PBM Facilities Non-PBM Facilities -------------------------- -------------------------- Maryland Heights, Missouri Maryland Heights, Missouri Tempe, Arizona Lincoln Park, New Jersey Bloomington, Minnesota Montville, New Jersey Bensalem, Pennsylvania Troy, New York Farmington Hills, Michigan Albuquerque, New Mexico Horsham, Pennsylvania Montreal, Quebec Mississauga, Ontario
Non-PBM revenues are derived from administrative fees received from drug manufacturers for the dispensing or distribution of pharmaceuticals requiring special handling or packaging. We also administer sample card programs for certain manufacturers and include the ingredient costs of pharmaceuticals dispensed from retail pharmacies in our Specialty Distribution Services subsidiary ("SDS") revenues. Additionally, the associated costs for this sample card program are recorded in cost of revenues. Non-PBM revenues are also generated from the sale of pharmaceuticals for and the provision of infusion therapy services through our Express Scripts Infusion Services subsidiary ("Infusion Services"). On June 12, 2001, we announced that we entered into an agreement with Option Care, Inc. to sell substantially all of the assets of our Infusion Services business, and we discontinued our acute home infusion services.
Our business has grown through strategic acquisitions over the last few years. On April 1, 1999, we acquired Diversified Pharmaceutical Services, Inc. ("DPS") from SmithKline Beecham Corporation for approximately $715 million. On April 1, 1998, we consummated our first major acquisition by acquiring Value Health, Inc. and Managed Prescription Network, Inc. (collectively, "ValueRx"), the PBM operations of HCA-Healthcare Corporation, for approximately $460 million in cash. Consequently, our operating results include those of DPS from April 1, 1999 and ValueRx from April 1, 1998. In addition to growth through acquisitions, we have been successful in adding net new clients each year such as the contract we were awarded by UnitedHealth Group in 2001 to provide retail network and mail pharmacy services to members of AARP.
Revenues for network pharmacy claims increased $1,687,020,000, or 33.9%, in 2001 over 2000 and $1,832,003,000, or 58.3%, in 2000 over 1999. These increases are due to a higher mix of clients utilizing retail pharmacy networks contracted by us, increased membership and member utilization, and higher drug ingredient costs. Network pharmacy claims processed increased 21.6% to 293,996,000 in 2001 over 2000 (excluding the 57,765,000 claims processed for the United HealthCare ("UHC") contract, which terminated effective May 31, 2000). The average revenue per network pharmacy claim increased 36.4% to $22.65 over 2000 due to the termination of the UHC contract (recorded on the Net Basis) and a higher mix of clients utilizing retail pharmacy networks contracted by us versus retail pharmacy networks contracted by the client. As previously discussed under "--Overview", we record the associated revenues for clients utilizing our retail pharmacy networks on the Gross Basis, therefore this shift to our retail pharmacy networks results in an increase in Gross Basis revenues (and corresponding cost of revenues) and revenue per claim. In 2002, we expect to see a higher mix of clients on the Gross Basis due to the loss of a large Net Basis client at the beginning of the year. During 2000, network pharmacy claims processed increased 25,675,000 or 9.4% over 1999. The average revenue per network pharmacy claim increased 44.7% in 2000 over 1999 primarily as a result of the increased rate of historical Express Scripts and DPS clients moving from retail pharmacy networks contracted by the clients to one contracted by us.
Other revenue decreased $10,423,000 in 2001 from 2000 due to the agreement with PlanetRx.com, Inc. (PlanetRx), which was restructured in July 2000. We received a $4,300,000 fee from PlanetRx to terminate the prior contract and no additional cash payments were made to us under the restructured agreement. Other revenues increased $7,423,000 in 2000 over 1999 due to the fees received under the agreement with PlanetRx, which became effective in December 1999.
Our cost of revenues for PBM services increased 37.6% in 2001 over 2000, and 62.2% in 2000 over 1999 mainly as a result of the increase in PBM revenues discussed above. The PBM cost of revenues grew slightly faster than revenues in 2001 and 2000 as a result of a larger percentage of our clients being recorded each year on the Gross Basis, for which we record the drug ingredient cost in cost of revenues (see further discussion under "--Overview"). We have been successful in offsetting margin pressure due to lower pricing on administrative fees and other clinical programs with higher profits from increased mail penetration, improved formulary compliance and other value-added clinical programs.
Cost of revenues for non-PBM services decreased 21.2% from 2000, while non-PBM revenues decreased only 15.6% primarily due to the discontinuance of our acute home infusion services (discussed above), which was less profitable than our SDS business. Cost of revenues for non-PBM services increased 16.2% in 2000 from 1999, while non-PBM revenues increased 33.8%, primarily due to additional volume of business within SDS, which represents a larger percentage of non-PBM revenues, where we primarily record as revenue only our administrative fee for distributing pharmaceutical manufacturers' products. SDS was also able to derive operating cost efficiencies as a result of the increase in volume serviced under a contract that took effect in the fourth quarter of 1999.
o In conjunction with the sale of the assets of YourPharmacy.com, Inc. to PlanetRx, we recorded a $19,520,000 stock compensation charge relating to former YourPharmacy.com employees. The amount of the charge was determined using the initial public offering price of $16 per share for PlanetRx common stock.
On February 22, 2001, we entered into an agreement with AdvancePCS and Merck-Medco to form RxHub, LLC ("RxHub"). RxHub will be an electronic exchange enabling physicians who use electronic prescribing technology to link to pharmacies, PBMs and health plans. The company is designed to operate as a utility for the conduit of information among all parties engaging in electronic prescribing. We own one-third of the equity of RxHub (as do each of the other two founders) and have committed to invest up to $20 million over the next five years with approximately $5.7 million invested during 2001 and an additional $4.3 million expected to be invested through 2003. We have recorded our investment in RxHub under the equity method of accounting, which requires our percentage interest in RxHub's results to be recorded in our Consolidated Statement of Operations. Our percentage of RxHub's loss for 2001 is $1,834,000 ($1,139,000 net of tax), and has been recorded in other income (expense) in our Consolidated Statement of Operations. Our investment in RxHub (approximately $3,866,000 at December 31, 2001) is recorded in other assets on our Consolidated Balance Sheet.
The $12,374,000, or 31.3%, decrease in net interest expense for the year ended December 31, 2001 over 2000 is primarily due to the reduction in debt of $50 million in 2001 and $240 million in 2000. Our interest expense, net decreased $14,775,000 during 2000 compared to 1999. The decrease is a result of utilizing the $299,378,000 proceeds from our June 1999 common stock offering to repay a portion of our credit facility, as well as utilizing $344,131,000 of our own cash to pay-down our credit facility from June 1999 through December 31, 2000. Associated with the prepayment of our loans during 2000, we recorded an ordinary gain in interest expense of $1.5 million ($926,000 net of tax) due to the restructuring of our interest rate swap agreements (see "--Market Risk"). Additionally, we repurchased $10,115,000 of our Senior Notes as of December 31, 2000 (see "--Liquidity and Capital Resources").
Excluding these one-time items and excluding financing costs on the temporary debt associated with the acquisition of DPS, after assuming our equity and Senior Notes offerings had been completed on April 1, 1999, net income for 2000 would have been $94,142,000, or $1.23 per basic share and $1.21 per diluted share, compared to $67,326,000, or $0.90 per basic share and $0.88 per diluted share for 1999, respectively.
During 2001 net cash provided by operations increased $35,080,000 to $280,990,000 from $245,910,000 in 2000. This increase is primarily due to increased cash earnings.
Our investment in net working capital as of December 31, 2001 increased to a $32,414,000 deficit from a $117,775,000 deficit as of December 31, 2000 and a $34,003,000 deficit as of December 31, 1999. The increase in working capital from the December 31, 2000 level reflects additional cash on hand as of December 31, 2001 in anticipation of cash required to close recently announced acquisitions in early 2002, and the timing of collections and payments.
On February 25 2002, we purchased substantially all of the assets utilized in the operation of Phoenix Marketing Group (Holdings), Inc. ("Phoenix"), a wholly-owned subsidiary of Access Worldwide Communications, Inc. for $33 million in cash plus the assumption of certain liabilities. Phoenix is one of the largest prescription drug sample fulfillment companies, shipping approximately 95 million sample units in 2001. The transaction will be accounted for under the provisions of FAS 141, "Business Combinations" and FAS 142, "Goodwill and Other Intangible Assets" and was funded with our operating cash flow.
On February 6, 2002, we signed a definitive agreement to acquire the businesses comprising National Prescription Administrators, Inc. ("NPA") for $515 million. NPA is a privately held full-service pharmacy benefit manager and will strengthen our participation in two key market segments, union and government sponsored plans. The transaction is expected to close near the end of the first quarter of 2002, subject to customary closing conditions and the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act. The transaction
In December 2000, the Department of Health and Human Services ("DHHS") issued final privacy regulations, pursuant to the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), which impose extensive restrictions on the use and disclosure of individually identifiable health information by certain entities. We will be required to comply with certain aspects of the regulations. We have established a plan and a process for implementing all necessary changes to our business operations by the statutory compliance date of April 2003. We believe compliance with these regulations will have a significant impact on our business operations. We have completed an assessment of the costs we will incur in complying with these regulations and do not believe they will be material to our results of operations, financial position and/or cash flow from operations. However, DHHS plans to issue additional regulations in 2002 and we can give no assurance that our implementation costs will not be material to us as a result of such changes.
During 2001, we utilized internally generated cash to prepay $50 million of our Term A loans (described below) and to repurchase 1,227,000 shares of our Common Stock for $54,500,000. As of December 31, 2001, we repurchased a total of 3,757,000 shares of our Common Stock (reflecting the two-for-one stock split effective June 22, 2001) under the stock repurchase program that we announced on October 25, 1996. Approximately 2,558,000 shares have been reissued in connection with employee compensation plans through December 31, 2001. In February 2002, our Board of Directors authorized an increase in our stock repurchase program from 5,000,000 shares to 6,500,000 and placed no limit on the duration of the program. Additional debt repayments or common stock repurchases, if any, will be made in such amounts and at such times as we deem appropriate based upon prevailing market and business conditions, subject to restrictions on stock repurchases contained in our bank credit facility and the Indenture which governs our Senior Notes.
Our credit facility requires us to pay interest quarterly on an interest rate spread based on several London Interbank Offered Rates ("LIBOR") or base rate options. Using a LIBOR spread, the Term A loans had an interest rate of 3.37% on December 31, 2001. To alleviate interest rate volatility, we have entered into interest rate swap arrangements, one of which expired in October 2001, which are discussed in "--Market Risk" below. The credit facility contains covenants that limit the indebtedness we may incur, dividends paid and the amount of annual capital expenditures. The covenants also establish a minimum interest coverage ratio, a maximum leverage ratio, and a minimum fixed charge coverage ratio. In addition, we are required to pay an annual fee of 0.25%, payable in quarterly installments, on the unused portion of the revolving credit facility ($150 million at December 31, 2001). At December 31, 2001, we are in compliance with all covenants associated with the credit facility.
The following table sets fourth our schedule of current maturities of our long-term debt, excluding the deferred interest rate swap gain of $648,000 at December 31, 2001, and future minimum lease payments due under noncancellable operating leases (in thousands):
Year Ended December 31, Current Maturities Future Minimum Of Long-term Debt Lease Payments - -------------------------------------------------------------------------------- 2002 $ - $ 13,521 2003 - 13,298 2004 39,450 13,361 2005 65,550 13,085 2006 11,691 Thereafter 240,771 23,960 -------------------------------------------- $ 345,771 $ 88,916 ============================================
As previously mentioned, to fund the acquisition of NPA we are amending our existing credit facility to add a $350 million Term B loan. The Term B loan will have a maturity of six years and will amortize 1% in years one through four, 25% in year five and 71% in year six. Interest will be payable quarterly on an interest rate spread based on several LIBOR or base rate options. The anticipated interest rate spread for LIBOR borrowings will be 225 basis points. The Term B loan will be secured on the same basis as our existing credit facility. In addition, we are requesting in the amendment to adjust certain covenants, relating to restricted junior payments and asset sales, and to provide for a future accounts receivable facility.
During July 2001, the Financial Accounting Standards Board issued Financial Accounting Statement Number ("FAS") 141, "Business Combinations" and FAS 142, "Goodwill and Other Intangible Assets". FAS 141 requires that all business combinations be accounted for using the purchase method of accounting. FAS 141 also defines acquired intangible assets and requires that a reassessment of a company's preexisting acquired intangible assets and goodwill be evaluated and adjusted to conform with that definition. We do not believe that FAS 141 will have a significant impact on our consolidated financial position, consolidated results of operations and/or our consolidated cash flows once implemented.
During October 2001, the Financial Accounting Standards Board issued FAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." FAS 144 requires that long -lived assets to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, FAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the
In May 2001, our stockholders approved our Amended and Restated Certificate of Incorporation. Among the changes to the Certificate of Incorporation was an amendment that consolidated and renamed our classes of Common Stock. Prior to the amendment we had 181,000,000 authorized shares of Common Stock consisting of 150,000,000 shares of Class A Common Stock and 31,000,000 shares of Class B Common Stock. No shares of the Class B Common Stock were outstanding. Pursuant to the Amended and Restated Certificate of Incorporation, the Class B Common Stock was eliminated and each share of Class A Common Stock was renamed as "Common Stock." As a result, we now have 181,000,000 shares of Common Stock authorized.
At December 31, 2001, NYLIFE LLC owned shares of our Common Stock representing approximately 21% of the outstanding shares, which includes the right to vote 6,900,000 shares of Common Stock that the Trust may deliver upon exchange of the Trust issued investment units. New York Life has agreed on behalf of itself and its subsidiaries, to vote these 6,900,000 shares of our Common Stock prior to delivery thereof by the Trust to the holders of the Trust investment units in the same proportion and to the same effect as the votes cast by our other stockholders at any meeting of stockholders, subject to the following exceptions: New York Life has agreed to vote its 16,240,000 shares (which includes the above described 6,900,000 shares) in favor of the slate of nominees for directors recommended by our Board of Directors for election by stockholders (provided that, so long as New York Life is entitled to representation on the Board of Directors, such slate includes New York Life's nominees).
A sensitivity analysis is used to determine the impact interest rate changes will have on the fair value of the interest rate swap, measuring the change in the net present value arising from the change in the interest rate. The fair value of the swap is then determined by calculating the present value of all cash flows expected to arise thereunder, with future interest rate levels implied from prevailing mid-market yields for money-market instruments, interest rate futures and/or prevailing mid-market swap rates. Anticipated cash flows are then discounted on the assumption of a continuously compounding zero-coupon yield curve. A 10 basis point (0.1%) decline in interest rates at December 31, 2001 would have caused the fair value of the swap to change by $198,000 pretax, resulting in a liability with a fair value of $5,996,000.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 65 present fairly, in all material respects, the financial position of Express Scripts, Inc. and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 14(a)(2) on page 65 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Earnings per share and weighted average shares outstanding included in Notes To Consolidated Financial Statements have been restated to reflect the two-for-one stock split effective June 22, 2001.
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 balances of $107,113,000 and $83,691,000 have been reclassified to claims and rebates payable at December 31, 2001 and 2000, respectively.
Property and equipment. Property and equipment is carried at cost and is depreciated using the straight-line method over estimated useful lives of seven years for furniture, five years for equipment and purchased computer software and three years for personal computers. Leasehold improvements are amortized on a straight-line basis over the term of the lease or the useful life of the asset, if shorter. Expenditures for repairs, maintenance and renewals are charged to income as incurred. Expenditures that improve an asset or extend its estimated useful life are capitalized. When properties are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is included in income. Research and development expenditures relating to the development of software to be marketed to clients, or to be used for internal purposes, are charged to expense until technological feasibility is established. Thereafter, the remaining software production costs up to the date of general release to customers, or to the date placed into production, are capitalized and included as Property and Equipment. Amortization of the capitalized amounts commences on the date of general release to customers, or the date placed into production, and is computed on a product-by-product basis using the straight-line method over the remaining estimated economic life of the product but not more than five years. Reductions, if any, in the carrying value of capitalized software costs to net realizable value are expensed.
Marketable securities. All investments not included as cash and cash equivalents are accounted for under Financial Accounting Standards Board Statement ("FAS") 115, "Accounting for Certain Investments in Debt and Equity Securities." Management determines the appropriate classification of our marketable securities at the time of purchase and reevaluates such determination at each balance sheet date. All marketable securities at December 31, 2001 and 2000 were recorded in other assets on our Consolidated Balance Sheet.
Securities bought and held principally for the purpose of selling them in the near term are classified as trading securities. Trading securities are reported at fair value, which is based upon quoted market prices, with unrealized holding gains and loss included in earnings. We held trading securities, consisting primarily of mutual funds, of $8,662,000 and $2,295,000 as of December 31, 2001 and 2000, respectively. We maintain our trading securities to offset changes in certain liabilities related to our deferred compensation plan discussed in Note 10. Net losses realized on the trading portfolio were $396,000 and $75,000 in 2001 and 2000, respectively.
Other intangible assets. Other intangible assets include, but are not limited to, customer contracts, non-compete agreements, deferred financing fees and certain fees paid to clients under contractual agreements and are amortized on a straight-line basis over periods from 2 to 20 years. The amount reported is net of accumulated amortization of $47,686,000 and $55,954,000 at December 31, 2001 and 2000, respectively. Amortization expense for customer contracts and non-compete agreements included in selling, general and administrative expenses was $9,136,000, $18,030,000 and $25,094,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Amortization expense for deferred financing fees included in interest expense was $2,009,000, $2,391,000, and $2,241,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Amortization expense for contractual agreements with customers is recorded against revenue and was $1,981,000 and $577,000 for 2001 and 2000, respectively; there was no expense in 1999.
Fair value of financial instruments. The carrying value of cash and cash equivalents, accounts receivable, claims and rebates payable, and accounts payable approximated fair values due to the short-term maturities of these instruments. The fair value, which approximates the carrying value, of our Credit Facility was estimated using either quoted market prices or the current rates offered to us for debt with similar maturity. The fair value of the interest rate swaps (an obligation of $5,798,000 and $991,000 at December 31, 2001 and 2000, respectively) was based on quoted market prices, which reflect the present values of the difference between estimated future fixed rate payments and future variable rate receipts. The fair value of our senior note facility ($265,073,000 and $245,882,000 at December 31, 2001 and 2000, respectively) was estimated based on quoted market prices.
Revenue recognition. Revenues from dispensing prescriptions from our mail pharmacies are recorded when the prescription is shipped. Revenue from sales of prescription drugs by retail pharmacies in our nationwide network and pharmacy claims processing revenues are recognized when the claims are processed. When we independently have a contractual obligation to pay our network pharmacy provider for benefits provided to our clients' members, we include
payments from these clients as revenue, and payments to the network pharmacy provider as cost of revenue (the "Gross Basis") in accordance with Emerging Issues Task Force ("EITF") 99-19, "Recording Revenue Gross as a Principal versus Net as an Agent". These transactions require us to assume credit risk and act as a principal. If we are merely administering clients' network pharmacy contracts in which we do not assume credit risks, but act as an agent, we record only our administrative or dispensing fees as revenue (the "Net Basis").
Income taxes. Deferred tax assets and liabilities are recognized based on temporary differences between financial statement basis and tax basis of assets and liabilities using presently enacted tax rates.
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 potential dilutive common shares had been issued. The difference between the number of weighted average shares used in the basic and diluted calculation for all years are outstanding stock options and stock warrants (1,738,000, 833,000 and 938,000 in 2001, 2000 and 1999, respectively), any unvested shares and shares issuable pursuant to employee elected deferral under the executive deferred compensation plan (22,000 and 3,000 in 2001 and 2000, respectively) and restricted stock we have issued (196,000 and 1,000 in 2001 and 2000, respectively), all calculated under the "treasury stock" method in accordance with FAS 128, "Earnings Per Share". Due to the net loss in 2000, all potentially dilutive common shares (942,000) have been excluded as they are anti-dilutive.
Foreign currency translation. The financial statements of ESI Canada, our Canadian operations, are translated into U.S. Dollars using the exchange rate at each balance sheet date for assets and liabilities and a weighted average exchange rate for each period for revenues, expenses, gains and losses. The functional currency for ESI Canada is the local currency and cumulative translation adjustments are recorded within the other comprehensive income component of stockholders' equity.
Employee stock-based compensation. We account for employee stock options in accordance with Accounting Principles Board No. ("APB") 25, "Accounting for Stock Issued to Employees." Under APB 25, we apply the intrinsic value method of accounting and, therefore, have not recognized compensation expense for options granted, because options have only been granted at a price equal to market value at the time of grant. During 1996, FAS 123 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. For companies that choose to continue applying the intrinsic value method, FAS 123 mandates certain pro forma disclosures as if the fair value method had been utilized (see Note 10).
Segment reporting. The segment information is derived from the management approach which designates the internal organization that is used by management for making operating decisions and assessing performance as the source of our reportable segments (see Note 13).
FAS 142 requires goodwill no longer be amortized under any circumstances. Instead, all goodwill (including goodwill associated with acquisitions consummated prior to the adoption of FAS 142) is to be evaluated for impairment annually in accordance with FAS 142 and when events or circumstances occur indicating that goodwill might be impaired. In accordance with the implementation provisions of FAS 142, we expect to complete our first impairment test under FAS 142 by the end of the second quarter of 2002, and we do not anticipate incurring an impairment charge. All goodwill impairment losses are to be presented as a separate line item in the operating section of the consolidated results of operations (unless the impairment loss is associated with a discontinued operation). FAS 142 requires the disclosure of income before extraordinary items and net income, and earnings per share for both income measures, all computed on a pro forma basis by reversing the goodwill amortized in the periods presented. Such pro forma disclosures are required in the period of adoption and thereafter until all periods presented reflect goodwill accounted for in accordance with FAS 142. Had FAS 142 been effective for 2001, our net income before extraordinary items would have been $151,111,000, or $1.94 per basic share and $1.89 per diluted share, and $17,687,000, or $0.23 per basic and diluted share, for the year ended December 31, 2001 and 2000, respectively.
Joint venture. On February 22, 2001, we entered into an agreement with AdvancePCS and Merck-Medco, to form RxHub, LLC ("RxHub"). RxHub will be an electronic exchange enabling physicians who use electronic prescribing technology to link to pharmacies, pharmacy benefit management ("PBM") companies and health plans. The company is designed to operate as a utility for the conduit of information among all parties engaging in electronic prescribing. We own one-third of the equity of RxHub (as do each of the other two founders) and have committed to invest up to $20 million over the next five years with approximately $5.7 million invested during 2001. We have recorded our investment in RxHub under the equity method of accounting, which requires our percentage interest in RxHub's results to be recorded in our Consolidated Statement of Operations. Our percentage of RxHub's loss for 2001 is $1,834,000 ($1,139,000 net of tax), and has been recorded in other income (expense) in our Unaudited Consolidated Statement of Operations. Our investment in RxHub (approximately $3,866,000 at December 31, 2001) is recorded in other assets on our Consolidated Balance Sheet.
first quarter of 2002, subject to customary closing conditions and expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act. The transaction will be accounted for under the provisions of FAS 141 and FAS 142. The purchase price will be funded with cash on hand, up to $100 million of borrowings on our revolving credit facility, a $350,000 million new tack-on Term B loan and the issuance of approximately 552,000 shares of our common stock. We will file an Internal Revenue Code ss.338(h)(10) election, making amortization expense of intangible assets, including goodwill, tax deductible.
On February 25 2002, we purchased substantially all of the assets utilized in the operation of Phoenix Marketing Group (Holdings), Inc. ("Phoenix"), a wholly-owned subsidiary of Access Worldwide Communications, Inc. for $33 million in cash plus the assumption of certain liabilities. Phoenix is one of the largest prescription drug sample fulfillment companies, shipping approximately 95 million sample units in 2001. The transaction, which will be accounted for under the provisions of FAS 141 and FAS 142.
On March 1, 2001, our Canadian subsidiary, ESI Canada, Inc., completed its acquisition of Centre d'autorisation et de paiement des services de sante, Inc. ("CAPSS"), a leading Quebec-based PBM, for approximately CAN$26.8 million (approximately US$17.5 million), which includes a purchase price adjustment for closing working capital. The transaction, which has been accounted for under the purchase method of accounting, was funded with our operating cash flow. The results of operations of CAPSS have been included in the consolidated financial statements and PBM segment since March 1, 2001. The purchase price has been allocated based upon the estimated fair value of net assets acquired at the date of the acquisition. The excess of purchase price over tangible net assets acquired has been allocated to intangible assets consisting of customer contracts in the amount of US$5,149,000 which are being amortized using the straight-line methods over the estimated useful life of 20 years and are included in other intangible assets, and goodwill in the amount of US$11,655,000 which was amortized using the straight-line method over the estimated useful life of 30 years. Pro forma information, as if CAPSS had been acquired as of the beginning of the year, is not being presented as the inclusion of CAPSS financial data would not have a material impact to our consolidated financial statements.
On April 1, 1999, we completed our acquisition of Diversified Pharmaceutical Services, Inc. and Diversified Pharmaceutical Services (Puerto Rico) Inc. (collectively, "DPS"), from SmithKline Beecham Corporation and SmithKline Beecham InterCredit BV (collectively, "SB") for approximately $715 million, which includes a purchase price adjustment for closing working capital and transaction costs. We filed an Internal Revenue Code ss.338(h)(10) election, making amortization expense of intangible assets, including goodwill, tax deductible. We used approximately $48 million of our own cash and financed the remainder of the purchase price and related acquisition costs.
The acquisition has been accounted for using the purchase method of accounting. The results of operations of DPS have been included in the consolidated financial statements and PBM segment since April 1, 1999. The purchase price has been allocated based on the estimated fair values of net assets acquired at the date of the acquisition. The excess of purchase price over tangible net assets acquired has been allocated to other intangible assets consisting of customer contracts in the amount of $129,500,000 which began amortizing in 1999 using the straight-line method over the estimated useful lives of 2 to 20 years and goodwill in the amount of $754,236,000 which was amortized using the straight-line method over the estimated useful life of 30 years.
On August 31, 1999, we, along with YourPharmacy.com, Inc. ("YPC"), our wholly-owned subsidiary, entered into an Asset Contribution and Reorganization Agreement (the "Contribution Agreement") with PlanetRx, PRX Holdings, Inc. ("Holdings"), and PRX Acquisition Corp. ("Acquisition Sub"). Pursuant to the Contribution Agreement, YPC agreed to contribute certain operating assets constituting its e-commerce business in prescription and non-prescription drugs and health and beauty aids to Holdings in exchange for 19.9% of the post-initial public offering common equity of Holdings (the "IPO"), and PlanetRx was also to assume certain obligations of YPC. Simultaneously with this transaction, Acquisition Sub was to merge into PlanetRx and PlanetRx shareholders would receive stock in Holdings, which would change its name to "PlanetRx.com, Inc." As a result of the transactions, YPC would be a 19.9% shareholder in the new PlanetRx (formerly Holdings), which would conduct business as an Internet pharmacy.
As part of our agreement, PlanetRx was to pay us an annual fee of $11,650,000 and reimbursement for certain expenses of $3,000,000 over a 5 year term, which could have extended to 10 years if we met certain performance measures. Additionally, we were eligible to receive an incremental fee based upon the number of our members who placed their first order for prescription drug or non-prescription merchandise with PlanetRx. We recorded $10,423,000 and $3,000,000 of revenue during 2000 and 1999, respectively. We also reduced selling and general administrative expenses by $1,500,000 and $750,000 for reimbursement of certain expenses relating to our Internet initiative during 2000 and 1999, respectively.
During 2000, we recorded a non-cash impairment charge to write-off our investment in PlanetRx common stock as the loss in value was deemed to be other than temporary. Therefore, any unrealized losses associated with recording our investment in PlanetRx at current market value that we had recorded in stockholders' equity were written off to the current period earnings, in addition to any additional charges necessary to write-off our investment. Additionally, during 2000 we donated approximately 200,000 shares (after giving effect to the 8-for-1 reverse stock split on December 4, 2000) of PlanetRx common stock and realized expenses related to the donation of approximately $713,000. At December 31, 2001 we own approximately 1,096,000 shares, or 17.8% (after giving effect to the 8-for-1 reverse stock split on December 4, 2000) of PlanetRx which are carried at no value.
Upon issuance of the shares, the Manulife contract will be extended for 10 years. Should Manulife terminate the agreement early, they would be required to reimburse us for the unamortized discount. As a result, the advance discount will be amortized over the 10-year extended contract period. Except for certain exemptions from registration under the 1933 Act, the shares issued to Manulife cannot be traded until they have been registered under the 1933 Act and applicable state laws. If Manulife attains additional claims processing volume, the maximum amount of total shares that could be issued to Manulife under the terms of this agreement cannot exceed approximately 474,000.
December 31, (in thousands) 2001 2000 - ------------------------------------------------------------------------------ Land $ 400 $ 400 Furniture 19,254 18,210 Equipment 106,299 87,515 Computer software 115,447 101,075 Leasehold improvements 18,237 14,594 ------------------------------------------- 259,637 221,794 Less accumulated depreciation and amortization 94,374 74,085 ------------------------------------------- $ 165,263 $ 147,709 ===========================================
Year Ended December 31, - ------------------------------------------------------------------------- 2002 $ - 2003 - 2004 39,450 2005 65,550 2006 - ----------------------- $ 105,000 =======================
We use interest rate swap agreements to manage our interest rate risk on future variable interest payments. As of December 31, 2001, we have one swap agreement to fix the variable interest payments on approximately $98 million of our debt under our credit facility. Under this swap agreement, we agree to receive a floating rate of interest on the notional principal amount of approximately $98 million based upon a three month LIBOR rate in exchange for payment of a fixed rate of 6.25% per annum. The notional principal amount will increase to $100 million in October 2002 and beginning in April 2003, will reduce to $60 million and in April 2004 will reduce to $20 million until maturing in April 2005.
Our present interest rate swap agreement is a cash flow hedge as it requires us to pay fixed-rates of interest, which hedges against changes in the amount of future cash flows associated with variable interest obligations. Accordingly, the fair value of our swap agreement is reported on the balance sheet in other liabilities ($5,798,000 pre-tax at December 31, 2001) and the related gains or losses on this agreement are deferred in shareholders' equity as a component of other comprehensive income (a $3,589,000, net of taxes, reduction at December 31, 2001). These deferred gains or losses are then recognized as an adjustment to interest expense over the same period in which the related interest payments being hedged are recorded in income. The gains or losses associated with the ineffective portion of this agreement are immediately recognized in income. For the year ended December 31, 2001, the gains and losses on the ineffective portion of our swap agreement were not material to the consolidated financial statements.
December 31, (in thousands) 2001 2000 - -------------------------------------------------------------------------------- Deferred tax assets: Allowance for doubtful accounts $ 8,519 $ 9,087 Accrued expenses 4,866 16,203 Non-compete agreements 2,151 2,292 Net operating loss carryforward - 2,975 Deferred compensation 3,862 1,006 Restricted stock 3,762 Deferred loss on interest rate swap 2,209 - Other 1,373 1,360 ---------------------------- Gross deferred tax assets 26,742 32,923 ---------------------------- Deferred tax liabilities: Depreciation and property differences (26,489) (17,799) Goodwill and customer contract amortization (23,677) (15,026) Other (3,061) (2,341) ---------------------------- Gross deferred tax liabilities (53,227) (35,166) ----------------------------
We have entered into noncancellable agreements to lease certain office and distribution facilities with remaining terms from one to ten years. Rental expense under the office and distribution facilities leases in 2001, 2000 and 1999 was $14,654,000, $12,041,000 and $11,147,000, respectively. The future minimum lease payments due under noncancellable operating leases are as follows (in thousands):
For the year ended December 31, 2001, approximately 50.5% of our pharmaceutical purchases were through one wholesaler. We believe other alternative sources are readily available and that no other concentration risks exist at December 31, 2001.
During September 2000, we sold our Albuquerque, New Mexico property and building for $7,806,000. These assets were then leased back from the purchaser over a period of 10 years with the option to extend the terms up to an additional 10 years. The resulting lease is being accounted for as an operating lease, and the resulting deferred gain of $4,136,000 is being amortized over the 10 year life of the lease.
In the ordinary course of business (which includes the business conducted by entities we have acquired prior to acquiring them, respectively), various legal proceedings, investigations or claims pending have arisen against us and our subsidiaries (ValueRx and DPS continue to be a party to proceedings that arose prior to their April 1, 1998 and April 1, 1999 respective acquisition dates). The effect of these actions on future financial results is not subject to reasonable estimation because considerable uncertainty exists about the outcomes. Nevertheless, in our opinion, the ultimate liabilities resulting from any such lawsuits, investigations or claims now pending are not expected to materially affect our consolidated financial position, results of operations and/or cash flows.
In May 2001, we announced a two-for-one stock split of our Class A Common Stock for stockholders of record on June 8, 2001, effective June 22, 2001. The split was effected in the form of a dividend by issuance of one share of Class A Common Stock for each share of Class A Common Stock outstanding. The earnings per share and the weighted average number of shares outstanding for basic and diluted earnings per share for all years presented have been adjusted for the stock split.
In June 1999, we consummated our offering of 10,350,000 shares of our Class A Common Stock at a price of $30.50 per share. The net proceeds of $299,378,000 were used to retire the $150 million senior subordinated bridge credit facility and a portion of the Term B loans under the $1.05 billion credit facility.
As of December 31, 2001, we have repurchased a total of 3,757,000 shares of our Common Stock under the stock repurchase program that we announced on October 25, 1996, of which, 1,227,000 shares were repurchased during 2001. Approximately 2,558,000 shares have been reissued in connection with employee compensation plans through December 31, 2001. In February 2002, our Board of Directors approved an increase in our stock repurchase program from 5,000,000 shares (adjusted for the June 2002 two for one stock split) to 6,500,000 shares, and placed no limit on the duration of the program. Additional purchases, if any, will be made in such amounts and at such times as we deem appropriate based upon prevailing market and business conditions, subject to restrictions on stock repurchases contained in our bank credit facility and the Indenture under which our Senior Notes were issued.
Retirement savings plan. We offer all of our full-time employees a retirement savings plan under Section 401(k) of the Internal Revenue Code. Employees may elect to enter a written salary deferral agreement under which a maximum of 15% of their salary, subject to aggregate limits required under the Internal Revenue Code, may be contributed to the plan. We match 100% of the first 4% of the employees' compensation contributed to the Plan. For the years ended December 31, 2001, 2000 and 1999, we had contribution expense of approximately $4,994,000, $4,718,000 and $3,604,000, respectively.
Stock-based compensation plans. In August 2000, the Board of Directors adopted the Express Scripts, Inc. 2000 Long-Term Incentive Plan which was subsequently amended in February 2001 (as amended, the "2000 LTIP"), which provides for the grant of various equity awards to our officers, Board of Directors and key employees selected by the Compensation Committee of the Board of Directors. The amended 2000 LTIP was approved by our stockholders in May 2001. As of December 31, 2001, 616,000 shares of our Common Stock are available for issuance under this plan. During 2001 and 2000, we granted approximately 228,000 and 453,000 restricted shares of Common Stock, 455,000 were issued from shares held in treasury, under the 2000 LTIP to certain of our officers and employees. These shares are subject to various cliff-vesting periods from three to ten years with provisions allowing for accelerated vesting based upon specific performance criteria. Prior to vesting, these restricted shares are subject to forfeiture to us without consideration upon termination of employment under certain circumstances. Approximately 93,000 shares have been forfeited as of February 28, 2002. Unearned compensation relating to the restricted shares is recorded as a separate component of stockholders' equity and is amortized to non-cash compensation expense over the estimated vesting periods. As of December 31, 2001 and 2000, unearned compensation was $11,944,000 and $13,594,000, respectively, which is net of compensation expense for 2001 and 2000 of $9,425,000 and $1,247,000, respectively.
As a result of the Board's adoption and stockholder approval of the 2000 LTIP, no additional awards will be granted under either of our 1992 amended and restated stock option plans (discussed below) or under our 1994 amended and restated Stock Option Plan (discussed below). However, these plans are still in existence as there are outstanding grants under these plans.
In April 1992, we also adopted a stock option plan that was amended and restated in 1995 and amended in 1996 and 1999 that provided for the grant of nonqualified stock options to purchase 48,000 shares to each director who is not an employee of ours or our affiliates. In addition, the second amendment to the plan gave each non-employee director who was serving in such capacity as of the date of the second amendment the option to purchase 2,500 additional shares. The second amendment options will vest over three years. The plan provides that the options vest over a two-, three- or five-year period from the date of grant depending upon the circumstances of the grant.
We apply APB 25 and related interpretations in accounting for our 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. Had compensation cost for stock option grants 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 would have been reduced to the pro forma amounts indicated below. Because future options may be granted and vesting typically occurs over a three to five year period, the pro forma impact shown for 2001, 2000 and 1999 is not necessarily representative of the impact in future years.
(in thousands, except per share data) 2001 2000 1999 - -------------------------------------------------------------------------------- Net income As reported $ 124,700 $ (9,126) $ 150,218 Pro forma 114,937 (19,796) 142,753
Basic earnings per share As reported $ 1.60 $ (0.12) $ 2.08 Pro forma 1.48 (0.26) 1.98
The fair value of options granted (which is amortized to expense 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:
During the second quarter of 1999, we recorded a pre-tax restructuring charge of $9,400,000 associated with the consolidation of our Plymouth, Minnesota facility into our Bloomington, Minnesota facility. In December 1999 and September 2000, the associated accrual was reduced by $2,301,000 and $44,000, primarily as a result of subleasing a portion of the unoccupied space. The consolidation plan includes the relocation of all employees at the Plymouth facility to the Bloomington facility that began in August 1999, with completion delayed until the first quarter of 2001 from the previously disclosed third quarter of 2000. Included in the restructuring charge are anticipated cash expenditures of approximately $4,779,000 for lease termination fees and rent on unoccupied space (which payments will continue through April 2001, when the lease expires) and anticipated non-cash charges of approximately $2,276,000 for the write-down of leasehold improvements and furniture and fixtures. The restructuring charge does not include any costs associated with the physical relocation of the employees.
All of the restructuring charges which include tangible assets to be disposed of are written down to their net realizable value, less cost of disposal. We expect recovery to approximate its cost of disposal. Considerable management judgment is necessary to estimate fair value; accordingly, actual results could vary from such estimates.
("EAP") and ESI Resources, Inc. ("ERI"). Consequently, the assets, liabilities and operations of ValueRx are incorporated into those of the issuer, Express Scripts, Inc. and the assets, liabilities and operations of SDS, ESI MPS, EAP and ERI are incorporated into those of the Guarantors.
We are organized on the basis of services offered and have determined we have two reportable segments: PBM services and non-PBM services (defined in Note 1 "organization and operations"). We manage the pharmacy benefit within an operating segment that encompasses a fully-integrated PBM service. The remaining operating service lines (SDS and Express Scripts Infusion Services) have been aggregated into a non-PBM reporting segment.
The following table presents information about the reportable segments for the years ended December 31:
- -------------------------------------------------------------------------------- Quarters ----------------------------------------------- (in thousands, except per share data) First Second Third Fourth - -------------------------------------------------------------------------------- FISCAL 2001 Total revenues $2,090,540 $ 2,247,343 $ 2,381,252 $ 2,609,647 Cost of revenues 1,945,641 2,097,059 2,236,799 2,453,415 Selling, general and administratitive 89,798 92,590 84,222 92,081 Operating income 55,101 57,694 60,231 64,151 Extraordinary item - - (372) - ------------------------------------------------- Net income $ 28,079 $ 30,244 $ 32,191 $ 34,186 =================================================
- -------------------------------------------------------------------------------- Quarters --------------------------------------------- (in thousands, except per share data) First Second(1) Third(2) Fourth(3) - -------------------------------------------------------------------------------- FISCAL 2000 Total revenues $1,504,645 $1,698,044 $1,757,825 $1,950,935 Cost of revenues 1,372,291 1,560,748 1,625,094 1,814,349 Selling, general and administrative 83,279 87,314 82,579 85,583 Operating income 49,075 49,982 50,152 51,003 Extraordinary item - - (898) (207) --------------------------------------------- Net income (loss) $ 21,432 $ (74,177)$ 23,875 $ 19,744 =============================================