EXPRESS SCRIPTS INC - 10-Q Quarterly Report

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

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.

	Three Months Ended March 31, 2005					Three Months Ended 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

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.

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.

2	Filed herein.