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UNITED
STATES
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 March 31, 2005.
|
o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the transition period from ____________ to
_____________. |
Commission
File Number: 0-20199
EXPRESS
SCRIPTS, INC.
(Exact
name of registrant as specified in its charter)
Delaware
(State
of Incorporation) |
43-1420563
(I.R.S.
employer identification no.)
|
13900
Riverport Dr., Maryland Heights, Missouri
(Address
of principal executive offices) |
63043
(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
__
Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes X
No
__
Common
stock outstanding as of March 31, 2005: |
74,178,639 |
Shares |
EXPRESS
SCRIPTS, INC.
INDEX
Part
I Financial
Information
Item
1. Financial
Statements (unaudited)
a) Unaudited
Consolidated Balance Sheet
b) Unaudited
Consolidated Statement of Operations
c) Unaudited
Consolidated Statement of Changes
in
Stockholders’ Equity
d) Unaudited
Consolidated Statement of Cash Flows
e) Notes to
Unaudited Consolidated Financial Statements
Item
2. Management’s
Discussion and Analysis of Financial
Condition
and Results of Operations
Item
3. Quantitative
and Qualitative Disclosures About
Market
Risk
Item
4. Controls
and Procedures
Part
II Other
Information
Item
1. Legal
Proceedings
Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds
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
Item
6. Exhibits
Signatures
Index to
Exhibits
PART I. FINANCIAL INFORMATION
Item
1. Financial
Statements
EXPRESS
SCRIPTS, INC. |
|
Unaudited
Consolidated Balance Sheet |
|
|
|
|
|
|
|
|
|
March
31, |
|
December
31, |
|
(in
thousands, except share data) |
2005 |
|
2004 |
|
Assets |
|
|
|
|
Current
assets: |
|
|
|
|
Cash
and cash equivalents |
$ |
255,121 |
|
$ |
166,054 |
|
Receivables,
net |
|
1,094,594 |
|
|
1,057,222 |
|
Inventories |
|
158,199 |
|
|
158,775 |
|
Deferred
taxes |
|
38,116 |
|
|
33,074 |
|
Prepaid
expenses and other current assets |
|
23,985 |
|
|
27,892 |
|
Total
current assets |
|
1,570,015 |
|
|
1,443,017 |
|
Property
and equipment, net |
|
171,793 |
|
|
181,166 |
|
Goodwill,
net |
|
1,707,674 |
|
|
1,708,935 |
|
Other
intangible assets, net |
|
237,929 |
|
|
245,270 |
|
Other
assets |
|
21,427 |
|
|
21,698 |
|
Total
assets |
$ |
3,708,838 |
|
$ |
3,600,086 |
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity |
|
|
|
|
|
|
Current
liabilities: |
|
|
|
|
|
|
Claims
and rebates payable |
$ |
1,213,001 |
|
$ |
1,236,775 |
|
Accounts
payable |
|
348,359 |
|
|
322,885 |
|
Accrued
expenses |
|
275,155 |
|
|
231,695 |
|
Current
maturities of long-term debt |
|
22,056 |
|
|
22,056 |
|
Total
current liabilities |
|
1,858,571 |
|
|
1,813,411 |
|
Long-term
debt |
|
356,508 |
|
|
412,057 |
|
Other
liabilities |
|
186,505 |
|
|
178,304 |
|
Total
liabilities |
|
2,401,584 |
|
|
2,403,772 |
|
|
|
|
|
|
|
|
Stockholders’
equity: |
|
|
|
|
|
|
Preferred
stock, $0.01 par value per share, 5,000,000 shares
authorized, |
|
|
|
|
|
|
and
no shares issued and outstanding |
|
- |
|
|
- |
|
Common
Stock, 275,000,000 shares authorized, $0.01 par value; |
|
|
|
|
|
|
shares
issued: 79,716,000 and 79,787,000, respectively; |
|
|
|
|
|
|
shares
outstanding: 74,179,000 and 73,858,000, respectively |
|
798 |
|
|
798 |
|
Additional
paid-in capital |
|
465,209 |
|
|
467,353 |
|
Unearned
compensation under employee compensation plans |
|
(11,817 |
) |
|
(18,177 |
) |
Accumulated
other comprehensive income |
|
8,023 |
|
|
8,266 |
|
Retained
earnings |
|
1,228,033 |
|
|
1,142,757 |
|
|
|
1,690,246 |
|
|
1,600,997 |
|
Common
Stock in treasury at cost, 5,537,000 and 5,929,000 |
|
|
|
|
|
|
shares,
respectively |
|
(382,992 |
) |
|
(404,683 |
) |
Total
stockholders’ equity |
|
1,307,254 |
|
|
1,196,314 |
|
Total
liabilities and stockholders’ equity |
$ |
3,708,838 |
|
$ |
3,600,086 |
|
|
|
|
|
|
|
|
See
accompanying Notes to Unaudited Consolidated Financial Statements
EXPRESS
SCRIPTS, INC.
Unaudited
Consolidated Statement of Operations
|
Three
Months Ended |
|
|
March
31, |
|
(in
thousands, except per share data) |
2005 |
|
2004 |
|
|
|
|
|
|
Revenues
1 |
$ |
3,839,122 |
|
$ |
3,627,815 |
|
Cost
of revenues 1 |
|
3,574,158 |
|
|
3,406,028 |
|
Gross
profit |
|
264,964 |
|
|
221,787 |
|
Selling,
general and administrative |
|
126,631 |
|
|
95,244 |
|
Operating
income |
|
138,333 |
|
|
126,543 |
|
Other
(expense) income: |
|
|
|
|
|
|
Undistributed
loss from joint venture |
|
(653 |
) |
|
(1,340 |
) |
Interest
income |
|
1,600 |
|
|
824 |
|
Interest
expense |
|
(4,747 |
) |
|
(12,710 |
) |
|
|
(3,800 |
) |
|
(13,226 |
) |
Income
before income taxes |
|
134,533 |
|
|
113,317 |
|
Provision
for income taxes |
|
49,257 |
|
|
43,354 |
|
Net
income |
$ |
85,276 |
|
$ |
69,963 |
|
|
|
|
|
|
|
|
Basic
earnings per share: |
$ |
1.16 |
|
$ |
0.90 |
|
|
|
|
|
|
|
|
Weighted
average number of common shares |
|
|
|
|
|
|
outstanding
during the period - Basic EPS |
|
73,634 |
|
|
77,333 |
|
|
|
|
|
|
|
|
Diluted
earnings per share: |
$ |
1.14 |
|
$ |
0.89 |
|
|
|
|
|
|
|
|
Weighted
average number of common shares |
|
|
|
|
|
|
outstanding
during the period - Diluted EPS |
|
74,631 |
|
|
78,571 |
|
1
Excludes estimated retail pharmacy co-payments of $1,483,703 and $1,397,111,
respectively. These are amounts we instructed retail pharmacies to collect from
members. We have no information regarding actual co-payments
collected.
See
accompanying Notes to Unaudited Consolidated Financial Statements
EXPRESS
SCRIPTS, INC. |
|
Unaudited
Consolidated Statement of Changes in Stockholders’
Equity |
|
|
|
|
|
|
|
Number
of Shares |
|
Amount |
|
(in
thousands) |
Common
Stock |
|
Common
Stock |
|
Additional
Paid-in
Capital |
|
Unearned
Compensation Under Employee Compensation Plans |
|
Accumulated
Other Comprehensive Income |
|
Retained
Earnings |
|
Treasury
Stock |
|
Total |
|
Balance
at December 31, 2004 |
|
79,787 |
|
$ |
798 |
|
$ |
467,353 |
|
$ |
(18,177) |
|
$ |
8,266 |
|
$ |
1,142,757 |
|
$ |
(404,683 |
) |
$ |
1,196,314 |
|
Comprehensive
income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
85,276 |
|
|
- |
|
|
85,276 |
|
Other comprehensive
income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
translation adjustment |
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(367) |
|
|
- |
|
|
- |
|
|
(367 |
) |
Realized and unrealized gains
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
on derivative financial |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
instruments, net of taxes |
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
124 |
|
|
- |
|
|
- |
|
|
124 |
|
Comprehensive
income |
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(243) |
|
|
85,276 |
|
|
- |
|
|
85,033 |
|
Treasury stock
acquired |
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
(487 |
) |
|
(487 |
) |
Changes in stockholders’
equity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
related to employee stock
plans |
|
(71) |
|
|
- |
|
|
(2,144) |
|
|
6,360 |
|
|
- |
|
|
- |
|
|
22,178 |
|
|
26,394 |
|
Balance
at March 31, 2005 |
|
79,716 |
|
$ |
798 |
|
$ |
465,209 |
|
$ |
(11,817) |
|
$ |
8,023 |
|
$ |
1,228,033 |
|
$ |
(382,992 |
) |
$ |
1,307,254 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying Notes to Unaudited Consolidated Financial Statements
EXPRESS
SCRIPTS, INC. |
|
Unaudited
Consolidated
Statement of Cash Flows |
|
|
|
|
Three
Months Ended |
|
|
March
31, |
|
(in
thousands) |
2005 |
|
2004 |
|
Cash
flows from operating activities: |
|
|
|
|
Net
income |
$ |
85,276 |
|
$ |
69,963 |
|
Adjustments
to reconcile net income to net cash |
|
|
|
|
|
|
provided
by operating activities, excluding |
|
|
|
|
|
|
the
effect of the acquisition: |
|
|
|
|
|
|
Depreciation
and amortization |
|
19,777 |
|
|
15,705 |
|
Non-cash
adjustments to net income |
|
23,617 |
|
|
21,764 |
|
Net
changes in operating assets and liabilities |
|
9,480 |
|
|
(9,647 |
) |
Net
cash provided by operating activities |
|
138,150 |
|
|
97,785 |
|
|
|
|
|
|
|
|
Cash
flows from investing activities: |
|
|
|
|
|
|
Purchases
of property and equipment |
|
(5,938 |
) |
|
(7,739 |
) |
Acquisition,
net of cash acquired, and investment in joint venture |
|
(14 |
) |
|
(331,810 |
) |
Loan
repayment from (loan to) PCA |
|
2,188 |
|
|
(1,000 |
) |
Other |
|
4
|
|
|
95 |
|
Net
cash used in investing activities |
|
(3,760 |
) |
|
(340,454 |
) |
|
|
|
|
|
|
|
Cash
flows from financing activities: |
|
|
|
|
|
|
Proceeds
from long-term debt |
|
- |
|
|
675,000 |
|
Repayment
of long-term debt |
|
(5,500 |
) |
|
(525,000 |
) |
Repayment
of revolving credit line, net |
|
(50,000 |
) |
|
- |
|
Treasury
stock acquired |
|
- |
|
|
(9,891 |
) |
Deferred
financing fees |
|
- |
|
|
(6,029 |
) |
Net
proceeds from employee stock plans |
|
10,352
|
|
|
13,541 |
|
Net
cash (used in) provided by financing activities |
|
(45,148 |
) |
|
147,621 |
|
|
|
|
|
|
|
|
Effect
of foreign currency translation adjustment |
|
(175 |
) |
|
(135 |
) |
|
|
|
|
|
|
|
Net
increase (decrease) in cash and cash equivalents |
|
89,067
|
|
|
(95,183 |
) |
Cash
and cash equivalents at beginning of period |
|
166,054
|
|
|
396,040 |
|
Cash
and cash equivalents at end of period |
$ |
255,121 |
|
$ |
300,857 |
|
|
|
|
|
|
|
|
See
accompanying Notes to Unaudited Consolidated Financial Statements
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 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, 2004 filed with
the Securities and Exchange Commission on March 3, 2005. For a full description
of our accounting policies, please refer to the Notes to Consolidated Financial
Statements included in our Annual Report on Form 10-K for the year ended
December 31, 2004.
We
believe 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 March 31, 2005, the
Unaudited Consolidated Statements of Operations for the three months ended March
31, 2005 and 2004, the Unaudited Consolidated Statement of Changes in
Stockholders’ Equity for the three months ended March 31, 2005, and the
Unaudited Consolidated Statements of Cash Flows for the three months ended March
31, 2005 and 2004. Operating results for the three months ended March 31, 2005
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2005.
REVENUE
RECOGNITION
Revenues
from our pharmacy benefit management (“PBM”) segment are earned by dispensing
prescriptions from our home delivery pharmacies, processing claims for
prescriptions filled by retail pharmacies in our networks, and by providing
services to drug manufacturers, including administration of discount programs
(see also “—Rebate Accounting”).
Revenues
from dispensing prescriptions from our home delivery pharmacies, which include
the co-payment received from members of the health plans we serve, are recorded
when prescriptions are shipped. At the time of shipment, our earnings process is
complete: the obligation 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.
Revenues
related to the sale of prescription drugs by retail pharmacies in our networks
consist of the amount the client has contracted to pay us (which excludes the
co-payment) for the dispensing of such drugs together with any associated
administrative fees. These revenues are recognized when the claim is processed.
When we independently have a contractual obligation to pay our network pharmacy
providers for benefits provided to our clients’ members, we act as a principal
in the arrangement and we include the total payments we have contracted to
receive from these clients as revenue, and payments we make to the network
pharmacy providers as cost of revenue in compliance with Emerging Issues Task
Force (“EITF”) Issue No. 99-19, “Reporting Gross Revenue as a Principal vs. Net
as an Agent.” When a prescription is presented by a member to a retail pharmacy
within our network, we are solely responsible for confirming member eligibility,
performing drug utilization review, reviewing for drug-to-drug interactions,
performing clinical intervention, which may involve a call to the member’s
physician, communicating plan provisions to the pharmacy, directing payment to
the pharmacy and billing the client for the amount they are contractually
obligated to pay us for the prescription dispensed, as specified within our
client contracts. We also provide benefit design and formulary consultation
services to clients. We have separately negotiated contractual relationships
with our clients and with network pharmacies, and under our contracts with
pharmacies we assume the credit risk of our clients’ ability to pay for drugs
dispensed by these pharmacies to clients’ members. Our clients are not obligated
to pay the pharmacies as we are primarily obligated to pay retail pharmacies in
our network the contractually agreed upon amount for the prescription dispensed,
as specified within our provider contracts. In addition, under most of our
client contracts, we realize a positive or negative margin represented by the
difference between the negotiated ingredient costs we will receive from our
clients and the separately negotiated ingredient costs we will pay to our
network pharmacies. These factors indicate we are a principal as defined by EITF
99-19 and, as such, we record ingredient cost billed to clients in revenue and
the corresponding ingredient cost paid to network pharmacies in cost of
revenues.
If we
merely administer a client’s network pharmacy contracts, to which we are not a
party and under which we do not assume credit risk, we record only our
administrative fees as revenue. For these clients, we earn an administrative fee
for collecting payments from the client and remitting the corresponding amount
to the pharmacies in the client’s network. In these transactions we act as a
conduit for the client. Because we are not the principal in these transactions,
drug ingredient cost is not included in our revenues or in our cost of
revenues.
In retail
pharmacy transactions, amounts paid to pharmacies and amounts charged to clients
are always exclusive of the applicable co-payment. Under our pharmacy
agreements, the pharmacy is solely obligated to collect the co-payment from the
member based on the amount we advise them to collect. We have no information
regarding actual co-payments collected. As such, we do not include member
co-payments to retail pharmacies in our revenue or in our cost of revenue.
Retail pharmacy co-payments, which we instructed retail pharmacies to collect
from members, of $1.5 billion and $1.4 billion for the three months ended March
31, 2005 and 2004, respectively, are excluded from revenues and cost of
revenues.
We bill
our clients based upon the billing schedules established in client contracts. At
the end of a period, any unbilled revenues related to the sale of prescription
drugs that have been adjudicated with retail pharmacies are estimated based on
the amount we will pay to the pharmacies and historical gross margin. Those
amounts due from our clients are recorded as revenue as they are contractually
due to us for past transactions. Adjustments are made to these estimated
revenues to reflect actual billings at the time clients are billed;
historically, these adjustments have not been material.
Certain
implementation and other fees paid to clients upon the initiation of a
contractual agreement are considered an integral part of overall contract
pricing and are recorded as a reduction of revenue. Where they are refundable
upon early termination of the contract, these payments are capitalized and
amortized as a reduction of revenue on a straight-line basis over the life of
the contract.
Revenues
from our non-PBM segment, Pharma Business Solutions (“PBS”), are derived from
the distribution of pharmaceuticals requiring special handling or packaging
where we have been selected by the pharmaceutical manufacturer as part of a
limited distribution network, the distribution of pharmaceuticals through
Patient Assistance Programs where we receive a fee from the pharmaceutical
manufacturer for administrative and pharmacy services for the delivery of
certain drugs free of charge to doctors for their indigent patients, sample
fulfillment and sample accountability services. Revenues earned by PBS include
administrative fees received from pharmaceutical manufacturers for dispensing or
distributing consigned pharmaceuticals requiring special handling or packaging
and administrative fees for verification of practitioner licensure and
distribution of consigned drug samples to doctors based on orders received from
pharmaceutical sales representatives. We also administer sample card programs
for certain manufacturers and include the ingredient costs of those drug samples
dispensed from retail pharmacies in PBS revenues, and the associated costs for
these sample card programs in cost of revenues. Because manufacturers are
independently obligated to pay us and we have an independent contractual
obligation to pay our network pharmacy providers for free samples dispensed to
patients under sample card programs, 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.
REBATE
ACCOUNTING
We
administer two rebate programs through which we receive rebates and
administrative fees from pharmaceutical manufacturers. Rebates earned for the
administration of these programs, performed in conjunction with claim processing
and home delivery services provided to clients, are recorded as a reduction of
cost of revenue and the portion of the rebate payable to customers is treated as
a reduction of revenue. When we earn rebates and administrative fees in
conjunction with formulary management services, but do not process the
underlying claims, we record rebates received from manufacturers, net of the
portion payable to customers, in revenue. We record rebates and administrative
fees receivable from the manufacturer and payable to clients when the
prescriptions covered under contractual agreements with the manufacturers are
dispensed; these amounts are not dependent upon future pharmaceutical sales.
With
respect to rebates based on actual market share performance, we estimate rebates
and the associated receivable from pharmaceutical manufacturers quarterly based
on our estimate of the number of rebatable prescriptions and the rebate per
prescription. The portion of rebates payable to clients is estimated quarterly
based on historical and/or anticipated sharing percentages and our estimate of
rebates receivable from pharmaceutical manufacturers. These estimates are
adjusted to actual when amounts are received from manufacturers and the portion
payable to clients is paid.
With
respect to rebates that are not based on market share performance, no estimation
is required because the manufacturer billing amounts and the client portion are
determinable when the drug is dispensed. We pay all or a contractually agreed
upon portion of such rebates to our clients.
COST
OF REVENUES
Cost of
revenues includes product costs, network pharmacy claims payments and other
direct costs associated with dispensing prescriptions, including shipping and
handling (see also “—Revenue Recognition” and “—Rebate
Accounting”).
CASH
AND CASH EQUIVALENTS
Cash and
cash equivalents include cash on hand and investments with original maturities
of three months or less. We have banking relationships resulting in certain cash
disbursement accounts being maintained by banks not holding our cash
concentration accounts. As a result, cash disbursement accounts carrying
negative book balances of $129.5 million and $160.3 million (representing
outstanding checks not yet presented for payment) have been reclassified to
claims and rebates payable, accounts payable and accrued expenses at March 31,
2005 and December 31, 2004, respectively. This reclassification restores
balances to cash and current liabilities for liabilities to our vendors which
have not been defeased. No overdraft or unsecured short-term loan exists in
relation to these negative balances.
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 network pharmacies and
historical gross margin. Estimates are adjusted to actual at the time of
billing. 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. Historically, adjustments to our estimates have been immaterial.
Included
in receivables, net, as of March 31, 2005 and December 31, 2004, is an allowance
for doubtful accounts of $34.3 million and $31.4 million,
respectively.
As of
March 31, 2005 and December 31, 2004, unbilled receivables were $669.1 million
and $664.5 million, 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.
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 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. Absent events or circumstances indicating an
impairment of goodwill, we perform an annual goodwill impairment test during the
fourth quarter. During the fourth quarter of 2004 we recorded a reserve against
our receivable from Pharmacy Care Alliance (“PCA”) (see Note 3). No other
impairments existed as of March 31, 2005 and December 31, 2004.
SELF-INSURANCE
RESERVES
We
maintain insurance coverage for claims that arise in the normal course of
business. Where insurance coverage is not available, or, in our judgment, is not
cost-effective, we maintain self-insurance reserves to reduce our exposure to
future legal costs, settlements and judgments. Self-insured losses are accrued
based upon estimates of the aggregate liability for the costs of uninsured
claims incurred using certain actuarial assumptions followed in the insurance
industry and our historical experience (see Note 7). It is not possible to
predict with certainty the outcome of these claims, and we can give no
assurances that any losses, in excess of our insurance and any self-insurance
reserves, will not be material.
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 we grant options 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. In December 2004, the Financial Accounting Standards Board (“FASB”)
revised FAS 123 (“FAS 123R”), “Share-Based Payment”, which replaces FAS 123,
“Accounting for Stock-Based Compensation”, and supersedes APB 25. FAS 123R will
require compensation cost related to share-based payment transactions to be
recognized in the financial statements. We will adopt FAS 123R using the
modified prospective method beginning January 1, 2006 (see “New Accounting
Guidance”).
The
following table shows stock-based compensation expense included in net income
and pro forma stock-based compensation expense, net income and earnings per
share had we elected to record compensation expense based on the estimated fair
value of options at the grant date for the three months ended March 31, 2005 and
2004 (see also Note 6):
|
Three
months ended March 31, |
|
(in
thousands, except per share data) |
2005 |
|
2004 |
|
|
|
|
|
Net
income, as reported(1) |
$ |
85,276 |
|
$ |
69,963 |
|
Less:
Employee stock-based compensation expense |
|
|
|
|
|
|
determined
using fair-value based method for |
|
|
|
|
|
|
stock-based
awards, net of tax(2) |
|
(3,181 |
) |
|
(983 |
) |
Pro
forma net income |
$ |
82,095 |
|
$ |
68,980 |
|
|
|
|
|
|
|
|
Basic
earnings per share |
|
|
|
|
|
|
As
reported |
$ |
1.16 |
|
$ |
0.90 |
|
Pro
forma |
|
1.11 |
|
|
0.89 |
|
|
|
|
|
|
|
|
Diluted
earnings per share |
|
|
|
|
|
|
As
reported |
$ |
1.14 |
|
$ |
0.89 |
|
Pro
forma |
|
1.10 |
|
|
0.88 |
|
(1) |
Net
income, as reported, includes stock-based compensation expense for the
three months ended March 31, 2005 and 2004 of $3.6 million ($5.7
million pre-tax) and $1.4 million ($2.2 million pre-tax),
respectively, related to restricted shares of Common Stock awarded to
certain of our officers and employees. |
(2) |
The
increase in pro forma compensation expense is due to the forfeiture of
options during the first quarter of 2004 which resulted in a reduction of
our pro forma compensation expense of $1.4 million ($2.3 million
pre-tax) |
NEW
ACCOUNTING GUIDANCE
In
December 2004, the Financial Accounting Standards Board (“FASB”) revised FAS
123. FAS 123R will require compensation cost related to share-based payment
transactions to be recognized in the financial statements. As permitted by FAS
123, we currently follow the guidance of APB 25, which allows the use of the
intrinsic value method of accounting to value share-based payment transactions
with employees. FAS 123R requires measurement of the cost of share-based payment
transactions to employees at the fair value of the award on the grant date and
recognition of expense over the requisite service or vesting period. FAS 123R
allows implementation using a modified version of prospective application, under
which compensation expense for the unvested portion of previously granted awards
and all new awards will be recognized on or after the date of adoption. FAS 123R
also allows companies to implement by restating previously issued financial
statements, basing the amounts on the expense previously calculated and reported
in their pro forma footnote disclosures required under FAS 123. We will adopt
FAS 123R using the modified prospective method beginning January 1, 2006. The
impact of adopting FAS 123R on our consolidated results of operations is not
expected to differ materially from the pro forma disclosures currently required
by FAS 123 (see “Employee stock-based compensation”).
Note
2 - Changes in business
On
January 30, 2004, we acquired the outstanding capital stock of CuraScript, for
approximately $333.4 million, which includes a purchase price adjustment
for closing working capital and transaction costs. CuraScript is one of the
nation’s largest specialty pharmacy services companies and has enhanced our
ability to provide comprehensive pharmaceutical management services to our
clients and their members. CuraScript operates seven specialty pharmacies
throughout the United States and serves over 175 managed care organizations, 30
Medicaid programs and the Medicare program. The transaction was accounted for
under the provisions of FAS 141, “Business Combinations.” The purchase price has
been allocated based upon the estimated fair value of net assets acquired at the
date of the acquisition. A portion of the excess of purchase price over tangible
net assets acquired has been allocated to intangible assets, consisting of
customer contracts in the amount of $28.7 million and non-competition agreements
in the amount of $2.7 million, which are being amortized using the straight-line
method over estimated useful lives of ten years and three years, respectively.
These assets are included in other intangible assets. In addition, the excess of
purchase price over tangible net assets and identified intangible assets
acquired has been allocated to goodwill in the amount of $284.9 million and
trade names in the amount of $1.3 million, which are not being
amortized.
Note
3 - Medicare discount card program
In
January 2004, we entered into an agreement to provide PBM services for the
Medicare discount program of PCA, a nonstock, not-for-profit entity jointly
controlled by the National Association of Chain Drugstores (“NACDS”) and us. Our
PBM services include the negotiation of discounts from individual retailers and
pharmaceutical manufacturers, the enrollment of cardholders and the processing
of prescription claims.
During
2004, we entered into a lending agreement with PCA, whereby we committed to lend
up to $17.0 million to PCA in the form of a revolving line of credit
available through December 31, 2005. Requests for borrowings on the revolving
line of credit require the unanimous consent of PCA’s board of directors, which
consists of representatives from NACDS and from our management team, or its
designated representatives. PCA will utilize the revolving line of credit to
fund its operating expenditures. NACDS has agreed to guarantee $2.0 million on
the revolving line of credit. As of March 31, 2005, we have loaned PCA
$14.6 million, and have received $2.9 million in interest and principal
payments.
In regard
to the revolving line of credit extended to PCA, the collectibility of any
unsecured borrowings will be a function of PCA’s success in enrolling new
members for its Medicare discount program. Through March 31, 2005,
enrollment has fallen short of expectations, with approximately 225,000 members
enrolled to date. In addition, utilization has been lower than expected. As a
result, the outstanding balance of our receivable from PCA is fully
reserved.
Note
4 - Goodwill and other intangibles
The
following is a summary of our goodwill and other intangible assets (amounts in
thousands).
|
March
31, 2005 |
|
December
31, 2004 |
|
|
Gross
Carrying Amount |
|
Accumulated
Amortization |
|
Gross
Carrying Amount |
|
Accumulated
Amortization |
|
Goodwill |
|
|
|
|
|
|
|
|
PBM
(1) |
$ |
1,792,552 |
|
$ |
107,014 |
|
$ |
1,793,830 |
|
$ |
107,031 |
|
Non-PBM |
|
22,136
|
|
|
- |
|
|
22,136 |
|
|
- |
|
|
$ |
1,814,688 |
|
$ |
107,014 |
|
$ |
1,815,966 |
|
$ |
107,031 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
intangible assets |
|
|
|
|
|
|
|
|
|
|
|
|
PBM
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer
contracts (1) |
$ |
294,006 |
|
$ |
88,821 |
|
$ |
294,063 |
|
$ |
85,067 |
|
Other
(1) |
|
72,710
|
|
|
44,165
|
|
|
72,346 |
|
|
40,408 |
|
|
|
366,716
|
|
|
132,986
|
|
|
366,409 |
|
|
125,475 |
|
Non-PBM |
|
|
|
|
|
|
|
|
|
|
|
|
Customer
contracts |
|
4,000 |
|
|
1,542
|
|
|
4,000 |
|
|
1,416 |
|
Other |
|
1,880 |
|
|
139 |
|
|
1,880 |
|
|
128 |
|
|
|
5,880 |
|
|
1,681
|
|
|
5,880 |
|
|
1,544 |
|
Total
other intangible assets |
$ |
372,596 |
|
$ |
134,667 |
|
$ |
372,289 |
|
$ |
127,019 |
|
(1)
In the first quarter of 2005 we finalized the allocation of the CuraScript
purchase price to tangible and intangible net assets resulting in a $1.1 million
decrease in goodwill (See Note 2). Changes in goodwill and accumulated
amortization from December 31, 2004 to March 31, 2005 are also a result of
changes in foreign currency exchange rates.
The
aggregate amount of amortization expense of other intangible assets was $7.5
million and $6.7 million for the three months ended March 31, 2005 and 2004,
respectively. The future aggregate amount of amortization expense of other
intangible assets is approximately $22.8 million for 2005, $24.2 million for
2006, $20.2 million for 2007, $17.2 million for 2008, and $15.8 million for
2009. The weighted average amortization period of intangible assets subject to
amortization is 17 years in total, and by major intangible class is 8 to 20
years for customer contracts and six years for other intangible
assets.
Note
5 - 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 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
March
31, |
|
2005 |
2004 |
Weighted
average number of common shares |
|
|
|
|
|
|
outstanding
during the period - Basic EPS |
|
73,634 |
|
|
77,333 |
|
Outstanding
stock options |
|
908 |
|
|
1,050 |
|
Executive
deferred compensation plan |
|
16 |
|
|
43 |
|
Restricted
stock awards |
|
73 |
|
|
145 |
|
Weighted
average number of common shares |
|
|
|
|
|
|
outstanding
during the period - Diluted EPS |
|
74,631 |
|
|
78,571 |
|
The above
shares are all calculated under the “treasury stock” method in accordance with
FAS 128, “Earnings Per Share.”
Note
6 - Stock-based compensation plans
We apply
APB 25 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, our net income and earnings per share for the three
months ended March 31, 2005 and 2004 would have been $82.1 million, or $1.10 per
diluted share and $69.0 million, or $0.88 per diluted share, respectively (see
also Note 1).
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 Ended
March
31, |
Three
Months Ended
March
31, |
|
|
2005 |
2004 |
|
Expected
life of option |
3-5
years |
3-5
years |
|
Risk-free
interest rate |
3.48%-4.05% |
1.97%-3.24% |
|
Expected
volatility of stock |
40% |
47% |
|
Expected
dividend yield |
None |
None |
A summary
of the status of our fixed stock option plans as of March 31, 2005 and 2004, and
changes during the periods ending on those dates are presented
below.
|
March
31, 2005 |
|
March
31, 2004 |
|
(share
data in thousands) |
Shares |
Weighted-Average
Exercise
Price |
|
Shares |
Weighted-Average
Exercise
Price |
|
Outstanding
at beginning of year |
|
3,585 |
|
$ |
43.71 |
|
|
4,016 |
|
$ |
35.96 |
|
Granted |
|
545 |
|
$ |
77.05 |
|
|
430 |
|
$ |
73.31 |
|
Exercised |
|
(370 |
) |
$ |
34.88 |
|
|
(459 |
) |
$ |
29.67 |
|
Forfeited/Cancelled |
|
(21 |
) |
$ |
51.30 |
|
|
(133 |
) |
$ |
51.79 |
|
Outstanding
at end of period |
|
3,739 |
|
$ |
49.40 |
|
|
3,854 |
|
$ |
40.33 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
exercisable at period end |
|
2,350 |
|
|
|
|
|
2,381 |
|
|
|
|
Weighted-average
fair value of
options
granted during the year |
$ |
27.34 |
|
|
|
|
$ |
28.76 |
|
|
|
|
The
following table summarizes information about fixed stock options outstanding at
March 31, 2005 (share
data in thousands):
|
|
Options
Outstanding |
|
Options
Exercisable |
Range
of
Exercise
Prices |
Number
Outstanding at 3/31/05 |
Weighted-Average
Remaining Contractual Life |
Weighted-Average
Exercise Price |
|
Number
Exercisable
at
3/31/05 |
Weighted-
Average
Exercise Price |
|
$7.44
- 21.20 |
|
333 |
|
|
2.2 |
|
$ |
17.16 |
|
|
|
323 |
|
$ |
17.10 |
|
|
25.81
- 36.81 |
|
942 |
|
|
4.5 |
|
|
30.01 |
|
|
|
940 |
|
|
30.01 |
|
|
39.24
- 54.19 |
|
1,086 |
|
|
4.0 |
|
|
45.21 |
|
|
|
869 |
|
|
44.44 |
|
|
59.47
- 75.24 |
|
801 |
|
|
5.9 |
|
|
71.12 |
|
|
|
218 |
|
|
71.39 |
|
|
77.28
- 79.36 |
|
577 |
|
|
6.8 |
|
|
77.44 |
|
|
|
-
|
|
|
-
|
|
|
|
|
3,739 |
|
|
4.8 |
|
$ |
49.40 |
|
|
|
2,350 |
|
$ |
37.41 |
|
Note
7 - Contingencies
We accrue
self-insurance reserves based upon estimates of the aggregate liability of claim
costs in excess of our insurance coverage. Reserves are estimated using certain
actuarial assumptions followed in the insurance industry and our historical
experience (see Note 1, “Self-insurance reserves”). The majority of these claims
are legal claims and our liability esimate is primarily related to the cost to
defend these claims. We do not accrue for settlements, judgments, monetary fines
or penalties until such amounts are probable and estimable, in compliance with
FAS 5, “Accounting for Contingencies.” Under FAS 5, if the range of possible
loss is broad, the liability accrual should be based on the lower end of the
range.
While we
believe that our services and business practices are in compliance with
applicable laws, rules and regulations in all material respects, we cannot
predict the outcome of these matters at this time. An unfavorable outcome in one
or more of these matters could result in the imposition of judgments, monetary
fines or penalties, or injunctive or administrative remedies. We can give no
assurance that such judgments, fines and remedies, and future costs associated
with legal matters would not have a material adverse effect on our financial
condition, our consolidated results of operations or our consolidated cash
flows.
Note
8 - Segment reporting
We report segments on the basis of services offered and have determined that we
have two reportable segments: PBM services and non-PBM services. Our PBM
operating results include those of CuraScript from January 30, 2004, the date of
acquisition. Our domestic and Canadian PBM operating segments have similar
characteristics and as such have been aggregated into a single PBM reporting
segment. Our Non-PBM operating segment includes our Specialty Distribution
Services and Phoenix Marketing Group service lines.
Operating
income is the measure used by our chief operating decision maker to assess the
performance of each of our operating segments. The following table presents
information about our reportable segments, including a reconciliation of
operating income to income before income taxes, for the three months ended March
31, 2005 and 2004:
(in
thousands) |
PBM |
|
Non-PBM |
|
Total |
|
For
the three months ended March 31, 2005 |
|
|
|
|
|
|
Product
revenue: |
|
|
|
|
|
|
Network
revenues |
$ |
2,301,264 |
|
$ |
- |
|
$ |
2,301,264 |
|
Home
delivery revenues |
|
1,440,086 |
|
|
- |
|
|
1,440,086 |
|
Other
revenues |
|
- |
|
|
35,419 |
|
|
35,419 |
|
Service
revenues |
|
33,827 |
|
|
28,526 |
|
|
62,353 |
|
Total
revenues |
|
3,775,177 |
|
|
63,945 |
|
|
3,839,122 |
|
Depreciation
and amortization expense |
|
18,404 |
|
|
1,373 |
|
|
19,777 |
|
Operating
income |
|
129,974 |
|
|
8,359 |
|
|
138,333 |
|
Undistributed
loss from joint venture |
|
|
|
|
|
|
|
(653 |
) |
Interest
income |
|
|
|
|
|
|
|
1,600 |
|
Interest
expense |
|
|
|
|
|
|
|
(4,747 |
) |
Income
before income taxes |
|
|
|
|
|
|
|
134,533 |
|
Capital
expenditures |
|
3,904 |
|
|
2,034 |
|
|
5,938 |
|
(in
thousands) |
PBM |
|
Non-PBM |
|
Total |
|
For
the three months ended March 31, 2004 |
|
|
|
|
|
|
Product
revenue: |
|
|
|
|
|
|
Network
revenues |
$ |
2,337,254 |
|
$ |
- |
|
$ |
2,337,254 |
|
Home
delivery revenues |
|
1,213,080 |
|
|
- |
|
|
1,213,080 |
|
Other
revenues |
|
- |
|
|
27,963 |
|
|
27,963 |
|
Service
revenues |
|
21,963 |
|
|
27,555 |
|
|
49,518 |
|
Total
revenues |
|
3,572,297 |
|
|
55,518 |
|
|
3,627,815 |
|
Depreciation
and amortization expense |
|
14,754 |
|
|
951 |
|
|
15,705 |
|
Operating
income |
|
118,819 |
|
|
7,724 |
|
|
126,543 |
|
Undistributed
loss from joint venture |
|
|
|
|
|
|
|
(1,340 |
) |
Interest
income |
|
|
|
|
|
|
|
824 |
|
Interest
expense |
|
|
|
|
|
|
|
(12,710 |
) |
Income
before income taxes |
|
|
|
|
|
|
|
113,317 |
|
Capital
expenditures |
|
4,018 |
|
|
3,721 |
|
|
7,739 |
|
|
|
|
|
|
|
|
|
|
|
As
of March 31, 2005 |
|
|
|
|
|
|
|
|
|
Total
assets |
$ |
3,557,458 |
|
$ |
151,380 |
|
$ |
3,708,838 |
|
Investment
in equity method investees |
|
765 |
|
|
- |
|
|
765 |
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2004 |
|
|
|
|
|
|
|
|
|
Total
assets |
$ |
3,460,426 |
|
$ |
139,660 |
|
$ |
3,600,086 |
|
Investment
in equity method investees |
|
808 |
|
|
- |
|
|
808 |
|
PBM
product revenue consists of revenues from the dispensing of prescription drugs
from our home delivery pharmacies and revenues from the sale of prescription
drugs by retail pharmacies in our retail pharmacy networks. Non-PBM product
revenues consist of revenues from certain specialty distribution activities. PBM
service revenue includes administrative fees associated with the administration
of retail pharmacy networks contracted by certain clients, market research
programs and informed decision counseling services. Non-PBM service revenue
includes revenues from certain specialty distribution services, and sample
distribution and accountability services.
Revenues
earned by our Canadian PBM totaled $7.6 million and $6.9 million for the three
months ended March 31, 2005 and 2004, respectively. All other revenues are
earned in the United States. Long-lived assets of our Canadian PBM (consisting
primarily of fixed assets and goodwill) totaled $35.8 million and $36.1 million
as of March 31, 2005 and December 31, 2004, respectively. All other long-lived
assets are domiciled in the United States.
Item
2. Management’s
Discussion And Analysis Of Financial Condition And Results Of
Operations
Information
that we have included or incorporated by reference in this Quarterly Report on
Form 10-Q, and information that may be contained in our other filings with the
Securities and Exchange Commission (the “SEC”) and our press releases or other
public statements, contain or may contain forward-looking statements. These
forward-looking statements include, among others, statements of our plans,
objectives, expectations or intentions.
Our
forward-looking statements involve risks and uncertainties. Our actual results
may differ significantly from those projected or suggested in any
forward-looking statements. We do not undertake any obligation to release
publicly any revisions to such forward-looking statements to reflect events or
circumstances occurring after the date hereof or to reflect the occurrence of
unanticipated events. Factors that might cause such a difference to occur
include, but are not limited to:
|
• |
costs
of and adverse
results in litigation, including a number of pending class action cases
that challenge certain of our business
practices |
|
• |
risks
arising from investigations of certain PBM practices and pharmaceutical
pricing, marketing and distribution practices currently being conducted by
the U.S. Attorney’s offices in Philadelphia and Boston, and by other
regulatory agencies including the Department of Labor, and various state
attorneys general |
|
• |
risks
and uncertainties
regarding the implementation and the ultimate terms of the Medicare Part D
prescription drug benefit, including financial risks to us if we
participate in the program on a risk-bearing basis and risks of client or
member losses to other providers under Medicare Part
D |
|
• |
risks
associated with our acquisitions (including our acquisition of
CuraScript), which include integration risks and costs, risks of client
retention and repricing of client contracts, and risks associated with the
operations of acquired businesses |
|
• |
risks
associated with our ability to maintain growth rates, or to control
operating or capital costs |
|
• |
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 |
|
• |
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 |
|
• |
adverse
results in regulatory matters, the adoption of new legislation or
regulations (including increased costs associated with compliance with new
laws and regulations), more aggressive enforcement of existing legislation
or regulations, or a change in the interpretation of existing legislation
or regulations |
|
• |
increased
compliance risks relating to our contracts with the DoD TRICARE Plan and
various state governments and agencies |
|
• |
the
possible loss, or adverse modification of the terms, of contracts with
pharmacies in our retail pharmacy
networks |
|
• |
risks
associated with the possible loss, or adverse modification of the terms
of, contracts with pharmacies in our retail pharmacy
network |
|
• |
risks
associated with the use and protection of the intellectual property we use
in our business |
|
• |
risks
associated with our leverage and debt service obligations, including the
effect of certain covenants in our borrowing agreements |
|
• |
risks
associated with our ability to continue to develop new products, services
and delivery channels |
|
• |
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 |
|
• |
increase
in credit risk relative to our clients due to adverse economic
trends |
|
• |
risks
associated with changes in average wholesale prices which could reduce our
pricing and margins |
|
• |
risks
associated with our inability to attract and retain qualified
personnel |
|
• |
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,
2004.
OVERVIEW
As one of
the largest full-service pharmacy benefit management (“PBM”) companies, we
provide health care management and administration services on behalf of our
clients, which include health maintenance organizations, health insurers,
third-party administrators, employers, union-sponsored benefit plans and
government health programs. Our integrated PBM services include network claims
processing, home delivery services, specialty home delivery claim fulfillment,
benefit design consultation, drug utilization review, formulary management,
disease management, and drug data analysis services. We also provide non-PBM
services, through our Pharma Business Solutions unit, which include distribution
of specialty pharmaceuticals requiring special handling or packaging where we
have been selected by the pharmaceutical manufacturer as part of a limited
distribution network; distribution of pharmaceuticals to low-income patients
through manufacturer-sponsored and company-sponsored generic patient assistance
programs, and distribution of sample units to physicians and verification of
practitioner licensure.
We report
two segments, PBM and non-PBM. We derive revenues primarily from the sale of PBM
services in the United States and Canada. Revenue generated by our segments can
be classified as either tangible product revenue or service revenue. We earn
tangible product revenue from the sale of prescription drugs by retail
pharmacies in our retail pharmacy networks and from dispensing prescription
drugs from our home delivery pharmacies. Service revenue includes administrative
fees associated with the administration of retail pharmacy networks contracted
by certain clients, market research programs, informed decision counseling
services, certain specialty distribution services, and sample fulfillment and
sample accountability services. Tangible product revenue generated through both
our PBM and non-PBM segments represented 98.4% of revenues for the three months
ended March 31, 2005 as compared to 98.6% for the same period of
2004.
On
January 30, 2004, we acquired the outstanding capital stock of CuraScript
Pharmacy, Inc. and CuraScript PBM Services, Inc. (collectively, “CuraScript”),
for approximately $333.4 million which includes a purchase price adjustment for
closing working capital and transaction costs. Consequently, our PBM operating
results include those of CuraScript from January 30, 2004.
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. Our estimates and assumptions are based
upon a combination of historical information and various other assumptions
believed to be reasonable under the particular circumstances. Actual results may
differ from our estimates. 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, 2004, filed with the
SEC on March 3, 2005.
REBATE
ACCOUNTING
ACCOUNTING
POLICY
We
administer a rebate program based on actual market share performance in which
rebates and the associated receivable from pharmaceutical manufacturers are
estimated quarterly based on our estimate of the number of rebatable
prescriptions and the rebate per prescription. The portion of rebates payable to
clients is estimated quarterly based on historical allocation percentages and
our estimate of rebates receivable from pharmaceutical manufacturers. With
respect to our market share rebate program, estimates are adjusted to actual
when amounts are received from manufacturers and the portion payable to clients
is paid.
FACTORS
AFFECTING ESTIMATE
The
factors that could impact our estimates of rebates, rebates receivable and
rebates payable are as follows:
· |
Differences
between the actual and the estimated number of rebatable
prescriptions; |
· |
Differences
between estimated aggregate allocation percentages and actual rebate
allocation percentages calculated on a client-by-client
basis; |
· |
Differences
between actual and estimated market share of a manufacturer’s brand drug
for our clients as compared to the national market
share; |
· |
Drug
patent expirations; and |
· |
Changes
in drug utilization patterns. |
Historically,
adjustments to our original estimates have been relatively
immaterial.
UNBILLED
REVENUE AND RECEIVABLES
ACCOUNTING
POLICY
We bill
our clients based upon the billing schedules established in client contracts. At
the end of a period, any unbilled revenues related to the sale of prescription
drugs that have been adjudicated with retail pharmacies are estimated based on
the amount we will pay to the pharmacies and historical gross
margin.
FACTORS
AFFECTING ESTIMATE
Unbilled
amounts are estimated based on historical margin. Historically, adjustments to
our original estimates have been immaterial. Significant differences between
actual and estimated margin could impact subsequent adjustments.
ALLOWANCE
FOR DOUBTFUL ACCOUNTS
ACCOUNTING
POLICY
We
provide an allowance for doubtful accounts equal to estimated uncollectible
receivables. This estimate is based on the current status of each customer’s
receivable balance.
FACTORS
AFFECTING ESTIMATE
We record
allowances for doubtful accounts based on a variety of factors including the
length of time the receivables are past due, the financial health of the
customer and historical experience. Our estimate could be impacted by changes in
economic and market conditions as well as changes to our customer’s financial
conditions.
SELF-INSURANCE
RESERVES
ACCOUNTING
POLICY
We accrue
self-insurance reserves based upon estimates of the aggregate liability of claim
costs in excess of our insurance coverage. Reserves are estimated using certain
actuarial assumptions followed in the insurance industry and our historical
experience. The majority of these claims are legal claims and our liability
estimate is primarily related to the cost to defend these claims. We do not
accrue for settlements, judgments, monetary fines or penalties until such
amounts are probable and estimable, in compliance with Financial Accounting
Standard (“FAS”) No. 5, “Accounting for Contingencies.” Under FAS 5, if the
range of possible loss is broad, the liability accrual should be based on the
lower end of the range.
FACTORS
AFFECTING ESTIMATE
Self-insurance
reserves are based on management’s estimates of the costs to defend legal
claims. We do not have significant experience with certain of these types of
cases. As such, differences between actual costs and management’s estimates
could be significant. In addition, actuaries do not have a significant history
with the PBM industry. Changes to assumptions used in the development of these
reserves can affect net income in a given period. In addition, changes in the
legal environment and number and nature of claims could impact our
estimate.
REVENUE
RECOGNITION
We
consider the following information about revenue recognition policies important
for an understanding of our results of operations:
· |
Revenues
from dispensing prescriptions from our home delivery pharmacies are
recorded when prescriptions are shipped. These revenues include the
co-payment received from members of the health plans we
serve. |
· |
Revenues
from the sale of prescription drugs by retail pharmacies are recognized
when the claim is processed. We do not include member co-payments to
retail pharmacies in revenue or cost of
revenue. |
· |
When
we independently have a contractual obligation to pay our network pharmacy
providers for benefits provided to our clients’ member, we act as a
principal in the arrangement and we include the total payments we have
contracted to receive from these clients as revenue and the total payments
we make to the network pharmacy providers as cost of
revenue. |
· |
When
we merely administer a client’s network pharmacy contracts, to which we
are not a party and under which we do not assume credit risk, we earn an
administrative fee for collecting payments from the client and remitting
the corresponding amount to the pharmacies in the client’s network. In
these transactions, drug ingredient cost is not included in our revenues
or in our cost of revenues. |
· |
We
administer two rebate programs through which we receive rebates and
administrative fees from pharmaceutical manufacturers.
|
· |
Gross
rebates and administrative fees earned for the administration of our
rebate programs, performed in conjunction with claim processing services
provided to clients, are recorded as a reduction of cost of revenue and
the portion of the rebate payable to customers is treated as a reduction
of revenue. |
· |
When
we earn rebates and administrative fees in conjunction with formulary
management services, but do not process the underlying claims, we record
rebates received from manufacturers, net of the portion payable to
customers, in revenue. |
· |
We
distribute pharmaceuticals in connection with our management of patient
assistance programs and earn a fee from the manufacturer for
administrative and pharmacy services for the delivery of certain drugs
free of charge to doctors for their indigent
patients. |
· |
We
earn a fee for the distribution of consigned pharmaceuticals requiring
special handling or packaging where we have been selected by the
pharmaceutical manufacturer as part of a limited distribution
network. |
· |
Non-PBM
product revenues include revenues earned through administering sample card
programs for certain manufacturers. We include ingredient cost of those
drug samples dispensed from retail pharmacies in our Non-PBM revenues and
the associated costs for these sample card programs in cost of
revenues. |
· |
Non-PBM
service revenues include administrative fees for the verification of
practitioner licensure and the distribution of consigned drug samples to
doctors based on orders received from pharmaceutical sales
representatives. |
RESULTS
OF OPERATIONS
PBM
OPERATING INCOME
|
Three
Months Ended March 31, |
|
(in
thousands) |
2005 |
Increase/
(Decrease) |
2004 |
Product
revenues |
|
|
|
|
|
|
|
|
|
Network
revenues |
$ |
2,301,264 |
|
|
(1.5) |
% |
$ |
2,337,254 |
|
Home
delivery revenues |
|
1,440,086 |
|
|
18.7
|
% |
|
1,213,080 |
|
Service
revenues |
|
33,827 |
|
|
54.0 |
% |
|
21,963 |
|
Total
PBM revenues |
|
3,775,177 |
|
|
5.7 |
% |
|
3,572,297 |
|
Cost
of PBM revenues |
|
3,521,969 |
|
|
4.8 |
% |
|
3,361,503 |
|
PBM
gross profit |
|
253,208 |
|
|
20.1 |
% |
|
210,794 |
|
PBM
SG&A expenses |
|
123,234 |
|
|
34.0 |
% |
|
91,975 |
|
PBM
operating income |
$ |
129,974 |
|
|
9.4 |
% |
$ |
118,819 |
|
Network
claims increased by 17.6 million, or 18.9%, in the first quarter of 2005 over
the same period of 2004. This increase in network claims is primarily due to the
implementation of our contract with the DoD TRICARE Retail Pharmacy (“TRICARE”)
program in June 2004. Note that revenues for the TRICARE program are included in
service revenue (see discussion below).
The $36.0
million, or 1.5%, decrease in network pharmacy revenues for the first quarter of
2005 as compared to the first quarter of 2004 is attributable to the following
factors:
· |
Network
pharmacy revenues decreased $131.0 million in the first quarter of 2005 as
compared to the first quarter of 2004 as a result of a higher mix of
generic claims and a 2.0% increase in the average co-payment per retail
pharmacy claim. Generic claims made up 54.6% of total network claims for
the first quarter of 2005 as compared to 50.4% of total network claims for
the same period of 2004. As mentioned in our Critical Accounting Policies
above, we do not include member co-payments to retail pharmacies in
revenue or cost of revenue. |
· |
These
factors were partially offset by an increase in pharmacy claims, resulting
in a $95.1 million increase in overall network pharmacy
revenues. |
The
$227.0 million, or 18.7%, increase in home delivery pharmacy revenues
for the first quarter of 2005 over the same period of 2004 is attributable to
the following factors:
· |
Our
CuraScript subsidiary is responsible for a $153.4 million increase in home
delivery revenue for the first quarter of 2005 over the same period of
2004. This increase is partially due to an additional month of claims and
revenues in 2005, as well as the growth of
CuraScript. |
· |
Excluding
CuraScript, we processed an additional 0.6 million claims in the first
quarter of 2005 over the same period in 2004. The increase in home
delivery claim volume resulted in a $79.2 million increase in home
delivery revenues. The increase in home delivery volume is primarily due
to the increased usage of our home delivery pharmacies by members of
existing clients. |
· |
Excluding
CuraScript, a decrease in the average home delivery revenue per claim
reduced revenues by $5.6 million in the first quarter of 2005 over the
same period in 2004. The decrease in average home delivery revenue per
claim is primarily due to a higher mix of generic claims. Our generic fill
rate increased to 43.2% in the first quarter of 2005 as compared to 39.2%
for the first quarter of 2004. Our home delivery generic fill rate is
lower than the retail generic fill rate as fewer generic substitutes are
available among maintenance medications (e.g. therapies for diabetes, high
cholesterol, etc.) commonly dispensed from home delivery pharmacies
compared to acute medications that are dispensed primarily by pharmacies
in our retail networks. |
PBM
service revenues include amounts received from clients for therapy management
services such as prior authorization and step therapy protocols and
administrative fees earned for processing claims for clients utilizing their own
retail pharmacy networks. The $11.9 million, or 54.0%, increase in PBM service
revenues in the first quarter of 2005 as compared to the first quarter of 2004
is primarily due to the implementation of the TRICARE contract in June 2004,
which was partially offset by a payment of $5.5 million received in the first
quarter of 2004 in connection with the early termination by a client in
2001.
PBM cost
of revenues increased $160.5 million, or 4.8%, in the first quarter of 2005 as
compared to the same period in 2004 as a result of the following:
· |
CuraScript’s
specialty home delivery pharmacy is responsible for $143.2 million of the
increase in cost of revenues in the first quarter of 2005 as compared to
the first quarter of 2004. This increase is partially due to an additional
month of claims and revenues in 2005, as well as the growth of
CuraScript. |
· |
Excluding
CuraScript, increases in network and home delivery claims volume (on an
unadjusted basis), resulted in higher PBM cost of revenues of $142.3 in
the first quarter of 2005 as compared to the first quarter of 2004.
|
· |
Excluding
CuraScript, PBM cost of revenues decreased $125.1 million in the first
quarter of 2005 over the same period of 2004 due to lower drug price
ingredient costs, primarily as a result of a higher mix of generic
claims. |
We expect
our PBM cost of revenues will increase slightly due to the opening of the new
Pueblo, Colorado Patient Care Contact Center during the second half of 2005 (see
“—Liquidity and Capital Resources”). These opening costs should be offset by our
continued effort to streamline our home delivery operations.
Our PBM
gross profit increased $42.4 million, or 20.1%, in the first quarter of 2005
over the same period of 2004. Increases in gross profit resulted from the growth
in home delivery and retail prescriptions and higher generic utilization, as
well as the growth of CuraScript, which was acquired January 30, 2004. These
increases were partially offset by the $5.5 million termination payment received
in the first quarter of 2004 as mentioned above, and by margin pressures arising
from the current competitive environment.
Selling,
general and administrative expenses (“SG&A”) increased $31.3 million, or
34.0%, in the first quarter of 2005 over the same period of 2004. This is
primarily due to the following factors:
· |
Increased
spending of $20.2 million on costs to improve the operation and the
administrative functions supporting the management of the pharmacy
benefit, a portion of which relates to increased management incentive
compensation |
· |
Increased
professional fees of $5.6 million, partially due to increased spending on
legal matters, as well as higher costs of compliance with the
Sarbanes-Oxley Act. |
· |
The
acquisition of CuraScript in January 2004 resulted in an increase of
SG&A expenses in the amount of $3.3
million. |
We expect
SG&A costs to increase beginning in the second quarter due to spending on
our Medicare Part D Program. Total Medicare Part D expenditures for 2005 are
estimated to range from $12.0 to $18.0 million, the majority of which will be
incurred in the second half of the year.
PBM
operating income increased $11.2 million, or 9.4%, in the first quarter of 2005
over the same period of 2004.
NON-PBM
OPERATING INCOME
|
Three
Months Ended March 31, |
|
(in
thousands) |
2005 |
Increase |
2004 |
Product
revenues |
$ |
35,419 |
|
|
26.7 |
% |
$ |
27,963 |
|
Service
revenues |
|
28,526
|
|
|
3.5 |
% |
|
27,555 |
|
Total
non-PBM revenues |
|
63,945 |
|
|
15.2 |
% |
|
55,518 |
|
Non-PBM
cost of revenues |
|
52,189 |
|
|
17.2 |
% |
|
44,525 |
|
Non-PBM
gross profit |
|
11,756 |
|
|
6.9 |
% |
|
10,993 |
|
Non-PBM
SG&A expense |
|
3,397 |
|
|
3.9 |
% |
|
3,269 |
|
Non-PBM
operating income |
$ |
8,359 |
|
|
8.2 |
% |
$ |
7,724 |
|
Non-PBM
product revenues increased $7.5 million, or 26.7%, in the first quarter of 2005
over the same period of 2004, mainly due to a higher mix of specialty
distribution volumes in which we include ingredient cost of pharmaceuticals
dispensed in our revenues. Non-PBM
service revenues increased $1.0 million, or 3.5%, in the first quarter of 2005
over the same period of 2004. The increase reflects new eligibility and service
programs initiated during the first quarter of 2005.
Non-PBM
cost of revenues increased $7.7 million, or 17.2%, in the first quarter of 2005
over the same period of 2004, mainly due to the additional volume in programs
where we include the ingredient costs of pharmaceuticals dispensed from retail
pharmacies in our Non-PBM revenues and cost of revenues (as discussed above).
Gross profit increased $0.8 million, or 6.9%, in the first quarter of 2005 as
compared to the first quarter of 2004.
Non-PBM
SG&A increased $0.1 million, or 3.9%, in the first quarter of 2005 over the
first quarter of 2004. Non-PBM operating income increased $0.6 million, or 8.2%,
in the first quarter of 2005 over the first quarter of 2004.
OTHER
(EXPENSE) INCOME
In
February 2001, we entered into an agreement with AdvancePCS (now owned by
CareMark, Inc.) and Medco Health Solutions, Inc. (formerly, “Merck-Medco,
L.L.C.”) to form RxHub, an electronic exchange enabling physicians who use
electronic prescribing technology to link to pharmacies, PBMs and health plans.
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 $18.0 million invested through March 31, 2005. 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
first quarter of 2005 was $0.7 million ($0.4 million, net of tax) compared to
$1.3 million ($0.8 million, net of tax) for the same period of
2004.
The $8.7
million, or 73.5% decrease in net interest expense in the first quarter of 2005
as compared to the same period in 2004 resulting from the refinancing of our
entire credit facility during the first quarter of 2004 (see “—Bank Credit
Facility”).
PROVISION
FOR INCOME TAXES
Our
effective tax rate decreased to 36.6% for the first quarter of 2005 as compared
to 38.3% for the same period of 2004. This decrease reflects a net tax benefit
of $2.3 million resulting from the recognition of the expected state tax benefit
associated with certain subsidiary losses generated in 2004. The effective tax
rate for the remainder of 2005 will be closer to our 2004 effective rate, and
the rate for the full year 2005 will be approximately 37.9%.
NET
INCOME AND EARNINGS PER SHARE
Net
income increased $15.3 million, or 21.9%, for the first quarter of 2005 over the
same period of 2004. Basic and diluted earnings per share increased 28.9% and
28.1%, respectively for the first quarter of 2005 over the same period of 2004.
LIQUIDITY
AND CAPITAL RESOURCES
OPERATING
CASH FLOW AND CAPITAL EXPENDITURES
For the
three months ended March 31, 2005, net cash provided by operations increased
$40.4 million to $138.2 million from $97.8 million during the three months ended
March 31, 2004. This increase reflects a $19.1 million increase from net changes
in our working capital components, increased earnings of $15.3 million, a $4.1
million increase in depreciation and amortization, and a $1.9 million increase
in non-cash adjustments to net income. The increase in working capital
components includes a $13.2 million increase resulting from the timing of
payments on liabilities, an increase of $6.9 million from changes in other
assets, and a $2.7 million increase from improved inventory management. These
increases were partially offset by a $3.7 million use of cash due to a higher
accounts receivable balance. The increase in non-cash adjustments relates to
higher tax benefits from the exercise of employee stock options during the first
quarter of 2005 and a $2.3 million increase in bad debt expense, offset by a
decrease of $2.7 million in deferred taxes.
Our
capital expenditures for the three months ended March 31, 2005 decreased $1.8
million, or 23.3%, as compared to the same period of 2004. We intend to continue
to invest in technology that we believe will provide efficiencies in operations
and facilitate growth and enhance the service we provide to our clients. We
expect 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.
We have
begun development of a new Patient Care Contact Center in Pueblo, Colorado which
will be completed during the fourth quarter of 2005. Total 2005 expenditures for
the project, the majority of which will be incurred in the second half the year,
are expected to range from $11.0 million to $13.0 million, of which
approximately $5.0 million to $7.0 million will be expensed and approximately
$6.0 million will be capitalized. We expect that a portion of these expenditures
will be reimbursed by the city of Pueblo and the state of Colorado, and that
such reimbursements will reduce the amount capitalized for this project.
CHANGES
IN BUSINESS
On
January 30, 2004, we acquired the outstanding capital stock of CuraScript, for
approximately $333.4 million, which includes a purchase price adjustment
for closing working capital and transaction costs. CuraScript is one of the
nation’s largest specialty pharmacy services companies and has enhanced our
ability to provide comprehensive pharmaceutical management services to our
clients and their members. CuraScript operates seven specialty pharmacies
throughout the United States and serves over 175 managed care organizations, 30
Medicaid programs and the Medicare program. The transaction was accounted for
under the provisions of FAS 141, “Business Combinations.” The purchase price has
been allocated based upon the estimated fair value of net assets acquired at the
date of the acquisition. A portion of the excess of purchase price over tangible
net assets acquired has been allocated to intangible assets, consisting of
customer contracts in the amount of $28.7 million and non-competition agreements
in the amount of $2.7 million, which are being amortized using the straight-line
method over estimated useful lives of ten years and three years, respectively.
These assets are included in other intangible assets. In addition, the excess of
purchase price over tangible net assets and identified intangible assets
acquired has been to goodwill in the amount of $284.9 million and trade names in
the amount of $1.3 million, which are not being amortized. Our PBM
operating results include those of CuraScript from January 30, 2004, the date of
acquisition.
Goodwill
is evaluated for impairment annually or when events or circumstances occur
indicating that goodwill might be impaired. In addition, we evaluate whether
events or circumstances have occurred that indicate the remaining estimated
useful lives of 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 at March 31, 2005 or December 31, 2004.
We
regularly review potential acquisitions and affiliation opportunities. We
believe available cash resources, bank financing or the issuance of additional
common stock or other securities could be used to finance future acquisitions or
affiliations. There can be no assurance we will make new acquisitions or
establish new affiliations in 2005 or thereafter.
In
January 2004, we entered into an agreement to provide PBM services for the
Medicare discount program of Pharmacy Care Alliance, Inc. (“PCA”), a nonstock,
not-for-profit entity jointly controlled by the National Association of Chain
Drugstores (“NACDS”) and us. Our PBM services include the negotiation of
discounts from individual retailers and pharmaceutical manufacturers, the
enrollment of cardholders and the processing of prescription claims.
During
2004, we entered into a lending agreement with PCA, whereby we committed to lend
up to $17.0 million to PCA in the form of a revolving line of credit
available through December 31, 2005. Requests for borrowings on the revolving
line of credit require the unanimous consent of PCA’s board of directors, which
consists of representatives from NACDS and from our management team, or its
designated representatives. PCA will utilize the revolving line of credit to
fund its operating expenditures. NACDS has agreed to guarantee $2.0 million on
the revolving line of credit. As of March 31, 2005, we have loaned PCA
$14.6 million, and have received $2.9 million in interest and principal
payments.
In regard
to the revolving line of credit extended to PCA, the collectibility of any
unsecured borrowings will be a function of PCA’s success in enrolling new
members for its Medicare discount program. Through March 31, 2005,
enrollment has fallen short of expectations, with approximately 225,000 members
enrolled to date. In addition, utilization has been lower than expected. As a
result, the outstanding balance of our receivable from PCA is fully
reserved.
BANK
CREDIT FACILITY
On
February 13, 2004, we refinanced our entire credit facility, negotiating an
$800.0 million credit facility with a bank syndicate which includes $200.0
million of Term A loans, $200.0 million of Term B loans and a $400.0
million revolving credit facility. At March 31, 2005, our credit facility
consisted of $180.0 million of Term A loans, $198.0 million of Term B loans and
a $400.0 million revolving credit facility (of which no debt was outstanding at
March 31, 2005). During the first quarter of 2005, we made scheduled payments on
our Term A and Term B loans totaling $5.0 million and $0.5 million,
respectively, and we made net payments of $50.0 million under our revolving
credit facility.
Our
credit facility requires us to pay interest periodically on the London Interbank
Offered Rates (“LIBOR”) or base rate options, plus a margin. The margin on the
Term A loans and on amounts outstanding under the revolving credit facility is
dependent on our credit rating and our ratio of debt to earnings before
interest, taxes, depreciation and amortization (“EBITDA”). The Term B loan
interest is based on the LIBOR or alternative base rate options plus a margin of
1.5% or 0.25% per annum, respectively. Under our new credit facility we are
required to pay commitment fees on the unused portion of the $400.0 million
revolving credit facility ($400.0 million at March 31, 2005). The
commitment fee will range from 0.2% to 0.5% depending on our credit rating and
our consolidated leverage ratio. The commitment fee is currently 0.25% per
annum.
At March
31, 2005, the weighted average interest rate on the new facility was 4.03%. Our
new credit facility contains covenants that limit the indebtedness we may incur,
the common shares we may repurchase and dividends we may pay. The covenants also
include a minimum interest coverage ratio and a maximum leverage ratio. At March
31, 2005, we are in compliance with all covenants associated with our credit
facility.
CONTRACTUAL
OBLIGATIONS
The
following table sets forth our schedule of maturities of our long-term debt and
future minimum lease payments due under noncancellable operating leases as of
March 31, 2005 (in thousands):
|
|
Payments
Due by Period as of March 31, |
|
|
Contractual
obligations |
Total |
2005 |
2006
- 2007 |
2008
- 2009 |
After
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt |
$ |
378,564 |
|
$ |
16,556 |
|
$ |
69,112 |
|
$ |
245,112 |
|
$ |
47,784 |
|
|
Future
minimum lease
payments
(1) |
|
104,886 |
|
|
18,411 |
|
|
40,729 |
|
|
20,632 |
|
|
25,114 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
contractual cash
obligations |
$ |
483,450 |
|
$ |
34,967 |
|
$ |
109,841 |
|
$ |
265,744 |
|
$ |
72,898 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) In
July 2004, we entered into a capital lease with the Camden County Joint
Development Authority in association with the development of our new Patient
Care Contact Center in St. Marys, Georgia. At March 31, 2005, our lease
obligation is $13.5 million. In accordance with FASB Interpretation Number 39,
“Offsetting of Amounts Related to Certain Contracts,” our lease obligation has
been offset against $13.5 million of industrial revenue bonds issued to us by
the Camden County Joint Development Authority.
OTHER
MATTERS
In
December 2004, the Financial Accounting Standards Board (“FASB”) revised FAS
123, “Share-Based Payment” (“FAS 123R”), which replaced FAS 123, “Accounting for
Stock-Based Compensation”, and superseded Accounting Principles Board No.
(“APB”) 25, “Accounting for Stock Issued to Employees.” FAS 123R will require
compensation cost related to share-based payment transactions to be recognized
in the financial statements. As permitted by FAS 123, we currently follow the
guidance of APB 25, which allows the use of the intrinsic value method of
accounting to value share-based payment transactions with employees. FAS 123R
requires measurement of the cost of share-based payment transactions to
employees at the fair value of the award on the grant date and recognition of
expense over the requisite service or vesting period. FAS 123R allows
implementation using a modified version of prospective application, under which
compensation expense for the unvested portion of previously granted awards and
all new awards will be recognized on or after the date of adoption. FAS 123R
also allows companies to implement by restating previously issued financial
statements, basing the amounts on the expense previously calculated and reported
in their pro forma footnote disclosures required under FAS 123. We will adopt
FAS 123R using the modified prospective method beginning January 31, 2006. The
impact of adopting FAS 123R on our consolidated results of operations is not
expected to differ materially from the pro forma disclosures currently required
by FAS 123 (see note 6 to our unaudited consolidated financial
statements).
We make
available through our website (www.express-scripts.com), access to our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, all amendments to those reports (when applicable), and other filings with
the SEC. Such access is free of charge and is available as soon as reasonably
practicable after such information is filed with the SEC. In addition, the SEC
maintains an internet site (www.sec.gov) containing reports, proxy and
information statements, and other information regarding issuers filing
electronically with the SEC (which includes us). Information included on our
website is not part of this annual report.
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.
Item
3. Quantitative
and Qualitative Disclosures About Market Risk
We are exposed to market risk from
changes in interest rates related to debt outstanding under our credit
facility. Our earnings are subject to change as a result of movements in
market interest rates. At March 31, 2005, we had $378.0 million of
obligations which were subject to variable rates of interest under our credit
facility. A hypothetical increase in interest rates of 1% would result in
an increase in annual interest expense of approximately $3.8 million pre-tax,
presuming that obligations subject to variable interest rates remained
constant.
Item
4. Controls
and Procedures
We
maintain a comprehensive set of disclosure controls and procedures (as defined
in Rules 13a-15(e) and under the Securities Exchange Act of 1934 (“Exchange
Act”)) designed to provide reasonable assurance that information required to be
disclosed in our filings under the Exchange Act is recorded, processed,
summarized and reported accurately and within the time periods specified in the
SEC’s rules and forms. Under the supervision and with the participation of our
management, including our Chief Executive Officer and President and our Senior
Vice President and Chief Financial Officer, we have evaluated the effectiveness
of the design and operation of our disclosure controls and procedures as of the
end of the period covered by this report. Based upon this evaluation, the Chief
Executive Officer and President and the Senior Vice President and Chief
Financial Officer concluded that the design and operation of these disclosure
controls and procedures are effective in providing reasonable assurance of the
achievement of the objectives described above.
During
the fiscal quarter ended March 31, 2005, there was no change in our internal
control over financial reporting that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
PART II.
OTHER INFORMATION
Item
1. Legal
Proceedings
We and/or
the Company’s subsidiary, NPA, are defendants in several lawsuits that purport
to be class actions, which were described in our Annual Report on Form 10-K for
the year ended December 31, 2004. Each case seeks damages in an unspecified
amount, and the allegations are such that the Company cannot at this time
estimate with any certainty the damages that the plaintiffs seek to recover.
Because these cases all are in their early stages and none of the cases has yet
been certified by the court as a class action, we are unable to evaluate the
effect that unfavorable outcomes might have on our financial condition or
consolidated results of operations. The following developments have occurred
since the Annual Report:
•
City
of Paterson, et al. v. Benecard Prescription Services, et. al. (Cause
No. L-005908-02, Superior Court of New Jersey, Law Division, Camden County). On
or about September 13, 2002, plaintiffs filed this action against Benecard
Prescription Services (“Benecard”) and our subsidiary, NPA, alleging violations
of the New Jersey Consumer Protection Act. ESI and NPA’s motions for partial
summary judgment on the class action allegations were granted, the court ruling
that class action treatment of the plaintiffs’ claim was improper. Subsequently,
the City of Paterson reached a confidential settlement with co-defendant
Benecard, pursuant to which the City has dismissed its claims against ESI and
NPA. Neither NPA nor ESI contributed to the settlement or paid any consideration
for the dismissal. The individual claims of the Township of Hamilton remain
pending.
•
American
Federation of State, County & Municipal Employees (AFSCME) v. AdvancePCS, et
al. (Cause
No. BC292227, Superior Court of the State of California for the County of Los
Angeles). A stipulated dismissal has been signed by the parties and an order of
dismissal with prejudice has been entered by the court. Plaintiffs retain the
right to appeal.
We
believe that our services and business practices are in compliance with all
applicable laws, rules and regulations in all material respects, and we will
cooperate fully with the government in these investigations. We cannot predict
the outcome of these matters at this time. An unfavorable outcome in one or more
of these matters could result in the imposition of monetary fines or penalties,
or injunctive or administrative remedies, and we can give no assurance that such
fines and remedies would not have a material adverse effect on our financial
condition, our consolidated results of operations or our consolidated cash
flows.
Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds
The
following is a summary of our stock repurchasing activity during the three
months ended March 31, 2005 (share data in thousands):
Period |
Shares
purchased |
Average
price
per
share |
Shares
purchased
as
part of a
publicly
announced
program |
Maximum
shares
that
may yet be purchased under
the
program |
|
|
|
|
|
|
|
|
|
1/1/2005
- 1/31/2005 |
|
- |
|
$ |
- |
|
|
- |
|
|
1,058 |
|
2/1/2005
- 2/29/2005 |
|
- |
|
|
- |
|
|
- |
|
|
6,058 |
|
3/1/2005
- 3/31/2005 |
|
6 |
|
|
85.39 |
|
|
- |
|
|
6,052 |
|
2005
Total |
|
6 |
|
$ |
85.39 |
|
|
- |
|
|
|
|
We have a
stock repurchase program, announced on October 25, 1996, under which our Board
of Directors has approved the repurchase of a total of 10.0 million shares.
Subsequently, our Board of Directors authorized a 9.0 million share
increase to the existing 10.0 million share repurchase program. There is no
limit on the duration of the program. Approximately 12.9 million of the 19.0
million total shares have been repurchased through March 31, 2005. Additional
share 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.
Item
5. Other
Information
(a) On March
1, 2005, the Compensation and Development Committee (the “Compensation
Committee”) of our Board of Directors authorized the payment of annual incentive
bonus awards with respect to the year ended December 31, 2004, to each of our
executive officers, including our Named Executive Officers (which officers were
determined by reference to our Notice and Proxy Statement, dated April 22,
2005). In addition, in December 2004, the Committee established annual financial
goals with respect to the year ending December 31, 2005 for each of our
executive officers, including such Named Executive Officers.
Each
executive officer has a base bonus target which is stated as a percentage of the
executive officer’s base salary. For each of the Named Executive Officers, these
base bonus target percentages are determined pursuant to his employment
agreement. For any bonus amount to be paid, we must meet an annual financial
goal which is based on budgeted EBITDA (earnings before interest, taxes,
depreciation and amortization) and earnings per share. If the corporate
financial targets are not met, then the corporate bonus pool is reduced to the
extent necessary to enable us to meet such targets.
If the
annual financial goal is achieved, then actual bonus awards for executive
officers are determined based on the executive officers’ respective bonus
targets and an evaluation by the Compensation Committee (and in the case of
senior executives also by the Chief Executive Officer) of the extent to which
work plan goals were achieved. In addition, if we meet certain “stretch”
financial and work plan targets, bonus payouts may be increased by as much as
100%. The Compensation Committee reviews and approves the annual financial
targets and the stretch work plan goals.
In 2004,
because certain financial goals were not achieved, the bonus pool was reduced
and the actual aggregate bonuses paid to current executive officers represented
approximately 60% of the total bonus targets for these executive officers.
The
annual bonuses for the Named Executive Officers for the year ended December 31,
2004 were as follows:
|
Barrett
A. Toan |
$375,000 |
|
George
Paz |
$270,000 |
|
David
A. Lowenberg |
$189,000 |
|
Thomas
M. Boudreau |
$135,000 |
|
Edward
Tenholder |
$89,100 |
The
target bonus awards for the Named Executive Officers for the year ending
December 31, 2005 (expressed as a percentage of base salary) are as
follows:
|
Base
Salary |
Target
Bonus
Award
(1) |
|
|
|
Barrett
A. Toan |
N/A(2) |
N/A(2) |
George
Paz |
$650,000 |
100% |
David
A. Lowenberg |
$450,000 |
70% |
Thomas
M. Boudreau |
$350,000 |
64% |
Edward
Tenholder |
$300,000 |
55% |
(1)
As noted above, if we meet certain “stretch” financial and work plan targets,
bonus targets may be increased by as much as 100%.
(2)
Mr. Toan retired on March 31, 2005.
On March
1, 2005, the Compensation Committee also approved increases in Mr. Lowenberg’s
base salary from $450,000 to $463,500, and in Mr. Boudreau’s base salary from
$350,000 to $360,500. These increases will become effective on July 1,
2005.
Item
6. Exhibits
(a)
See Index
to Exhibits below.
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: April
26, 2005 |
By:
/s/ George
Paz
George
Paz, President and Chief Executive Officer |
Date: April
26, 2005 |
By:
/s/ Edward
Stiften
Edward
Stiften, Sr. Vice President and
Chief
Financial Officer |
INDEX TO
EXHIBITS
(Express
Scripts, Inc. - Commission File Number 0-20199)
Exhibit
Number |
Exhibit |
2.11 |
Stock
Purchase Agreement, dated December 19, 2003, by and among the Company, CPS
Holdings, LLC, CuraScript Pharmacy, Inc. and CuraScript PBM Services, Inc,
incorporated by reference to Exhibit No. 2.1 to the Company’s Current
Report on Form 8-K filed December 24, 2003.
|
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 |
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).
|
4.3 |
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).
|
4.4 |
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.
|
4.5 |
Amendment
dated April 25, 2003 to the Stockholder and Registration Rights Agreement
dated as of October 6, 2000 between the Company and New York Life
Insurance Company.
|
10.1 |
Consulting
Agreement, dated as of March 24, 2005, and effective as of March 31, 2005,
between the Company and Barrett A. Toan, incorporated by reference to
Exhibit No. 10.1 to the Company’s Current Report on Form 8-K filed March
30, 2005.
|
10.2 |
Executive
Employment Agreement, dated as of April 11, 2005, and effective as of
April 1, 2005, between the Company and George Paz, incorporated by
reference to Exhibit No. 10.1 to the Company’s Current Report on Form 8-K
filed April 14, 2005.
|
10.32 |
Description
of Compensation Payable to Non-Employee Directors.
|
31.12 |
Certification
by George Paz, as President and Chief Executive Officer of Express
Scripts, Inc., pursuant to Exchange Act Rule 13a-14(a).
|
31.22 |
Certification
by Edward Stiften, as Senior Vice President and Chief Financial Officer of
Express Scripts, Inc., pursuant to Exchange Act Rule
13a-14(a).
|
32.12 |
Certification
by George Paz, as President and Chief Executive Officer of Express
Scripts, Inc., pursuant to 18 U.S.C. § 1350 and Exchange Act Rule
13a-14(b).
|
32.22 |
Certification
by Edward Stiften, as Senior Vice President and Chief Financial Officer of
Express Scripts, Inc., pursuant to 18 U.S.C. § 1350 and Exchange Act Rule
13a-14(b).
|
1 |
The
Company agrees to furnish supplementally a copy of any omitted schedule to
this agreement to the Commission upon
request. |