prescriptions and rebate
per prescription have been determined and the billing to the
manufacturers has been completed. With respect to rebates that
are not based on market share performance, no estimation is
required because the amount is determinable when the drug is
dispensed.
7
Non-PBM revenues are derived from the following sources:
o Administrative fees received from drug manufacturers for
dispensing or distributing of pharmaceuticals requiring
special handling or packaging. We also administer sample card
programs for certain manufacturers and include the ingredient
costs of those drug samples dispensed from retail pharmacies
in our SDS revenues, and the associated costs for this sample
card program in cost of revenues. Because we have an
independent contractual obligation to pay our network pharmacy
providers for free samples dispensed to patients under the
sample card program, we include the total payments from these
manufacturers (including ingredient costs) as revenue, and
payments to the network pharmacy provider as cost of revenue.
These transactions require us to assume credit risk.
o Our Phoenix Marketing Group subsidiary, which is one of the
largest prescription drug sample fulfillment companies,
shipping approximately 65 million sample units during the nine
months ended September 30, 2002 and approximately 95 million
sample units in 2001. Phoenix records an administrative fee
for distributing samples to doctors based on orders received
from pharmaceutical sales representatives.
o Infusion therapy services through our Express Scripts Infusion
Services subsidiary ("Infusion Services"). On June 12, 2001,
we announced that we entered into an agreement with Option
Care, Inc. to sell substantially all of the assets of our
Infusion Services business, and we discontinued our acute home
infusion services.
COST OF REVENUES
Cost of revenues includes product costs, network pharmacy claims
payments and other direct costs associated with dispensing prescription drugs
from our mail service pharmacies, including shipping and handling.
RECEIVABLES
Based on our revenue recognition policies discussed above, certain
claims at the end of a period are unbilled. Revenue and unbilled receivables for
those claims are estimated each period based on the amount to be paid to the
pharmacies and historical gross margin. Estimates are adjusted to actual at the
time of billing, typically within 30 days based on the contractual billing
schedule agreed upon with the client. In addition, revenue and unbilled
receivables for rebates based on market share performance are calculated
quarterly based on an estimate of rebatable prescriptions and the rebate per
prescription. These estimates are adjusted to actual when the number of
rebatable prescriptions and the rebate per prescription have been determined and
the billing to the manufacturers has been completed.
INVENTORIES
Inventories consist of prescription drugs and medical supplies that are
stated at the lower of first-in first-out cost or market.
PROPERTY AND EQUIPMENT
Property and equipment is carried at cost and is depreciated using the
straight-line method over estimated useful lives of seven years for furniture,
five years for equipment and purchased computer software and three years for
certain computer equipment, which exceed minimum capitalization levels.
Leasehold improvements are amortized on a straight-line basis over the term of
the lease or the useful life of the asset, if shorter. Expenditures for repairs,
maintenance and renewals are charged to income as incurred. Expenditures that
improve an asset or extend its estimated useful life are capitalized. When
properties are retired or otherwise disposed of, the related cost and
accumulated depreciation are removed from the accounts and any gain or loss is
included in income. Research and development expenditures relating to the
development of software are charged to expense until technological feasibility
is established. Thereafter, the remaining software production costs, up to the
date placed into production, are capitalized and included as Property and
Equipment. Amortization of the capitalized amounts commences on the date placed
into production, and is computed on a product-by-product basis using the
straight-line method over the remaining estimated economic life of the product
but not more than five years. We continually review the useful lives of assets
and adjust the remaining lives based on the deployment of new technologies.
Reductions, if any, in the carrying value of capitalized software costs to net
realizable value are expensed.
8
OTHER INTANGIBLE ASSETS
Other intangible assets include, but are not limited to, customer
contracts, non-compete agreements, deferred financing fees, trade names and
certain fees paid to clients under contractual agreements. Other intangible
assets, excluding trade names, which have an indefinite life, are amortized on a
straight-line basis over periods from 2 to 20 years.
IMPAIRMENT OF LONG LIVED ASSETS
We evaluate whether events and circumstances have occurred that
indicate the remaining estimated useful life of long lived assets, including
goodwill and other intangible assets, may warrant revision or that the remaining
balance of an asset may not be recoverable. The measurement of possible
impairment is based on the ability to recover the balance of assets from
expected future operating cash flows on an undiscounted basis. Impairment
losses, if any, would be determined based on the present value of the cash flows
using discount rates that reflect the inherent risk of the underlying business.
No such impairment existed as of September 30, 2002 and December 31, 2001.
We adopted FAS 142, "Goodwill and Other Intangible Assets" effective
January 1, 2002. FAS 142 requires that goodwill no longer be amortized. Instead,
all goodwill (including goodwill associated with acquisitions consummated prior
to the adoption of FAS 142) is to be evaluated for impairment annually or when
events or circumstances occur indicating that goodwill might be impaired. In
accordance with the implementation provisions of FAS 142, we completed our first
impairment test under FAS 142 during the second quarter of 2002, which did not
result in an impairment charge.
EMPLOYEE STOCK-BASED COMPENSATION
We account for employee stock options in accordance with Accounting
Principles Board No. ("APB") 25, "Accounting for Stock Issued to Employees."
Under APB 25, we apply the intrinsic value method of accounting and, therefore,
have not recognized compensation expense for options granted, because options
have only been granted at a price equal to market value at the time of grant.
During 1996, FAS 123, "Accounting for Stock-Based Compensation" became effective
for us. FAS 123 prescribes the recognition of compensation expense based on the
fair value of options determined on the grant date. However, FAS 123 grants an
exception that allows companies currently applying APB 25 to continue using that
method. We have, therefore, elected to continue applying the intrinsic value
method under APB 25. Had we utilized the fair value method within FAS 123, pro
forma net income for the three and nine months ended September 30, 2002 would
have been $51,149,000, or $0.64 per diluted share and $138,524,000 or $1.74 per
diluted share, respectively (see Note 11).
NOTE 2 - GOODWILL AND OTHER INTANGIBLES
We adopted Financial Accounting Standards Board Statement No. ("FAS")
142, "Goodwill and Other Intangible Assets" effective January 1, 2002. FAS 142
requires that goodwill no longer be amortized. Instead, all goodwill (including
goodwill associated with acquisitions consummated prior to the adoption of FAS
142) is to be evaluated for impairment annually or when events or circumstances
occur indicating that goodwill might be impaired. In accordance with the
implementation provisions of FAS 142, we completed our first impairment test
during the second quarter of 2002, which did not result in an impairment charge.
9
The following is a summary of our goodwill and other intangible assets
(amounts in thousands).
SEPTEMBER 30, 2002 DECEMBER 31, 2001
GROSS ACCUMULATED GROSS ACCUMULATED
CARRYING AMOUNT AMORTIZATION CARRYING AMOUNT AMORTIZATION
- ----------------------------------------------------------------------------------------------------------------------
Goodwill
PBM (1) $ 1,466,282 $ 106,555 $ 1,048,831 $ 106,551
Non-PBM 22,106 - - -
------------------------------------ ------------------------------------
$ 1,488,388 $ 106,555 $ 1,048,831 $ 106,551
==================================== ====================================
Other intangible assets
PBM
Customer contracts $ 260,917 $ 54,877 $ 184,612 $ 46,659
Other 74,859 34,535 56,148 28,752
------------------------------------ ------------------------------------
335,776 89,412 240,760 75,411
Non-PBM
Customer contracts 4,000 292 - -
Other 1,880 26 - -
------------------------------------ ------------------------------------
5,880 318 - -
------------------------------------ ------------------------------------
Total other intangible assets $ 341,656 $ 89,730 $ 240,760 $ 75,411
==================================== ====================================
(1) The change in accumulated amortization from December 31, 2001 to September
30, 2002 is a result of changes in foreign currency exchange rates.
The aggregate amount of amortization expense of other intangible assets
was $5,095,000 and $3,343,000 for the three months ended September 30, 2002 and
2001, respectively, and $14,319,000 and $9,304,000 for the nine months ended
September 30, 2002 and 2001, respectively. The future aggregate amount of
amortization expense of other intangible assets is $19,712,000 for 2002,
$23,116,000 for 2003, $22,780,000 for 2004, $21,659,000 for 2005, and
$16,456,000 for 2006. The weighted average amortization period of intangible
assets subject to amortization is 17 years in total, and by major intangible
class is 20 years for customer contracts and 6 years for other intangible
assets.
The following table compares our net income and per share amounts for
the three and nine months ended September 30, 2002, to net income and per share
amounts for the three and nine months ended September 30, 2001, adjusted for the
amortization of goodwill (in thousands, except per share amounts).
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Reported net income $ 53,442 $ 32,191 $ 146,111 $ 90,514
Add back: Goodwill amortization, net of tax - 6,543 - 19,625
------------------------------------------------------------
Adjusted net income $ 53,442 $ 38,734 $ 146,111 $ 110,139
============================================================
Reported basic earnings per share $ 0.69 $ 0.41 $ 1.87 $ 1.16
Add back: Goodwill amortization, net of tax - 0.08 - 0.25
------------------------------------------------------------
Adjusted basic earnings per share $ 0.69 $ 0.49 $ 1.87 $ 1.41
============================================================
Reported diluted earnings per share $ 0.67 $ 0.40 $ 1.83 $ 1.13
Add back: Goodwill amortization, net of tax - 0.08 - 0.24
------------------------------------------------------------
Adjusted diluted earnings per share $ 0.67 $ 0.48 $ 1.83 $ 1.37
============================================================
10
NOTE 3 - CHANGES IN BUSINESS
On April 12, 2002, we completed the acquisition of National
Prescription Administrators, Inc, a privately held full-service pharmacy benefit
manager ("PBM"), and certain affiliated companies (collectively, "NPA") for a
nominal purchase price of approximately $513 million, which includes the
issuance of 552,000 shares of our common stock (fair value of $26.4 million upon
the transaction announcement date), and transaction costs. The purchase price
was subsequently reduced to $489 million as a result of the receipt of a $23.8
million working capital purchase price adjustment during the third quarter. The
$489 million purchase price has not been reduced to reflect a further
anticipated working capital adjustment of $16.1 million, which has been recorded
as a receivable, and is included in other current assets. The transaction was
accounted for under the provisions of FAS 141, "Business Combinations" and FAS
142. The purchase price has been preliminarily allocated based upon the
estimated fair value of net assets acquired at the date of the acquisition. The
excess of purchase price over tangible net assets acquired has been
preliminarily allocated to intangible assets, consisting of customer contracts
in the amount of $76,290,000 and non-competition agreements in the amount of
$2,860,000, which are being amortized using the straight-line method over the
estimated useful lives of 20 years and five years, respectively. These assets
are classified as other intangible assets. In addition, the excess of the
purchase price over tangible net assets acquired has been preliminarily
allocated to goodwill in the amount of $417,403,000, which is not being
amortized.
The acquisition was funded with a new $325 million Term B loan facility
(see Note 8), $78 million of cash on hand, the issuance of 552,000 shares of our
common stock (fair value of $26.4 million upon the transaction announcement
date), and $25 million in borrowings under our revolving credit facility. An
election under Internal Revenue Code Section 338(h)(10) will be made so that for
tax purposes the transaction will be treated as a purchase of assets, making
amortization expense of intangible assets, including goodwill, tax deductible.
In addition, we borrowed an additional $75 million under our revolving credit
facility to fund post-closing working capital requirements of NPA.
On February 25, 2002, we purchased substantially all of the assets
utilized in the operation of Phoenix Marketing Group (Holdings), Inc.
("Phoenix"), a wholly-owned subsidiary of Access Worldwide Communications, Inc.,
for $34.1 million in cash, including acquisition-related costs, plus the
assumption of certain liabilities. Phoenix is one of the largest prescription
drug sample fulfillment companies, shipping approximately 65 million sample
units during the nine months ended September 30, 2002 and approximately 95
million sample units in 2001. The acquisition has been accounted for under the
provisions of FAS 141 and FAS 142. The purchase price has been preliminarily
allocated based upon the estimated fair value of net assets acquired at the date
of the acquisition. The excess of purchase price over tangible net assets
acquired has been allocated preliminarily to intangible assets, consisting of
customer contracts in the amount of $4,000,000 and non-competition agreements in
the amount of $180,000, which are being amortized using the straight-line method
over the estimated lives of eight years and four years, respectively, and trade
name in the amount of $1,700,000, which is not being amortized. These assets are
included in other intangible assets. In addition, the excess of purchase price
over tangible net assets acquired was allocated preliminarily to goodwill in the
amount of $22,106,000, which is not being amortized. The transaction was
structured as a purchase of assets, making amortization expense of intangible
assets, including goodwill, tax deductible.
The following unaudited pro forma information presents a summary of our
combined results of operations and those of NPA and Phoenix as if the
acquisitions had occurred at the beginning of the periods presented, along with
certain pro forma adjustments to give effect to amortization of other intangible
assets, interest expense on acquisition debt and other adjustments. The
following pro forma financial information is not necessarily indicative of the
results of operations as they would have been had the transaction been effected
on the assumed date, nor is it an indication of trends in future results (in
thousands, except per share data):
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
---------------------------------------------
Total revenues $ 10,223,062 $ 8,214,042
Net income $ 148,212 $ 99,957
Basic earnings per share $ 1.90 $ 1.28
Diluted earnings per share $ 1.85 $ 1.24
11
On June 12, 2001, we announced that we entered into an agreement with
Option Care, Inc. to sell our Express Scripts Infusion Services branch offices
for an amount approximating the book value of the assets. In addition, we
discontinued all of our remaining acute home infusion services revenue
generating activities. The sale to Option Care, Inc. did not have a material
effect on our financial statements.
On March 1, 2001, our Canadian subsidiary, ESI Canada, Inc., completed
its acquisition of Centre d'autorisation et de paiement des services de sante,
Inc. ("CAPSS"), a leading Quebec-based PBM, for approximately CAN$26.8 million
(approximately US$17.5 million at the acquisition date). The transaction, which
was accounted for under the purchase method of accounting, was funded with our
operating cash flows. The results of operations of CAPSS have been included in
our consolidated financial statements and PBM segment since March 1, 2001. The
purchase price has been allocated based upon the estimated fair value of net
assets acquired at the date of the acquisition. The excess of the purchase price
over tangible net assets acquired was allocated to intangible assets consisting
of customer contracts in the amount of US$5,149,000 (at the March 1, 2001
exchange rate), which are being amortized using the straight-line method over
the estimated useful life of 20 years and are included in other intangible
assets, and goodwill in the amount of US$11,655,000 (at the March 1, 2001
exchange rate), which effective January 1, 2002 is no longer being amortized.
Pro forma information, as if CAPSS had been acquired as of the beginning of
2001, is not being presented as the inclusion of CAPSS financial data would not
have a material impact to our consolidated financial statements.
On February 22, 2001, we announced that we entered into an agreement
with AdvancePCS and Merck-Medco, L.L.C. to form RxHub, LLC ("RxHub"). RxHub will
be an electronic exchange enabling physicians who use electronic prescribing
technology to link to pharmacies, PBMs and health plans. The company is designed
to operate as a utility for the exchange of information among all parties
engaging in electronic prescribing. We own one-third of the equity of RxHub (as
do each of the other two founders) and have committed to invest up to $20
million over five years with approximately $8.7 million invested through
September 30, 2002. We have recorded our investment in RxHub under the equity
method of accounting, which requires our percentage interest in RxHub's results
to be recorded in our Consolidated Statement of Operations. Our percentage of
RxHub's loss for the three months and nine months ended September 30, 2002 is
$1,224,000 ($761,000 net of tax) and $3,294,000 ($2,046,000 net of tax),
respectively, compared to $435,000 ($272,000 net of tax) and $1,093,000
($679,000 net of tax), respectively, for the three months and nine months ended
September 30, 2001. These losses have been recorded in other (expense) income in
our Unaudited Consolidated Statement of Operations. Our investment in RxHub
(approximately $3,422,000 at September 30, 2002) is recorded in other assets on
our Consolidated Balance Sheet.
NOTE 4 - RECEIVABLES
Included in receivables, net, as of September 30, 2002 and December 31,
2001, are allowance for doubtful accounts of $40,258,000 and $24,157,000,
respectively. This increase is primarily due to certain customers who are
experiencing financial difficulties in the current economy.
As of September 30, 2002 and December 31, 2001, unbilled receivables
were $489,278,000 and $435,708,000, respectively. Unbilled receivables are
billed to clients typically within 30 days of the transaction date based on the
contractual billing schedule agreed upon with the client.
NOTE 5 - PROPERTY AND EQUIPMENT
During the first half of 2002, the estimated useful lives of certain
computer equipment and software associated with our legacy computer systems were
shortened due to the continued progress of our integration to one point-of-sale
claim adjudication platform. This change in the estimated useful lives increased
depreciation and amortization expense by approximately $18 million during the
first half of 2002.
12
NOTE 6 - CONTRACTUAL AGREEMENTS
In March 2002, we renegotiated certain terms of our relationship with
The Manufacturer's Life Insurance Company ("Manulife") and entered into an
amended agreement which, among other things, extended the term of the agreement
through March 2009. During 2001, Manulife earned 101,000 shares of our common
stock to be issued in 2002. These shares, or a pro rata portion thereof, were to
be returned to us if Manulife terminated the contract early and, as such, were
recorded as other intangible assets as of December 31, 2001. In lieu of the
issuance of the 101,000 shares, we made a cash payment to Manulife. Therefore,
the advance discount recorded in other intangible assets as of December 31, 2001
was recorded against revenue during the first quarter of 2002. In addition, the
amendment eliminated the ability for Manulife to receive shares of our common
stock or the warrants contemplated in the original agreement.
NOTE 7 - EARNINGS PER SHARE
Basic earnings per share is computed using the weighted average number
of common shares outstanding during the period. Diluted earnings per share is
computed in the same manner as basic earnings per share but adds the number of
additional common shares that would have been outstanding for the period if the
dilutive potential common shares had been issued. The following, which reflects
the two-for-one stock split effective June 22, 2001, is the reconciliation
between the number of weighted average shares used in the basic and diluted
earnings per share calculation for all periods (amounts in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------
Weighted average number of common shares
outstanding during the period - Basic EPS 77,829 78,382 77,962 77,978
Outstanding stock options 1,379 1,986 1,583 1,971
Executive deferred compensation plan 37 25 35 20
Restricted stock awards 204 219 206 187
---------------------------------------------------------
Weighted average number of common shares
outstanding during the period - Diluted EPS 79,449 80,612 79,786 80,156
=========================================================
The above shares are all calculated under the "treasury stock" method in
accordance with FAS 128, "Earnings Per Share."
NOTE 8 - FINANCING
During the third quarter of 2002, we prepaid $50 million of our Term A
loan facility. The $55 million principal balance of the Term A Loans matures in
March 2005. As a result of the prepayment on the Term A loans, we recognized an
extraordinary charge in the amount of $495,000, net of tax, from the write-off
of deferred financing fees.
In April 2002, we amended our existing credit facility to add a $325
million Term B loan facility. We amended certain covenants of the credit
facility relating to restricted junior payments, asset sales and a provision
enabling a future accounts receivable securitization facility. The Term B loans
have a maturity of six years and amortize 1% in years one through four, 25% in
year five and 71% in year six. Interest is payable quarterly on an interest rate
spread of 200 basis points based on several London Interbank Offered Rates
("LIBOR") or base rate options. The Term B loans are secured on the same basis
as our existing credit facility.
NOTE 9 - DERIVATIVE FINANCIAL INSTRUMENTS
Effective January 1, 2001, we adopted FAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by FAS 137 and FAS
138 ("FAS 133"). FAS 133 requires all derivative financial instruments, such as
interest rate swaps, to be recognized as either assets or liabilities in the
statement of financial position and measured at fair value.
As of September 30, 2002, we have one swap agreement to fix the
variable rate interest payments on approximately $89 million of our debt under
our credit facility. Under this swap agreement, we agree to receive a variable
rate of interest on the notional principal amount of approximately $89 million
based upon a three month LIBOR rate in exchange for payment of a fixed rate of
6.25% per annum. The notional principal amount will increase to $100 million in
October 2002 before decreasing to $60 million in April 2003 and to $20 million
in April 2004 until maturing in April 2005.
13
Our present interest rate swap agreement is a cash flow hedge under
which we agree to pay a fixed rate of interest, which hedges against changes in
the amount of future cash flows associated with variable rate interest
obligations. Accordingly, the fair value of our swap agreement is reported on
the balance sheet in other liabilities ($6,507,000 pre-tax at September 30,
2002) and the related gains or losses on these agreements are deferred in
stockholders' equity as a component of other comprehensive income (a reduction
of $4,032,000, net of taxes, at September 30, 2002). These deferred gains or
losses are then recognized as an adjustment to interest expense over the same
period in which the related interest payments being hedged are recorded in
income. If any of these agreements are determined to have hedge ineffectiveness,
the gains or losses associated with the ineffective portion of these agreements
are immediately recognized in income. For the three and nine months ended
September 30, 2002 and 2001, the gains and losses on the ineffective portion of
our swap agreement were not material to our consolidated financial statements.
On October 1, 2002, we entered into a swap agreement to fix the
variable rate interest payments on an additional $50 million of debt under our
credit facility. Under this swap agreement, which matures September 30, 2003, we
agree to receive a variable rate of interest on the notional principal amount of
$50 million based upon a three month LIBOR rate in exchange for payment of a
fixed rate of 1.66% per annum.
NOTE 10 - COMMON STOCK
As of September 30, 2002, we have repurchased a total of 5,081,000
shares of our common stock under the stock repurchase program that we announced
on October 25, 1996, of which 1,324,000 shares were repurchased during the first
nine months of 2002. Approximately 3,360,000 shares have been reissued in
connection with employee compensation plans through September 30, 2002. In July
2002, our Board of Directors approved an increase in the stock repurchase
program from 6,500,000 shares to 10,000,000 shares. There is no limit on the
duration of the program. Additional purchases, if any, will be made in such
amounts and at such times as we deem appropriate based upon prevailing market
and business conditions, subject to restrictions on the amount of stock
repurchases contained in our bank credit facility and the Indenture under which
our Senior Notes were issued.
In May 2001, we announced a two-for-one stock split of our common stock
for stockholders of record on June 8, 2001, which was effective June 22, 2001.
The split was effected in the form of a dividend by issuance of one share of
common stock for each share of common stock outstanding. The earnings per share
and the weighted average number of shares outstanding for basic and diluted
earnings per share have been adjusted for the stock split.
NOTE 11 - STOCK-BASED COMPENSATION PLANS
We apply Accounting Principles Board Opinion No. ("APB") 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for our stock-based compensation plans. Accordingly, compensation
cost has been recorded based upon the intrinsic value method of accounting for
restricted stock and no compensation cost has been recognized for stock options
granted as the exercise price of the options was not less than the fair market
value of the shares at the time of grant. If compensation cost for stock option
grants had been determined based on the fair value at the grant dates consistent
with the method prescribed by FAS 123, "Accounting for Stock Based
Compensation," our net income and earnings per share would have been reduced to
the pro forma amounts indicated below. Because future options may be granted and
vesting typically occurs over a three year period, the pro forma impact shown
for the three and nine months ended September 30, 2002 and 2001 are not
necessarily representative of the impact in future years.
14
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
- -----------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Net income
As reported $ 53,442 $ 32,191 $ 146,111 $ 90,514
Pro forma 51,149 30,113 138,524 84,153
Basic earnings per share
As reported $ 0.69 $ 0.41 $ 1.87 $ 1.16
Pro forma 0.66 0.38 1.78 1.08
Diluted earnings per share
As reported $ 0.67 $ 0.40 $ 1.83 $ 1.13
Pro forma 0.64 0.37 1.74 1.05
The fair value of options granted (which is amortized over the option
vesting period in determining the pro forma impact) is estimated on the date of
grant using the Black-Scholes multiple option-pricing model with the following
weighted average assumptions:
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
- ------------------------------------- ---------------------- --------------------- ------------------- ------------------
2002 2001 2002 2001
- ------------------------------------- ---------------------- --------------------- ------------------- ------------------
Expected life of option 2-5 years 2-5 years 2-5 years 2-5 years
Risk-free interest rate 1.33%-2.72% 3.63%-4.59% 1.22%-4.29% 3.63%-5.01%
Expected volatility of stock 54% 55% 54% 55%
Expected dividend yield None None None None
A summary of the status of our fixed stock option plans as of September
30, 2002 and December 31, 2001, and changes during the periods ending on those
dates are presented below.
NINE-MONTHS ENDED TWELVE MONTHS ENDED
SEPTEMBER 30, 2002 DECEMBER 31, 2001
----------------------------------------- ---------------
Weighted- Weighted-
Average Average
Exercise Exercise
(SHARE DATA IN THOUSANDS) Shares Price Shares Price
- -----------------------------------------------------------------------------------------------
Outstanding at beginning of year 5,992 $ 26.26 6,448 $ 20.58
Granted 283 $ 53.57 1,230 $ 41.93
Exercised (860) $ 21.14 (1,531) $ 15.25
Forfeited/Cancelled (90) $ 32.77 (155) $ 22.93
------------- -------------
Outstanding at end of period 5,325 $ 28.43 5,992 $ 26.26
============= =============
Options exercisable at period end 2,684 2,758
============= =============
Weighted-average fair value of
options granted during the year $ 23.57 $ 19.06
============= =============
15
The following table summarizes information about fixed stock options
outstanding at September 30, 2002:
Options Outstanding Options Exercisable
------------------------------------------------------------ ----------------------------------
Range of
Exercise Prices Number Weighted-Average Number Weighted-
(SHARE DATA IN Outstanding at Remaining Weighted-Average Exercisable Average
THOUSANDS) 9/30/02 Contractual Life Exercise Price at 9/30/02 Exercise Price
- ---------------------- ------------------- ------------------- -------------------- ----------------- ----------------
$ 3.53 - 17.81 1,229 4.61 $ 13.12 1,034 $ 12.51
19.16 - 25.81 1,313 6.16 22.40 659 21.63
27.44 - 35.78 1,162 6.90 30.35 802 31.03
36.81 - 46.44 1,072 6.01 40.19 87 42.63
46.48 - 54.90 549 6.03 50.08 102 47.62
------------------- -----------------
$ 3.53 - 54.90 5,325 5.92 $ 28.43 2,684 $ 22.59
=================== =================
NOTE 12 - CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
Our Senior Notes are unconditionally and jointly and severally
guaranteed by our wholly-owned domestic subsidiaries other than Great Plains
Reinsurance Co., ValueRx of Michigan, Inc., Diversified NY IPA, Inc., and
Diversified Pharmaceutical Services (Puerto Rico), Inc. The following condensed
consolidating financial information has been prepared in accordance with the
requirements for presentation of such information. We believe that this
information, presented in lieu of complete financial statements for each of the
guarantor subsidiaries, provides sufficient detail to allow investors to
determine the nature of the assets held by, and the operations of, each of the
consolidating groups. During 2000 and 2001, we undertook internal corporate
reorganizations to eliminate various entities whose existence was deemed to be
no longer necessary, including, among others, ValueRx, and to create several new
entities to conduct certain activities, including Express Scripts Specialty
Distribution Services ("SDS"), ESI Mail Pharmacy Service, Inc. ("ESI MPS"),
Express Access Pharmacy, Inc. ("EAP") and ESI Resources, Inc. ("ERI").
Consequently, the assets, liabilities and operations of ValueRx are included in
those of the issuer, Express Scripts, Inc., and the assets, liabilities and
operations of SDS, ESI MPS, EAP and ERI are included in those of the Guarantors.
Effective December 31, 2001, Practice Patterns Science, Inc. ("PPS") was
dissolved. The condensed consolidated non-guarantors' financial statements for
2001 include the assets, liabilities and operations of PPS. During 2002, Phoenix
Marketing Group LLC was established to acquire the assets of Phoenix. Subsequent
to the acquisition on February 25, 2002, the assets, liabilities and operations
of Phoenix Marketing Group, LLC have been included in those of the Guarantors.
In addition, subsequent to the acquisition of NPA on April 12, 2002, the assets,
liabilities and operations of NPA have been included in those of the Guarantors.
16
CONDENSED CONSOLIDATING BALANCE SHEET
- -----------------------------------------------------------------------------------------------------------------------------------
EXPRESS NON-
(IN THOUSANDS) SCRIPTS, INC. GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
- -----------------------------------------------------------------------------------------------------------------------------------
AS OF SEPTEMBER 30, 2002
Current assets $ 868,312 $ 435,578 $ 13,626 $ - $ 1,317,516
Property and equipment, net 118,151 36,193 2,303 - 156,647
Investments in subsidiaries 1,654,178 771,079 - (2,425,257) -
Intercompany 643,907 (609,818) (34,089) - -
Goodwill, net 241,457 1,125,401 14,975 - 1,381,833
Other intangible assets, net 71,236 172,026 8,664 - 251,926
Other assets 17,181 (1,042) 5 - 16,144
--------------- ---------------- ---------------- --------------- ----------------
Total assets $ 3,614,422 $ 1,929,417 $ 5,484 $ (2,425,257) $ 3,124,066
=============== ================ ================ =============== ================
Current liabilities $ 401,195 $ 1,040,224 $ 1,244 $ - $ 1,442,663
Long-term debt 620,884 - - - 620,884
Other liabilities 43,719 46,430 (408) - 89,741
Stockholders' equity 2,548,624 842,763 4,648 (2,425,257) 970,778
--------------- ---------------- ---------------- --------------- ----------------
Total liabilities and stockholders' equity $ 3,614,422 $ 1,929,417 $ 5,484 $ (2,425,257) $ 3,124,066
=============== ================ ================ =============== ================
AS OF DECEMBER 31, 2001
Current assets $ 972,844 $ 230,303 $ 10,056 $ - $ 1,213,203
Property and equipment, net 131,567 32,500 1,196 - 165,263
Investments in subsidiaries 1,208,931 752,256 - (1,961,187) -
Intercompany 214,531 (185,148) (29,383) - -
Goodwill, net 241,457 685,893 14,930 - 942,280
Other intangible assets, net 62,198 93,787 9,364 - 165,349
Other assets 87,024 (72,492) (382) - 14,150
--------------- ---------------- ---------------- --------------- ----------------
Total assets $ 2,918,552 $ 1,537,099 $ 5,781 $ (1,961,187) $ 2,500,245
=============== ================ ================ =============== ================
Current liabilities $ 482,157 $ 759,969 $ 3,491 $ - $ 1,245,617
Long-term debt 346,119 - - - 346,119
Other liabilities 151,754 (73,173) (2,069) - 76,512
Stockholders' equity 1,938,522 850,303 4,359 (1,961,187) 831,997
--------------- ---------------- ---------------- --------------- ----------------
Total liabilities and stockholders' equity $ 2,918,552 $ 1,537,099 $ 5,781 $ (1,961,187) $ 2,500,245
=============== ================ ================ =============== ================
17
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
- -----------------------------------------------------------------------------------------------------------------------------------
EXPRESS NON-
(IN THOUSANDS) SCRIPTS, INC. GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
- -----------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 2002
Total revenues $ 1,670,892 $ 1,750,996 $ 4,310 $ - $ 3,426,198
Operating expenses 1,629,976 1,693,075 3,847 - 3,326,898
--------------- ---------------- ---------------- --------------- ----------------
Operating income 40,916 57,921 463 - 99,300
Undistributed loss from joint venture (1,224) - - - (1,224)
Interest (expense) income, net (10,712) 269 81 - (10,362)
--------------- ---------------- ---------------- --------------- ----------------
Income before tax effect 28,980 58,190 544 - 87,714
Income tax provision 11,065 22,645 67 - 33,777
--------------- ---------------- ---------------- --------------- ----------------
Income before extraordinary item 17,915 35,545 477 - 53,937
Extraordinary item, net of tax (495) - - - (495)
--------------- ---------------- ---------------- --------------- ----------------
Net income $ 17,420 $ 35,545 $ 477 $ - $ 53,442
=============== ================ ================ =============== ================
THREE MONTHS ENDED SEPTEMBER 30, 2001
Total revenues $ 1,448,502 $ 928,906 $ 3,844 $ - $ 2,381,252
Operating expenses 1,397,221 920,940 2,860 - 2,321,021
--------------- ---------------- ---------------- --------------- ----------------
Operating income 51,281 7,966 984 - 60,231
Undistributed loss from joint venture (435) - - - (435)
Interest (expense) income, net (5,810) (9) (761) - (6,580)
--------------- ---------------- ---------------- --------------- ----------------
Income before tax effect 45,036 7,957 223 - 53,216
Income tax provision 17,999 3,106 (452) - 20,653
--------------- ---------------- ---------------- --------------- ----------------
Income before extraordinary item 27,037 4,851 675 - 32,563
Extraordinary item, net of tax (372) - - - (372)
--------------- ---------------- ---------------- --------------- ----------------
Net income $ 26,665 $ 4,851 $ 675 $ - $ 32,191
=============== ================ ================ =============== ================
NINE MONTHS ENDED SEPTEMBER 30, 2002
Total revenues $ 5,064,869 $ 4,504,974 $ 8,062 $ - $ 9,577,905
Operating expenses 4,930,099 4,368,539 10,904 - 9,309,542
--------------- ---------------- ---------------- --------------- ----------------
Operating income (loss) 134,770 136,435 (2,842) - 268,363
Undistributed loss from joint venture (3,294) - - - (3,294)
Interest (expense) income, net (28,417) 471 181 - (27,765)
--------------- ---------------- ---------------- --------------- ----------------
Income (loss) before tax effect 103,059 136,906 (2,661) - 237,304
Income tax provision 39,448 52,640 (1,390) - 90,698
--------------- ---------------- ---------------- --------------- ----------------
Income before extraordinary item 63,611 84,266 (1,271) - 146,606
Extraordinary item, net of tax (495) - - - (495)
--------------- ---------------- ---------------- --------------- ----------------
Net income (loss) $ 63,116 $ 84,266 $ (1,271) $ - $ 146,111
=============== ================ ================ =============== ================
NINE MONTHS ENDED SEPTEMBER 30, 2001
Total revenues $ 4,167,209 $ 2,539,145 $ 12,781 $ - $ 6,719,135
Operating expenses 4,028,712 2,507,136 10,261 - 6,546,109
--------------- ---------------- ---------------- --------------- ----------------
Operating income 138,497 32,009 2,520 - 173,026
Undistributed loss from joint venture (1,093) - - - (1,093)
Interest (expense) income, net (19,977) (14) (678) - (20,669)
--------------- ---------------- ---------------- --------------- ----------------
Income before tax effect 117,427 31,995 1,842 - 151,264
Income tax provision 48,062 12,130 186 - 60,378
--------------- ---------------- ---------------- --------------- ----------------
Income before extraordinary item 69,365 19,865 1,656 - 90,886
Extraordinary item, net of tax (372) - - - (372)
--------------- ---------------- ---------------- --------------- ----------------
Net income $ 68,993 $ 19,865 $ 1,656 $ - $ 90,514
=============== ================ ================ =============== ================
18
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
- -----------------------------------------------------------------------------------------------------------------------------------
EXPRESS NON-
(IN THOUSANDS) SCRIPTS, INC. GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
- -----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2002
Net cash provided by (used in)
operating activities $ 95,922 $ 197,922 $ (6,880) $ - $ 286,964
--------------- ---------------- ---------------- --------------- ----------------
Cash flows from investing activities:
Purchase of property and equipment (32,123) 1,027 (1,376) - (32,472)
Acquisitions and joint venture 444 (497,673) - - (497,229)
Other 655 - - - 655
--------------- ---------------- ---------------- --------------- ----------------
Net cash (used in)
Investing activities (31,024) (496,646) (1,376) - (529,046)
--------------- ---------------- ---------------- --------------- ----------------
Cash flows from financing activities:
Proceeds from long-term debt 425,000 - - - 425,000
Repayment of long-term debt (150,000) - - - (150,000)
Treasury stock acquired (66,840) - - - (66,840)
Proceeds from employee stock plans 21,700 - - - 21,700
Net transaction with parent (330,538) 319,474 11,064 - -
Other (3,885) - - (3,885)
--------------- ---------------- ---------------- --------------- ----------------
Net cash (used in) provided by
financing activities (104,563) 319,474 11,064 - 225,975
--------------- ---------------- ---------------- --------------- ----------------
Effect of foreign currency
translation adjustment - - (10) - (10)
--------------- ---------------- ---------------- --------------- ----------------
Net increase (decrease) in cash and
cash equivalents (39,665) 20,750 2,798 - (16,117)
Cash and cash equivalents at beginning
of the period 272,891 (102,163) 6,987 - 177,715
Cash and cash equivalents at end --------------- ---------------- ---------------- --------------- ----------------
of the period $ 233,226 $ (81,413) $ 9,785 $ - $ 161,598
=============== ================ ================ =============== ================
19
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
- -----------------------------------------------------------------------------------------------------------------------------------
EXPRESS NON-
(IN THOUSANDS) SCRIPTS, INC. GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED
- -----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2001
Net cash (used in) provided by
operating activities $ (59,168) $ 212,991 $ 14,376 $ (147) $ 168,052
--------------- ---------------- ---------------- --------------- ----------------
Cash flows from investing activities:
Purchase of property and equipment (27,241) (9,466) (123) - (36,830)
Acquisitions and joint venture (3,182) - (16,400) - (19,582)
Other (6,862) 810 (338) - (6,390)
--------------- ---------------- ---------------- --------------- ----------------
Net cash (used in) investing activities (37,285) (8,656) (16,861) - (62,802)
--------------- ---------------- ---------------- --------------- ----------------
Cash flows from financing activities:
Repayment of long-term debt (50,000) - - - (50,000)
Treasury stock acquired (27,055) - - - (27,055)
Proceeds from employee stock plans 23,633 - - - 23,633
Net transaction with parent 202,443 (207,810) 5,220 147 -
--------------- ---------------- ---------------- --------------- ----------------
Net cash provided by (used in)
financing activities 149,051 (207,810) 5,220 147 (53,392)
--------------- ---------------- ---------------- --------------- ----------------
Effect of foreign currency
translation adjustment - - (242) - (242)
--------------- ---------------- ---------------- --------------- ----------------
Net increase in cash and cash equivalents 52,598 (3,475) 2,493 - 51,616
Cash and cash equivalents at beginning
of the period 148,311 (98,519) 3,412 - 53,204
Cash and cash equivalents at end --------------- ---------------- ---------------- --------------- ----------------
of the period $ 200,909 $ (101,994) $ 5,905 $ - $ 104,820
=============== ================ ================ =============== ================
20
NOTE 13 - SEGMENT REPORTING
We are organized on the basis of services offered and have determined
that we have two reportable segments: PBM services and non-PBM services. We
manage the pharmacy benefit within an operating segment that encompasses a fully
integrated PBM service. The remaining three operating service lines (Specialty
Distribution Services, Phoenix and Express Scripts Infusion Services) have been
aggregated into a non-PBM reporting segment. On June 12, 2001, we announced that
we entered into an agreement with Option Care, Inc. to sell substantially all of
the assets of our Infusion Services business, and we discontinued our acute home
infusion services.
The following table presents income statement information about our
reportable segments for the:
(IN THOUSANDS) PBM NON-PBM TOTAL
- -------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 2002
Product revenues $ 3,284,287 $ 19,166 $ 3,303,453
Service revenues 98,312 24,433 122,745
---------------------------------------
Total revenues 3,382,599 43,599 3,426,198
Income before income taxes 80,025 7,689 87,714
THREE MONTHS ENDED SEPTEMBER 30, 2001
Product revenues $ 2,292,827 $ 2,064 $ 2,294,891
Service revenues 74,193 12,168 86,361
---------------------------------------
Total revenues 2,367,020 14,232 2,381,252
Income before income taxes 50,751 2,465 53,216
NINE MONTHS ENDED SEPTEMBER 30, 2002
Product revenues $ 9,182,630 $ 49,527 $ 9,232,157
Service revenues 280,552 65,196 345,748
---------------------------------------
Total revenues 9,463,182 114,723 9,577,905
Income before income taxes 216,420 20,884 237,304
NINE MONTHS ENDED SEPTEMBER 30, 2001
Product revenues $ 6,430,950 $ 20,904 $ 6,451,854
Service revenues 233,050 34,231 267,281
---------------------------------------
Total revenues 6,664,000 55,135 6,719,135
Income before income taxes 146,009 5,255 151,264
Product revenue consists of revenues from the dispensing of
prescription drugs from our mail pharmacies and revenues from the sale of
prescription drugs by retail pharmacies in our retail pharmacy networks. Service
revenue includes administrative fees associated with the administration of
retail pharmacy networks contracted by certain clients, market research
programs, informed decision counseling services, a portion of SDS services, and
sampling services by our Phoenix Marketing subsidiary.
The following table presents balance sheet information for our
reportable segments as of:
(IN THOUSANDS) PBM NON-PBM TOTAL
- --------------------------------------------------------------------------------
TOTAL ASSETS
September 30, 2002 $ 3,024,461 $ 99,605 $ 3,124,066
December 31, 2001 2,437,323 62,922 2,500,245
21
NOTE 14 - NEW ACCOUNTING GUIDANCE
In April 2002, FAS 145, "Rescission of FASB Statements No. 4, 44, and
64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued.
In rescinding FAS 4, "Reporting Gains and Losses from Extinguishment of Debt,"
and FAS 64 "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements,"
FAS 145 eliminates the required classification of gains and losses from
extinguishment of debt as extraordinary. This Statement also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. FAS
145 is effective for financial statements issued for fiscal years beginning
after May 15, 2002 and will be implemented by ESI in January 2003.
Implementation of FAS 145 will not have a significant impact on our consolidated
financial position, consolidated results of operations and/or our consolidated
cash flows.
In July 2002, FAS 146, "Accounting for Costs Associated with Exit or
Disposal Activities," which deals with issues on the accounting for costs
associated with a disposal activity, was issued. FAS 146 nullifies the guidance
in Emerging Issues Task Force (EITF) Issue No. 94-3 (EITF 94-3), "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring.)" by prohibiting
liability recognition based on a commitment to an exit/disposal plan. Under FAS
146, exit/disposal costs will be expensed as incurred. The provisions of FAS 146
are effective for exit or disposal activities initiated after December 31, 2002
and are not expected to have a significant impact on our consolidated financial
position, consolidated results of operations and/or our consolidated cash flows.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
IN THIS ITEM 2, "WE," "US," "OUR" AND THE "COMPANY" REFER TO EXPRESS
SCRIPTS, INC. AND ITS SUBSIDIARIES, UNLESS THE CONTEXT INDICATES OTHERWISE.
INFORMATION INCLUDED IN THIS QUARTERLY REPORT ON FORM 10-Q, AND INFORMATION THAT
MAY BE CONTAINED IN OTHER FILINGS BY US WITH THE SECURITIES AND EXCHANGE
COMMISSION ("SEC") AND RELEASES ISSUED OR STATEMENTS MADE BY US, CONTAIN OR MAY
CONTAIN FORWARD-LOOKING STATEMENTS, INCLUDING BUT NOT LIMITED TO STATEMENTS OF
OUR PLANS, OBJECTIVES, EXPECTATIONS OR INTENTIONS. SUCH FORWARD-LOOKING
STATEMENTS NECESSARILY INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS MAY
DIFFER SIGNIFICANTLY FROM THOSE PROJECTED OR SUGGESTED IN ANY FORWARD-LOOKING
STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH DIFFERENCES TO OCCUR INCLUDE, BUT ARE
NOT LIMITED TO:
o RISKS ASSOCIATED WITH OUR ACQUISITIONS OF NPA AND RELATED COMPANIES AND
OUR ACQUISITION OF THE BUSINESS OPERATIONS OF PHOENIX MARKETING GROUP
(HOLDINGS), INC., INCLUDING INTEGRATION RISKS AND COSTS, RISKS OF
CLIENT RETENTION AND REPRICING OF CLIENT CONTRACTS, AND RISKS
ASSOCIATED WITH THE OPERATIONS OF ACQUIRED BUSINESSES
o RISKS ASSOCIATED WITH OUR ABILITY TO MAINTAIN INTERNAL GROWTH RATES, OR
TO CONTROL OPERATING OR CAPITAL COSTS
o CONTINUED PRESSURE ON MARGINS RESULTING FROM CLIENT DEMANDS FOR LOWER
PRICES, ENHANCED SERVICE OFFERINGS AND/OR HIGHER SERVICE LEVELS, AND
THE POSSIBLE TERMINATION OF, OR UNFAVORABLE MODIFICATION TO, CONTRACTS
WITH KEY CLIENTS OR PROVIDERS
o COMPETITION IN THE 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
o ADVERSE RESULTS IN REGULATORY MATTERS, THE ADOPTION OF NEW LEGISLATION
OR REGULATIONS (INCLUDING INCREASED COSTS ASSOCIATED WITH COMPLIANCE
WITH NEW LAWS AND REGULATIONS, SUCH AS PRIVACY REGULATIONS UNDER THE
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT (HIPAA)), MORE
AGGRESSIVE ENFORCEMENT OF EXISTING LEGISLATION OR REGULATIONS, OR A
CHANGE IN THE INTERPRETATION OF EXISTING LEGISLATION OR REGULATIONS
o RISKS ARISING FROM INVESTIGATIONS OF CERTAIN PBM PRACTICES AND
PHARMACEUTICAL PRICING, MARKETING AND DISTRIBUTION PRACTICES CURRENTLY
BEING CONDUCTED BY THE U.S. ATTORNEY OFFICES IN PHILADELPHIA AND BOSTON
AND OTHER REGULATORY AGENCIES
o THE POSSIBLE LOSS, OR ADVERSE MODIFICATION OF THE TERMS, OF OUR
RELATIONSHIPS WITH PHARMACEUTICAL MANUFACTURERS, OR CHANGES IN PRICING,
DISCOUNT OR OTHER PRACTICES OF PHARMACEUTICAL MANUFACTURERS
o ADVERSE RESULTS IN LITIGATION, INCLUDING A PENDING CASE WHICH PURPORTS
TO BE A CLASS ACTION, CHALLENGING EXPRESS SCRIPTS' BUSINESS PRACTICES
UNDER THE EMPLOYEE RETIREMENT INCOME SECURITY ACT (ERISA)
o RISKS ASSOCIATED WITH THE USE AND PROTECTION OF THE INTELLECTUAL
PROPERTY WE USE IN OUR BUSINESS
o RISKS ASSOCIATED WITH OUR LEVERAGE AND DEBT SERVICE OBLIGATIONS,
INCLUDING THE EFFECT OF CERTAIN COVENANTS IN OUR BORROWING AGREEMENTS
o RISKS ASSOCIATED WITH OUR ABILITY TO CONTINUE TO DEVELOP NEW PRODUCTS,
SERVICES AND DELIVERY CHANNELS
o GENERAL DEVELOPMENTS IN THE HEALTH CARE INDUSTRY, INCLUDING THE IMPACT
OF INCREASES IN HEALTH CARE COSTS, CHANGES IN DRUG UTILIZATION AND COST
PATTERNS AND INTRODUCTIONS OF NEW DRUGS
o UNCERTAINTIES REGARDING THE IMPLEMENTATION AND THE ULTIMATE TERMS OF
PROPOSED GOVERNMENT INITIATIVES, INCLUDING A MEDICARE PRESCRIPTION DRUG
BENEFIT
o INCREASE IN CREDIT RISK RELATIVE TO OUR CLIENTS DUE TO ADVERSE ECONOMIC
TRENDS
o RISKS ASSOCIATED WITH OUR INABILITY TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL
o 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" OF OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31,
2001. WE DO NOT UNDERTAKE ANY OBLIGATION TO RELEASE PUBLICLY ANY REVISIONS TO
SUCH FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE
DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS.
23
OVERVIEW
We are one of the largest full-service pharmacy benefit management
("PBM") companies independent of pharmaceutical manufacturer ownership in North
America. We provide health care management and administration services on behalf
of clients that include health maintenance organizations, health insurers,
third-party administrators, employers and union-sponsored benefit plans. Our
fully integrated PBM services include network claims processing, mail pharmacy
services, benefit design consultation, drug utilization review, formulary
management, disease management, medical and drug data analysis services, medical
information management services, and informed decision counseling services
through our Express Health LineSM division. We also provide non-PBM services
which include distribution of specialty pharmaceuticals through our Express
Scripts Specialty Distribution Services subsidiary ("SDS"); sampling services
through our Phoenix Marketing Group subsidiary; and prior to June 12, 2001,
infusion therapy services through our wholly-owned subsidiary IVTx, Inc.,
operating as Express Scripts Infusion Services.
We derive our revenues primarily from the sale of PBM services in the
United States and Canada. Tangible products revenue consists of revenues from
the dispensing of prescription drugs from our mail pharmacies and revenues from
the sale of prescription drugs by retail pharmacies in our retail pharmacy
networks. Service revenue includes administrative fees associated with the
administration of retail pharmacy networks contracted by certain clients, market
research programs, informed decision counseling services, SDS services, and
sampling services by our Phoenix Marketing subsidiary. Tangible product revenue
represented 96.4% of our total revenues for the three and nine months ended
September 30, 2002, compared to 96.4% and 96.0%, respectively, for the same
periods last year.
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 that 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. We evaluate our estimates and
assumptions on an ongoing basis based on a combination of historical information
and various other assumptions that are believed to be reasonable under the
particular circumstances. Actual results may differ from these estimates based
on different assumptions or conditions. We believe that certain of the
accounting policies that most impact our consolidated financial statements and
that require our management to make difficult, subjective or complex judgments
are described below. This should be read in conjunction with Note 1, "Summary of
Significant Accounting Policies" and with the notes to the consolidated
financial statements included in our Annual Report on Form 10-K for the year
ended December 31, 2001 filed with the Securities and Exchange Commission on
March 8, 2002.
REVENUE RECOGNITION
PBM revenues are derived from the following sources:
o Revenues from dispensing prescriptions from our mail
pharmacies, which include the co-payment received from our
members, are recorded when the prescription is shipped. At
this time our earnings process is complete as the obligations
of our customer to pay for the drugs is fixed, and due to the
nature of the product, the member may not return the drugs nor
receive a refund.
o Revenues from the sale of prescription drugs by retail
pharmacies in our nationwide network are recognized when the
claim is processed, and exclude co-payments that our members
pay to the retail pharmacy. When we independently have a
contractual obligation to pay our network pharmacy providers
for benefits provided to our clients' members, we include the
total payments from these clients as revenue, and payments to
the network pharmacy provider as cost of revenue (the "Gross
Basis"). These transactions require us to assume the credit
risk of our clients' ability to pay. In addition, under most
of our client contracts we may realize a positive or negative
margin represented by the difference between the negotiated
ingredient costs we will receive from our clients and
negotiated ingredient costs we will pay to our network
pharmacies. If we merely administer clients' network pharmacy
contracts in which we do not assume credit risk, we record
only our administrative or dispensing fees as revenue (the
"Net Basis") and do not realize a positive or negative margin.
At the end of a period, any
24
unbilled revenues related to the sale of prescription drugs by
retail pharmacies are estimated based on the amount to be paid
to the pharmacies and historical gross margin. Revenues are
adjusted to actual at the time of billing.
o We receive payments from drug manufacturers, including those
relating to the administration of manufacturer rebate and
discount programs. Revenues relating to these services, which
include manufacturer rebates and associated administrative
fees, are recognized as earned when the prescriptions covered
under contractual agreements with the manufacturers are
dispensed; these revenues are not dependent upon future
pharmaceutical sales. The portion of the rebate that is
payable to customers is treated as a reduction from revenues.
With respect to rebates that are based on market share
performance, we estimate rebates receivable from
pharmaceutical manufacturers on a quarterly basis based on our
estimate of the number of rebatable prescriptions and the
rebate per prescription. These estimates are adjusted to
actual when the number of rebatable prescriptions and rebate
per prescription have been determined and the billing to the
manufacturers has been completed. With respect to rebates that
are not based on market share performance, no estimation is
required because the amount is determinable when the drug is
dispensed.
Non-PBM revenues are derived from the following sources:
o Administrative fees received from drug manufacturers for
dispensing or distributing of pharmaceuticals requiring
special handling or packaging. We also administer sample card
programs for certain manufacturers and include the ingredient
costs of those drug samples dispensed from retail pharmacies
in our SDS revenues, and the associated costs for this sample
card program in cost of revenues. Because we have an
independent contractual obligation to pay our network pharmacy
providers for free samples dispensed to patients under the
sample card program, we include the total payments from these
manufacturers (including ingredient costs) as revenue, and
payments to the network pharmacy provider as cost of revenue.
These transactions require us to assume credit risk.
o Our Phoenix Marketing Group subsidiary, which is one of the
largest prescription drug sample fulfillment companies,
shipping approximately 65 million sample units during the nine
months ended September 30, 2002 and approximately 95 million
sample units in 2001. Phoenix records an administrative fee
for distributing samples to doctors based on orders received
from pharmaceutical sales representatives.
o Infusion therapy services through our Express Scripts Infusion
Services subsidiary ("Infusion Services"). On June 12, 2001,
we announced that we entered into an agreement with Option
Care, Inc. to sell substantially all of the assets of our
Infusion Services business, and we discontinued our acute home
infusion services.
RECEIVABLES
Based on our revenue recognition policies discussed above, certain
claims at the end of a period are unbilled. Revenue and unbilled receivables for
those claims are estimated each period based on the amount to be paid to the
pharmacies and historical gross margin. Estimates are adjusted to actual at the
time of billing, typically within 30 days based on the contractual billing
schedule agreed upon with the client. In addition, revenue and unbilled
receivables for rebates based on market share performance are calculated
quarterly based on an estimate of rebatable prescriptions and the rebate per
prescription. These estimates are adjusted to actual when the number of
rebatable prescriptions and the rebate per prescription have been determined and
the billing to the manufacturers has been completed.
25
RESULTS OF OPERATIONS
PBM GROSS PROFIT
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
INCREASE/ INCREASE/
(IN THOUSANDS) 2002 DECREASE 2001 2002 DECREASE 2001
- -------------------------------------------------------------------------------------------------------------------
PBM Gross Basis revenues $ 3,376,074 43.4% $ 2,354,058 $ 9,447,273 42.7% $ 6,619,980
PBM Net Basis revenues 6,525 (49.7%) 12,962 15,909 (63.9%) 44,020
----------------------------------------------------------------------------------
Total PBM revenues 3,382,599 42.9% 2,367,020 9,463,182 42.0% 6,664,000
Cost of PBM revenues 3,182,688 42.9% 2,227,673 8,895,731 42.5% 6,241,169
----------------------------------------------------------------------------------
PBM Gross Profit $ 199,911 43.5% $ 139,347 $ 567,451 34.2% $ 422,831
==================================================================================
Revenues for network pharmacy claims increased $700,698,000, or 41.5%,
and $1,906,680,000, or 39.8%, respectively, during the three months and nine
months ended September 30, 2002 over 2001. These increases are due to an
increase in the rate of utilization of prescription drugs by members, the
acquisition of National Prescription Administrators, Inc. ("NPA"), higher drug
ingredient costs and a higher mix of clients utilizing retail pharmacy networks
contracted by us versus retail pharmacy networks contracted by the client. The
increase in drug ingredient costs is primarily attributable to increases in the
average wholesale price index that is used to calculate payments due to
pharmacies and payments due from clients. We anticipate these increases will
continue to benefit gross profit in future quarters. Network pharmacy claims
processed increased 26.3% to 88,869,000 during the third quarter of 2002 over
2001 and 21.8% to 260,591,000 during the nine months ended September 30, 2002
over 2001. Excluding NPA, network pharmacy claims processed increased 11.6% and
12.2%, respectively, for the three and nine months ended September 30, 2002.
The average revenue per network pharmacy claim increased 12.0% to
$26.89 and 14.8% to $25.69, respectively, over the three and nine months ended
September 30, 2001 due to higher drug ingredient costs, and a higher mix of
clients utilizing retail pharmacy networks contracted by us versus retail
pharmacy networks contracted by the client. As previously discussed under
"--Overview", we record the associated revenues for clients utilizing our retail
pharmacy networks on the Gross Basis; therefore, this shift to our retail
pharmacy networks results in increased Gross Basis revenues (and corresponding
cost of revenues) and revenue per claim. As expected, we saw a higher mix of
clients on the Gross Basis in 2002 due to the loss of a large Net Basis client
at the beginning of 2002.
Revenues for mail pharmacy services and mail pharmacy claims processed
increased $321,035,000, or 48.5%, and 1,632,000, or 30.2%, respectively, for the
third quarter of 2002 over 2001. Revenues for mail pharmacy services and mail
pharmacy claims processed increased $895,877,000, or 48.8%, and 5,263,000, or
35.6%, respectively, for the first nine months of 2002 over 2001. These
increases are primarily due to increased rate of utilization of prescription
drugs by members, the acquisition of NPA and higher drug ingredient costs. For
the three and nine months ended September 30, 2002, the average revenue per mail
pharmacy claim increased 14.1% and 9.7%, respectively, over 2001 primarily due
to higher drug ingredient costs. Excluding NPA, mail pharmacy claims processed
increased 13.5% and 24.3%, respectively, for the three and nine months ended
September 30, 2002.
Our cost of revenues for PBM services increased 42.9% in the third
quarter of 2002 over 2001 and 42.5% in the first nine months of 2002 over 2001
primarily as a result of the increase in PBM revenues. The increase for the nine
months ended September 30, 2002 was partially offset by the renegotiation of a
contract with a large client, in which we eliminated a contract pricing reserve,
resulting in a non-recurring, non-cash decrease in cost of revenues of
approximately $15 million in the first quarter of 2002. The PBM cost of revenues
grew slightly faster than revenues in the first nine months of 2002 as a result
of a larger percentage of our clients being recorded on the Gross Basis, for
which we record the drug ingredient cost in cost of revenues (see further
discussion under "--Overview").
We have been successful in offsetting margin pressure caused by lower
pricing on administrative fees and other clinical programs with higher profits
from increased utilization of our mail service pharmacies, improved formulary
compliance and increased utilization of generic drugs, and we expect these
trends to continue. Our PBM gross profit increased $60,564,000, or 43.5% over
the third quarter of 2001 and $144,620,000, or 34.2% over the first nine months
26
of 2001. A portion of these increases was due to the acquisition of NPA, the
increase in the average wholesale price index and the renegotiation of a
contract with a large client in the first quarter of 2002, discussed above.
NON-PBM GROSS PROFIT
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
INCREASE/ INCREASE/
(IN THOUSANDS) 2002 DECREASE 2001 2002 DECREASE 2001
- -------------------------------------------------------------------------------------------------------------------
Non-PBM revenues $ 43,599 206.3% $ 14,232 $ 114,723 108.1% $ 55,135
Non-PBM cost of revenues 32,048 251.2% 9,126 83,951 119.0% 38,330
----------------------------------------------------------------------------------
Non-PBM gross profit $ 11,551 126.2% $ 5,106 $ 30,772 83.1% $ 16,805
==================================================================================
The increase in revenue for non-PBM services in the three months and
nine months ended September 30, 2002 over 2001 is primarily due to the
additional volume in SDS, including the sample card programs we administer for
certain manufacturers, where we include the ingredient costs of pharmaceuticals
dispensed from retail pharmacies in our SDS revenues. We also began recording
revenues from Phoenix after the acquisition was completed on February 25, 2002.
The increase for the nine months ended September 30, 2002 was partially offset
by the discontinuance of our acute home infusion services revenue-generating
activities on June 12, 2001.
Gross profit from non-PBM services increased 126.2% and 83.1%,
respectively, for the three months and nine months ended September 30, 2002 over
2001, reflecting mainly the increased volume in SDS and the addition of Phoenix.
The percentage increase in non-PBM costs of revenues grew faster than the
percentage increase in revenues due the additional volume in the sample card
program (discussed above), where we include the ingredient costs of
pharmaceuticals dispensed from retail pharmacies in our SDS revenues and costs
of revenues. The percentage increase in the non-PBM cost of revenues was
partially offset by Phoenix, which does not purchase samples from the
manufacturers, but records an administrative fee for distributing samples to
doctors based on orders received from pharmaceutical sales representatives. In
addition, the acute home infusion service, which was discontinued last year, was
less profitable than our SDS business.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses increased $27,940,000, or
33.2%, in the third quarter of 2002 over 2001, and $63,250,000, or 23.7% for the
first nine months of 2002 over 2001 due in part to the acquisition of NPA and
Phoenix, and costs incurred during the integration of NPA and Phoenix ($557,000
and $1,534,000 during the three and nine months ended September 30, 2002,
respectively). These increases were also partially due to expenditures required
to expand operational and administrative support functions in order to enhance
management of the pharmacy benefit. Additionally, we continually review the
useful lives of assets that support our claims processing system and other
technologies. Depreciation expense increased in the first half of 2002 as useful
lives were shortened due to the continued progress of our integration to one
adjudication platform and the deployment of new technologies. In addition, we
established the Express Scripts Foundation (the "Foundation"), an independent
charitable foundation, in 2001. The Foundation was established primarily to
support healthcare and educational causes. During the first nine months of 2002,
we contributed $12 million to the Foundation. See "--Liquidity And Capital
Resources".
These increases were partially offset by the adoption of FAS 142, which
eliminates goodwill amortization. A total of $8,910,000 ($6,543,000 after tax)
and $26,724,000 ($19,625,000 after tax) of goodwill was amortized in the third
quarter and the nine months ended September 2001, respectively. Excluding
depreciation and amortization, selling, general and administrative expenses were
3.1% of total revenue for the three months ended September 30, 2002 compared to
2.9% last year, and 3.0% for the nine months ended September 30, 2002 compared
to 3.3% last year.
27
OTHER (EXPENSE) INCOME
On February 22, 2001, we announced that we entered into an agreement
with AdvancePCS and Medco Health Solutions, Inc. (formerly, "Merck-Medco,
L.L.C.") to form RxHub. RxHub will be an electronic exchange enabling physicians
who use electronic prescribing technology to link to pharmacies, PBMs and health
plans. The company is designed to operate as a utility for the exchange of
information among all parties engaging in electronic prescribing. We own
one-third of the equity of RxHub (as do each of the other two founders) and have
committed to invest up to $20 million over five years with approximately $8.7
million invested to date through September 30, 2002. We have recorded our
investment in RxHub under the equity method of accounting, which requires our
percentage interest in RxHub's results to be recorded in our Unaudited
Consolidated Statement of Operations. Our percentage of RxHub's loss for the
three and nine months ended September 30, 2002 was $1,224,000 ($761,000 net of
tax) and $3,294,000 ($2,046,000 net of tax), respectively, compared to $435,000
($272,000 net of tax) and $1,093,000 ($679,000 net of tax) for the three and
nine months ended September 30, 2001, respectively. These amounts have been
recorded in other (expense) income in our Unaudited Consolidated Statement of
Operations.
The $3,782,000, or 57.5%, increase in net interest expense for the
third quarter of 2002 over 2001 and $7,096,000, or 34.3% increase for the nine
months ended September 30, 2002 is primarily due to the additional debt incurred
during the second quarter of 2002 to finance the NPA acquisition.
PROVISION FOR INCOME TAXES
Our effective tax rate decreased to 38.5% for the third quarter of 2002
from 38.8% in 2001 and decreased to 38.2% for the first nine months of 2002 from
39.9% in 2001. These decreases are due primarily to the adoption of FAS 142 in
which we no longer amortize goodwill, a portion of which was non-deductible.
NET INCOME AND EARNINGS PER SHARE
Net income before extraordinary items increased $21,374,000, or 65.6%,
and $55,720,000 or 61.3%, respectively, for the three and nine months ended
September 30, 2002 over 2001. During the third quarter, we recorded an
extraordinary charge of $495,000, net of tax, due to the write off of deferred
financing fees on the prepayment of debt (see "--Liquidity and Capital
Resources").
Our net income increased $21,251,000, or 66.0%, and $55,597,000, or
61.4%, respectively, for the three months and nine months ended September 30,
2002 over 2001. Basic and diluted earnings per share increased 68.3% and 67.5%,
respectively, for the third quarter of 2002 over 2001, and 61.2% and 61.9%,
respectively, for the nine months ended September 30, 2002 over 2001. Reflecting
the application of FAS 142 in 2001, our net income increased $14,708,000, or
38.0% for the third quarter of 2002 over 2001, while basic and diluted earnings
per share increased 40.8% and 39.6%, respectively. Reflecting the application of
FAS 142 in 2001, our net income increased $35,972,000, or 32.7%, for the first
nine months of 2002 over 2001, while basic and diluted earnings per share
increased 32.6% and 33.6%, respectively.
We account for employee stock options in accordance with APB 25 and
have not recognized compensation expense for options granted. Had we accounted
for stock options in accordance with FAS 123 and recognized compensation expense
based on the fair value of options determined on the grant date, pro forma net
income for the three and nine months ended September 30, 2002 would have been
$51,149,000, or $0.64 per diluted share and $138,524,000 or $1.74 per diluted
share, respectively.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING CASH FLOW AND CAPITAL EXPENDITURES
During the first nine months of 2002, net cash provided by operations
increased $118,912,000 to $286,964,000 from $168,052,000 in 2001. This increase
is primarily due to increased cash earnings, working capital improvements, and
the acquisition of NPA. In addition, net cash provided by operations for the
first half of 2001 was negatively impacted by the termination of a large
contract in late 2000, which resulted in the payment of the remaining
liabilities in the first and second quarters of 2001.
28
As a percent of accounts receivable, our allowance for doubtful
accounts was 3.9% and 2.7% at September 30, 2002 and December 31, 2001,
respectively. This increase is primarily due to certain customers who are
experiencing financial difficulties in the current economy.
We established the Express Scripts Foundation, an independent
charitable foundation, in 2001. During the first nine months of 2002, we
contributed $12 million to the Foundation, which was recorded as selling,
general and administrative expense. The Company has no commitment to make future
contributions to the Foundation; any future contributions will be funded from
operating cash flow.
Our capital expenditures for the nine months ended September 30, 2002
decreased $4,358,000 or 11.8% from 2001. In order to manage growth, we will
begin working on a capital project to renovate and expand our Tempe mail order
facility during the fourth quarter of 2002. A significant portion of the work
will be performed during the fourth quarter of 2002 and the first quarter of
2003 and capital expenditures for the project are expected to range from $18
million to $24 million. We also expect to continue to invest in technology that
we believe will provide efficiencies in operations, facilitate growth and
enhance the service we provide to our clients. Future 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.
During the second quarter of 2002, the Department of Defense (DoD)
TRICARE Management Activity selected Express Scripts to provide mail pharmacy
services for the TRICARE Program. The new five-year contract, which will become
operational at the beginning of March 2003, covers nearly 9 million United
States Armed Forces personnel and dependents worldwide. In preparation for this
new contract, we will incur operating expenses, working capital expenditures and
capital expenditures during the fourth quarter of 2002 and first quarter of
2003, including the purchase of $15 million to $20 million of additional
inventory. We anticipate that such expenditures will be funded from operating
cash flow.
In December 2000, the Department of Health and Human Services issued
final privacy regulations, pursuant to the Health Insurance Portability and
Accountability Act of 1996, which impose extensive restrictions on the use and
disclosure of individually identifiable health information by certain entities.
We will be required to comply with certain aspects of the regulations. We have
established a plan and a process for implementing all necessary changes to our
business operations by the statutory compliance date of April 2003. We believe
compliance with these regulations will have a significant impact on our business
operations. We have completed an assessment of the costs we will incur in
complying with these regulations and do not believe they will be material to our
results of operations, financial position and/or cash flow from operations.
STOCK REPURCHASE PROGRAM
As of September 30, 2002, we have repurchased a total of 5,081,000
shares of our common stock under the stock repurchase program that we announced
on October 25, 1996. As of September 30, 2002, approximately 3,360,000 shares
have been reissued in connection with employee compensation plans. In July 2002,
our Board of Directors authorized an increase in our stock repurchase program
from 6,500,000 shares to 10,000,000 shares. There is no limit on the duration of
the program. Additional common stock repurchases, if any, will be made in such
amounts and at such times as we deem appropriate based upon prevailing market
and business conditions, subject to restrictions on stock repurchases contained
in our bank credit facility and the Indenture under which our Senior Notes were
issued.
ACQUISITIONS
On April 12, 2002, we completed the acquisition of NPA, a privately
held full-service pharmacy benefit manager, for a nominal purchase price of
approximately $513 million, which includes the issuance of 552,000 shares of our
common stock (fair value of $26.4 million upon the transaction announcement
date), and transaction costs. The purchase price was subsequently reduced to
$489 million as a result of the receipt of a $23.8 million working capital
purchase price adjustment during the third quarter. The $489 million purchase
price has not been reduced to reflect a further anticipated working capital
adjustment of $16.1 million, which has been recorded as a receivable, and is
included in other current assets. The transaction was accounted for under the
29
provisions of FAS 141, "Business Combinations," and FAS 142. The purchase price
has been preliminarily allocated based upon the estimated fair value of net
assets acquired at the date of the acquisition. The excess of purchase price
over tangible net assets acquired has been preliminarily allocated to intangible
assets consisting of customer contracts in the amount of $76,290,000 and
non-competition agreements in the amount of $2,860,000, which are being
amortized using the straight-line method over the estimated useful lives of 20
years and 5 years, respectively. These assets are classified as other intangible
assets. In addition, the excess of the purchase price over tangible net assets
acquired has been preliminarily allocated to goodwill in the amount of
$417,403,000, which is not being amortized.
The acquisition of NPA was funded with the proceeds of a new $325
million Term B loan facility, $78 million of cash on hand, the issuance of
552,000 shares of our common stock (fair value of $26.4 million when issued),
and $25 million in borrowings under our revolving credit facility. We plan to
file an Internal Revenue Code Section 338(h)(10) election, making amortization
expense of intangible assets, including goodwill, tax deductible. We estimate
this election will provide a tax benefit to us of approximately $85 million on a
present value basis. In addition, we borrowed an additional $75 million under
our revolving credit facility to fund post-closing working capital requirements
of NPA.
On February 25, 2002, we purchased substantially all of the assets
utilized in the operation of Phoenix , a wholly-owned subsidiary of Access
Worldwide Communications, Inc. for $34.1 million in cash, including
acquisition-related costs, plus the assumption of certain liabilities. Phoenix
is one of the largest prescription drug sample fulfillment companies, shipping
approximately 65 million sample units during the nine months ended September 30,
2002 and approximately 95 million sample units in 2001. The acquisition has been
accounted for under the provisions of FAS 141 and FAS 142. The purchase price
has been preliminarily allocated based upon the estimated fair value of net
assets acquired at the date of the acquisition. The excess of purchase price
over tangible net assets acquired has been preliminarily allocated to intangible
assets consisting of customer contracts in the amount of $4,000,000 and
non-competition agreements in the amount of $180,000 which are being amortized
using the straight-line method over the estimated lives of eight years and four
years, respectively, and trade name in the amount of $1,700,000, which is not
being amortized. These assets are included in other intangible assets. In
addition, the excess of purchase price over tangible net assets acquired was
preliminarily allocated to goodwill in the amount of $22,106,000, which is not
being amortized. The transaction was structured as a purchase of assets, making
amortization expense of intangible assets, including goodwill, tax deductible.
On March 1, 2001, our Canadian subsidiary, ESI Canada, Inc., completed
its acquisition of Centre d'autorisation et de paiement des services de sante,
Inc. ("CAPSS"), a leading Quebec-based PBM, for approximately CAN$26.8 million
(approximately US$17.5 million), which includes a purchase price adjustment for
closing working capital. The transaction, which was accounted for under the
purchase method of accounting, was funded with our operating cash flow. The
results of operations of CAPSS have been included in our consolidated financial
statements and PBM segment since March 1, 2001. The purchase price has been
allocated based upon the estimated fair value of net assets acquired at the date
of the acquisition. The excess of the purchase price over tangible net assets
acquired was allocated to intangible assets consisting of customer contracts in
the amount of US$5,149,000 (at the March 1, 2001 exchange rate), which are being
amortized using the straight-line method over the estimated useful life of 20
years and are included in other intangible assets, and goodwill in the amount of
US$11,655,000 (at the March 1, 2001 exchange rate), which effective January 1,
2002 is no longer being amortized.
We regularly review potential acquisitions and affiliation
opportunities. We believe that available cash resources, bank financing or the
issuance of additional common stock could be used to finance future acquisitions
or affiliations. There can be no assurance we will make new acquisitions or
establish new affiliations in 2002 or thereafter, other than our previously
announced acquisitions of Phoenix and NPA.
BANK CREDIT FACILITY
We have a credit facility with a commercial bank syndicate consisting
of $55 million of Term A loans and a $150 million revolving credit facility, of
which nothing is outstanding at September 30, 2002. During the third quarter of
2002, we repaid $50 million of the Term A loans and $35 million under the
revolving credit agreement. As a result of the $50 million prepayment of our
Term A Loans noted above, we recorded an extraordinary charge during the third
quarter of 2001 for the write off of deferred financing fees in the amount of
$495,000, net of tax. The Term A loans and the revolving credit facility mature
on March 31, 2005. The capital stock of each of our existing and subsequently
acquired domestic subsidiaries, excluding ValueRx of Michigan, Inc., Diversified
NY IPA, Inc. and Diversified Pharmaceutical Services (Puerto Rico), Inc., have
been pledged as collateral for the credit facility.
30
Our credit facility requires us to pay interest quarterly on an
interest rate spread based on several London Interbank Offered Rates ("LIBOR")
or base rate options. Using a LIBOR spread, the Term A loans have an interest
rate of 3.09% on September 30, 2002. The credit facility contains covenants that
limit the indebtedness we may incur, dividends paid and the amount of annual
capital expenditures. The covenants also establish a minimum interest coverage
ratio, a maximum leverage ratio, and a minimum fixed charge coverage ratio. In
addition, we are required to pay an annual fee of 0.25%, payable in quarterly
installments, on the unused portion of the revolving credit facility
($150,000,000 at September 30, 2002). At September 30, 2002, we are in
compliance in all material respects with all covenants associated with the
credit facility.
To fund the acquisition of NPA, we amended our existing credit facility
to add a $325 million Term B loan. The Term B loan has a maturity of six years
and will amortize 1% in years one through four, 25% in year five and 71% in year
six. Interest will be payable quarterly on an interest rate spread of 200 basis
points based on several LIBOR or base rate options, and had a weighted average
interest rate of 4.13% on September 30, 2002. The Term B loan is secured on the
same basis as our existing credit facility. In addition, the lenders approved
the amendment of certain covenants, relating to restricted junior payments and
asset sales, and a provision enabling a future accounts receivable
securitization facility.
To alleviate interest rate volatility on our Term A and Term B loans,
we have entered into interest rate swap arrangements, which are discussed in
"--Market Risk" below.
BONDS
In June 1999, we issued $250 million of 9 5/8% Senior Notes due 2009,
which require interest to be paid semi-annually on June 15 and December 15. As
of September 30, 2002, $239,885,000 of Senior Notes remains outstanding. The
Senior Notes are callable at specified rates beginning in June 2004. The Senior
Notes are unconditionally and jointly and severally guaranteed by our
wholly-owned domestic subsidiaries other than PPS, Great Plains Reinsurance Co.,
ValueRx of Michigan, Inc., Diversified NY IPA, Inc., and Diversified
Pharmaceutical Services (Puerto Rico), Inc. The Senior Notes have covenants that
limit the indebtedness we may incur, dividends paid, and the amount and the sale
of assets and subsidiary stock.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table sets fourth our schedule of current maturities of
our long-term debt, excluding the deferred interest rate swap gain of $498,000
at September 30, 2002, and future minimum lease payments due under
noncancellable operating leases (in thousands):
Current Maturities Future Minimum
Year Ended December 31, Of Long-term Debt Lease Payments
- -----------------------------------------------------------------------------------------------
2002 (reflects October 2002 to December 2002) $ - $ 4,171
2003 3,250 16,382
2004 3,250 16,253
2005 58,250 16,055
2006 3,250 14,443
Thereafter 552,386 27,153
-------------------------------------------
$ 620,386 $ 94,457
===========================================
OTHER MATTERS
In 2002, we adopted FAS 141, and FAS 142. FAS 141 requires all business
combinations be accounted for using the purchase method of accounting. FAS 141
also defines acquired intangible assets and requires a reassessment of a
company's preexisting acquired intangible assets and goodwill be evaluated and
adjusted to conform with that definition. The adoption of FAS 141 did not have a
significant impact on our consolidated financial position, consolidated results
of operations and/or our consolidated cash flows.
31
FAS 142 requires goodwill no longer be amortized. Instead, all goodwill
(including goodwill associated with acquisitions consummated prior to the
adoption of FAS 142) is to be evaluated for impairment annually or when events
or circumstances occur indicating that goodwill might be impaired. In accordance
with the implementation provisions of FAS 142, we completed our first impairment
test under FAS 142 during the second quarter of 2002, and did not incur an
impairment charge. All goodwill impairment losses are to be presented as a
separate line item in the operating section of the consolidated results of
operations (unless the impairment loss is associated with a discontinued
operation or the initial adoption of FAS 142, which would be recorded as a
change in accounting principle).
Effective January 1, 2002, we adopted FAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." FAS 144 requires that long-lived
assets to be disposed of by sale be measured at the lower of book value or fair
value, less cost to sell. Additionally, FAS 144 expands the scope of
discontinued operations to include all components of an entity with operations
that (1) can be distinguished from the rest of the entity and (2) will be
eliminated from the ongoing operations of the entity in a disposal transaction.
The implementation of FAS 144 did not have an impact on our consolidated
financial position, consolidated results of operations and/or our consolidated
cash flows.
In April 2002, FAS 145, "Rescission of FASB Statements No. 4, 44, and
64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued.
In rescinding FAS 4, "Reporting Gains and Losses from Extinguishment of Debt,"
and FAS 64 "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements,"
FAS 145 eliminates the required classification of gains and losses from
extinguishment of debt as extraordinary. This Statement also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. FAS
145 is effective for financial statements issued for fiscal years beginning
after May 15, 2002 and will be implemented by ESI in January 2003.
Implementation of FAS 145 will not have a significant impact on our consolidated
financial position, consolidated results of operations and/or our consolidated
cash flows.
In July 2002, FAS 146, "Accounting for Costs Associated with Exit or
Disposal Activities," which deals with issues on the accounting for costs
associated with a disposal activity, was issued. FAS 146 nullifies the guidance
in Emerging Issues Task Force (EITF) Issue No. 94-3 (EITF 94-3), "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring.)" by prohibiting
liability recognition based on a commitment to an exit/disposal plan. Under FAS
146, exit/disposal costs will be expensed as incurred. The provisions of FAS 146
are effective for exit or disposal activities initiated after December 31, 2002
and are not expected to have a significant impact on our consolidated financial
position, consolidated results of operations and/or our consolidated cash flows.
IMPACT OF INFLATION
Changes in prices charged by manufacturers and wholesalers for
pharmaceuticals affect our revenues and cost of revenues. Most of our contracts
provide that we bill clients based on a generally recognized price index for
pharmaceuticals, and accordingly we have been able to recover price increases
from our clients under the terms of our agreements.
MARKET RISK
Effective January 1, 2001, we adopted FAS 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by FAS 137 and 138
("FAS 133"). FAS 133 requires all derivative financial instruments, such as
interest rate swaps, to be recognized as either assets or liabilities in the
statement of financial position and measured at fair value. The adoption of FAS
133 did not have a material effect on our financial statements, but did reduce
other comprehensive income during 2001 by $612,000, net of taxes due to a
cumulative effect of change in accounting principle.
32
As of September 30, 2002, we have one swap agreement to fix the
variable interest rate payments on approximately $89 million of our debt under
our credit facility. Under this swap agreement, we agree to receive a variable
rate of interest on the notional principal amount of approximately $89 million
based upon a three month LIBOR rate in exchange for payment of a fixed rate of
6.25% per annum. The notional principal amount will increase to $100 million in
October 2002 before reducing to $60 million in April 2003 and to $20 million in
April 2004 until maturing in April 2005.
Our present interest rate swap agreement is a cash flow hedge under
which we agree to pay a fixed rate of interest, which hedges against changes in
the amount of future cash flows associated with our variable rate interest
obligations. Accordingly, the fair value of our swap agreement is reported on
the balance sheet in other liabilities ($6,507,000 pre-tax at September 30,
2002) and the related gains or losses on these agreements are deferred in
stockholders' equity as a component of other comprehensive income (a $4,032,000,
net of taxes reduction at September 30, 2002). These deferred gains or losses
are then recognized as an adjustment to interest expense over the same period in
which the related interest payments being hedged are recorded in income. If any
of these agreements are determined to have hedge ineffectiveness, the gains or
losses associated with the ineffective portion of these agreements are
immediately recognized in income. For the three and nine months ended September
30, 2002 and 2001, the gains and losses on the ineffective portion of our swap
agreement were not material to our consolidated financial statements.
On October 1, 2002, we entered into a swap agreement to fix the
variable rate interest payments on an additional $50 million of debt under our
credit facility. Under this swap agreement, which matures September 30, 2003, we
agree to receive a variable rate of interest on the notional principal amount of
$50 million based upon a three month LIBOR rate in exchange for payment of a
fixed rate of 1.66% per annum.
Interest rate risk is monitored on the basis of changes in the fair
value and a sensitivity analysis is used to determine the impact interest rate
changes will have on the fair value of the interest rate swap, measuring the
change in the net present value arising from the change in the interest rate.
The fair value of the swap is then determined by calculating the present value
of all cash flows expected to arise thereunder, with future interest rate levels
implied from prevailing mid-market yields for money-market instruments, interest
rate futures and/or prevailing mid-market swap rates. Anticipated cash flows are
then discounted on the assumption of a continuously compounding zero-coupon
yield curve. A 10 basis point decline in interest rates at September 30, 2002
would have caused the fair value of the swap to change by $134,000, resulting in
a liability with a fair value of $6,641,000.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Response to this item is included in Item 2 "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Market Risk"
above.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we have
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within 90 days of the filing date of this quarterly
report. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that these disclosure controls and procedures are
effective in timely alerting them to any material information that is required
to be disclosed by us in reports that we file with the Securities and Exchange
Commission. There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
33
- --------------------------------------------------------------------------------
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS
The Company is a defendant in MINSHEW V. EXPRESS SCRIPTS, No. Civ. 01 -
2412 PHX MHM (D.Az.). On December 12, 2001, this purported class action lawsuit
was filed by Gerald R. Minshew in the United States District Court for the
District of Arizona. On May 21, 2002, a substantially identical case, VOUGHT V.
EXPRESS SCRIPTS, No. Civ. 02 - 0949 PHX MHM (D.Az.), which does not purport to
be a class action, was filed in the same court. The MINSHEW and VOUGHT
complaints assert that certain of our business practices, including those
relating to our contracts with pharmaceutical manufacturers for retrospective
discounts on pharmaceuticals and those related to our retail pharmacy network
contracts, violate fiduciary duties that we allegedly owe to certain of our
clients. The purported class in the MINSHEW case consists of health benefit
plans that are self-funded by an employer client. The complaint seeks money
damages and injunctive relief on behalf of this class of health plans. We
believe the complaints are without merit and will vigorously defend them. The
company's motion to transfer the MINSHEW case to The Federal District Court for
the Eastern District of Missouri was granted on September 19, 2002. A motion to
transfer the VOUGHT case is pending. Although the ultimate outcome of these
cases is uncertain, a determination adverse to us could result in changes in our
business practices with respect to our formulary and rebate programs and our
retail pharmacy network contracting, and/or an award of money damages, either of
which could have a material adverse effect on our results of operations,
financial position and/or cash flow from operations.
On August 6, 2002, Express Scripts received a subpoena duces tecum
issued by the Defense Criminal Investigative Service ("DCIS") of the Office of
Inspector General of the Department of Defense. This subpoena sought information
pertaining to the purchase of Lipitor, a cholesterol-reducing drug, from
Parke-Davis, Incorporated, Warner Lambert Company and Pfizer, Inc. for sale to
the TRICARE program, a Department of Defense health care program. The Company
has been advised by DCIS that it is no longer necessary for the Company to
respond to this subpoena. The Company has not produced any documents pursuant to
this subpoena.
On October 29, 2002, a case styled BAUER V. EXPRESS SCRIPTS, Case No.
2002CV60672, was filed in the Superior Court of Fulton County, Georgia. The
case is a putative class action, seeking damages on behalf of individuals
allegedly damaged monetarily due to the classification of tamoxifen, a drug
primarily used to treat breast cancer, as a brand drug rather than as a generic.
The Company is investigating the allegations in the complaint, and intends to
defend the suit vigorously.
In addition to the matters described above, in the ordinary course of
our business there have arisen various other legal proceedings, investigations
or claims now pending against us or our subsidiaries unrelated to the
Acquisition and us. The effect of these actions on future financial results is
not subject to reasonable estimation because considerable uncertainty exists
about the outcomes. Nevertheless, in the opinion of management, the ultimate
liabilities resulting from any such lawsuits, investigations or claims now
pending are not expected to materially affect our consolidated financial
position, results of operations and/or cash flows.
34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS. See Index to Exhibits on page 20.
--------
(b) REPORTS ON FORM 8-K.
-------------------
(i) On July 26, 2002, we filed a Current Report on Form
8-K, dated July 26, 2002, under Items 5, 7 and 9,
regarding a press release we issued concerning our
second quarter 2002 financial performance.
(ii) On August 13, 2002, we filed a Current Report on Form
8-K, dated August 13, 2002, under Item 5, regarding a
press release we issued concerning a subpoena duces
tecum issued by the Defense Criminal Investigative
Service of the Office of Inspector General of the
Department of Defense, and Item 9, regarding the
certifications pursuant to 18 U.S.C. Section 1350
(Section 906 of the Sarbanes-Oxley Act of 2002) that
was delivered to the Securities and Exchange
Commission.
(iii) On August 13, 2002, we filed a Current Report on Form
8-K, dated August 13, 2002, under Item 5, regarding a
press release we issued concerning a subpoena duces
tecum issued by the Office of Inspector General (OIG)
of the U.S. Department of Health and Human Services.
35
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.
EXPRESS SCRIPTS, INC.
(Registrant)
Date: November 14, 2002 By: /s/ Barrett A. Toan
---------------------------
Barrett A. Toan, Chairman of the Board,
and Chief Executive Officer
Date: November 14, 2002 By: /s/ George Paz
---------------------------
George Paz, Senior Vice President and
Chief Financial Officer
36
I, Barrett A. Toan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Express
Scripts, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
/s/ Barrett A. Toan
-------------------------------------------
Barrett A. Toan, Chairman of the Board and
Chief Executive Officer
37
I, George Paz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Express
Scripts, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
/s/ George Paz
-------------------------------------------
George Paz, Senior Vice President and
Chief Financial Officer
38
INDEX TO EXHIBITS
(Express Scripts, Inc. - Commission File Number 0-20199)
EXHIBIT
NUMBER EXHIBIT
2.1a Stock Purchase Agreement by and among SmithKline Beecham Corporation,
SmithKline Beecham InterCredit BV and Express Scripts, Inc., dated as
of February 9, 1999, and certain related Schedules, incorporated by
reference to Exhibit No. 2.1 to the Company's Current Report on Form
8-K filed February 18, 1999.
2.2 Asset Contribution and Reorganization Agreement dated August 31, 1999
by and among PlanetRx.com, Inc., PRX Holdings, Inc., PRX Acquisition,
Corp., YourPharmacy.com, Inc., and Express Scripts, Inc. (incorporated
by reference to the Exhibit No. 2.1 to PlanetRx's Registration
Statement on Form S-1, as amended (Registration Number 333-82485)).
2.3a Asset Purchase Agreement, dated as of December 19, 2001, by and among
the Company, Phoenix Marketing Group (Holdings), Inc., and Access
Worldwide Communications, Inc.("Access"), incorporated by reference to
Appendix A to Access' Definitive Proxy Statement on Schedule 14A, filed
January 15, 2002.
2.4a Stock and Asset Purchase Agreement dated February 5, 2002 by and among
the Company, Richard O. Ullman and the other Shareholders of National
Prescription Administrators, Inc., Central Fill, Inc., CFI of New
Jersey, Inc., and NPA of New York, IPA, Inc., Richard O. Ullman as
agent for such Shareholders, The Ullman Family Partnership, LP, and
Airport Properties, LLC, incorporated by reference to Exhibit No. 2.1
to the Company's Current Report on Form 8-K filed April 26, 2002.
2.5a Amendment No. 1 to Stock and Asset Purchase Agreement dated April 12,
2002 by and among the Company, Richard O. Ullman and the other
Shareholders of National Prescription Administrators, Inc., Central
Fill, Inc., CFI of New Jersey, Inc., and NPA of New York, IPA, Inc.,
Richard O. Ullman as agent for such Shareholders, The Ullman Family
Partnership, LP, and Airport Properties, LLC, incorporated by reference
to Exhibit No. 2.2 to the Company's Current Report on Form 8-K filed
April 26, 2002.
3.1 Amended and Restated Certificate of Incorporation of the Company,
incorporated by reference to the Company's Annual Report on Form 10-K
for the year ending December 31, 2001.
3.2 Third Amended and Restated Bylaws, incorporated by reference to Exhibit
No. 3.2 to the Company's Annual Report on Form 10-K for the year ending
December 31, 2000.
4.1 Form of Certificate for Common Stock, incorporated by reference to
Exhibit No. 4.1 to the Company's Registration Statement on Form S-1
filed June 9, 1992 (No. 33-46974) (the "Registration Statement").
4.2 Indenture, dated as of June 16, 1999, among the Company, Bankers Trust
Company, as trustee, and Guarantors named therein, incorporated by
reference to Exhibit No. 4.4 to the Company's Registration Statement on
Form S-4 filed August 4, 1999 (No. 333-83133) (the "S-4 Registration
Statement").
4.3 Supplemental Indenture, dated as of October 6, 1999, to Indenture dated
as of June 16, 1999, among the Company, Bankers Trust Company, as
trustee, and Guarantors named therein, incorporated by reference to
Exhibit No. 4.3 to the Company's Annual Report on Form 10-K for the
year ending December 31, 1999.
4.4 Second Supplemental Indenture, dated as of July 19, 2000, to Indenture
dated as of June 16, 1999, among the Company, Bankers Trust Company, as
trustee, and Guarantors named therein, incorporated by reference to
Exhibit No. 4.4 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2000.
4.5 Stockholder and Registration Rights Agreement dated as of October 6,
2000 between the Company and New York Life Insurance Company,
incorporated by reference to Exhibit No. 4.2 to the Company's Amendment
No. 1 to Registration Statement on Form S-3 filed October 17, 2000
(Registration Number 333-47572).
39
4.6 Asset Acquisition Agreement dated October 17, 2000, between NYLIFE
Healthcare Management, Inc., the Company, NYLIFE LLC and New York Life
Insurance Company, incorporated by reference to Exhibit No. 4.3 to the
Company's amendment No. 1 to the Registration Statement on Form S-3
filed October 17, 2000 (Registration Number 333-47572).
4.7 Rights Agreement, dated as of July 25, 2001, between the Corporation
and American Stock Transfer & Trust Company, as Rights Agent, which
includes the Certificate of Designations for the Series A Junior
Participating Preferred Stock as Exhibit A, the Form of Right
Certificate as Exhibit B and the Summary of Rights to Purchase
Preferred Shares as Exhibit C, incorporated by reference to Exhibit No.
4.1 to the Company's Current Report on Form 8-K filed July 31, 2001.
99.1b Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of the
United States Code by the Chief Executive Officer.
99.2b Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of the
United States Code by the Chief Financial Officer.
- -----------------------
a The Company agrees to furnish supplementally a copy of
any omitted schedule to this agreement to the Commission upon request.
b Filed herein.
40