Changes in business

9 Months Ended

Sep. 30, 2012

Changes in business

Note 3—Changes in business

As a result of the Merger on April 2, 2012, Medco and ESI each became 100% owned subsidiaries of Express Scripts and former Medco and ESI stockholders became owners of stock in Express Scripts, which is listed for trading on the NASDAQ stock exchange. Upon closing of the Merger, former ESI stockholders owned approximately 59% of Express Scripts and former Medco stockholders owned approximately 41%. Per the terms of the Merger Agreement, upon consummation of the Merger on April 2, 2012, each share of Medco common stock was converted into (i) the right to receive $28.80 in cash, without interest and (ii) 0.81 shares of Express Scripts stock. Holders of Medco stock options, restricted stock units, and deferred stock units received replacement awards at an exchange ratio of 1.3474 Express Scripts stock awards for each Medco award owned, which is equal to the sum of (i) 0.81 and (ii) the quotient obtained by dividing (1) $28.80 (the cash component of the Merger consideration) by (2) an amount equal to the average of the closing prices of ESI common stock on the NASDAQ for each of the 15 consecutive trading days ending with the fourth complete trading day prior to the completion of the Merger.

Based on the opening price of Express Scripts’ stock on April 2, 2012, the purchase price was comprised of the following:

(in millions)
Cash paid to Medco stockholders(1)	$	11,309.6
Value of shares of common stock issued to Medco stockholders(2)		17,963.8
Value of stock options issued to holders of Medco stock options(3) (4)		706.1
Value of restricted stock units issued to holders of Medco restricted stock units(3)		174.9
Total consideration	$	30,154.4

(1) Equals Medco outstanding shares multiplied by $28.80 per share.

(2) Equals Medco outstanding shares immediately prior to the Merger multiplied by the exchange ratio of 0.81, multiplied by the Express Scripts opening share price on April 2, 2012 of $56.49.

(3) In accordance with applicable accounting guidance, the fair value of replacement awards attributable to precombination service is recorded as part of the consideration transferred in the Merger, while the fair value of replacement awards attributable to postcombination service is recorded separately from the business combination and recognized as compensation cost in the post-acquisition period over the remaining service period.

(4) The fair value of the Company’s equivalent stock options was estimated using the Black-Scholes valuation model utilizing various assumptions. The expected volatility of the Company’s common stock price is a blended rate based on the average historical volatility over the expected term based on daily closing stock prices of ESI and Medco common stock. The expected term of the option is based on Medco historical employee stock option exercise behavior as well as the remaining contractual exercise term.

The unaudited consolidated statement of operations for Express Scripts for the three months and nine months ended September 30, 2012 following consummation of the Merger on April 2, 2012 includes Medco’s total revenues of $15,175.5 million and $30,847.9 million, respectively, and net income of $82.1 million and $46.9 million, respectively, which includes integration expense and amortization.

The following unaudited pro forma information presents a summary of Express Scripts’ combined results of operations for the three and nine months ended September 30, 2012 and 2011 as if the Merger and related financing transactions had occurred at January 1, 2011. The following pro forma financial information is not necessarily indicative of the results of operations as it would have been had the transactions been effected on the assumed date, nor is it necessarily an indication of trends in future results for a number of reasons, including, but not limited to, differences between the assumptions used to prepare the pro forma information, basic shares outstanding and dilutive equivalents, cost savings from operating efficiencies, potential synergies, and the impact of incremental costs incurred in integrating the businesses:

	Three Months Ended September 30,				Nine Months Ended September 30,
(in millions, except per share data)	2012		2011		2012		2011
Total revenues	$	26,999.4	$	28,499.1	$	82,804.0	$	85,006.3
Net income		391.4		279.1		837.7		516.5
Basic earnings per share		0.48		0.35		1.03		0.62
Diluted earnings per share	$	0.47	$	0.35	$	1.01	$	0.62

                                  Pro forma net income for the three and nine months ended September 30, 2011 includes total non-recurring amounts of $180.7 million and $1,045.0 million, respectively, related to estimated severance payments, accelerated stock-based compensation, and transaction and integration costs incurred in connection with the Merger. These amounts represent the best available estimates as of the date of issuance. Actual costs recorded in the year ended December 31, 2012 may differ materially from estimates utilized for pro forma purposes.

The Merger is accounted for under the acquisition method of accounting with ESI treated as the acquirer for accounting purposes. The purchase price has been allocated based on the estimated fair value of net assets acquired and liabilities assumed at the date of the acquisition. Express Scripts retained third-party valuation advisors to conduct analyses of the assets acquired and liabilities assumed in order to assist in the determination of the preliminary purchase price allocation. The preliminary purchase price allocation may be subject to further refinement and may result in significant changes. These changes will primarily relate to the fair value of obligations acquired.

During the third quarter ended September 30, 2012, the Company recorded fair value adjustments of approximately $104.0 million to its preliminary allocation of purchase price related to intangible assets, which had the effect of increasing intangible assets and reducing goodwill. In connection with the adjustment to fair value, the Company recorded a cumulative adjustment to amortization expense of $4.8 million. The adjustments to fair value resulted in an increase in deferred tax liabilities of $37.2 million and deferred tax assets of $58.7 million.

Also during the third quarter ended September 30, 2012, the Company made other adjustments to its preliminary allocation of purchase price related to accounts receivable, allowance for doubtful accounts, and contingent liabilities. These adjustments had the effect of increasing goodwill and reducing accounts receivable, increasing allowance for doubtful accounts and increasing current liabilities.

Express Scripts expects that if any further refinements become necessary, they will be completed by April 2013. There can be no assurance that such finalization will not result in material changes. The following table summarizes Express Scripts’ preliminary estimates of the fair values of the assets acquired and liabilities assumed in the Medco acquisition:

(in millions)	Amounts Recognized as of  Acquisition Date
Current assets	$	6,917.3
Property and equipment		1,390.6
Goodwill		23,897.2
Acquired intangible assets		16,216.7
Other noncurrent assets		48.3
Current liabilities		(9,033.1	)
Long-term debt		(3,008.3	)
Deferred income taxes		(5,924.0	)
Other noncurrent liabilities		(350.3	)
Total	$	30,154.4

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 $15,935.0 million with an estimated weighted average amortization period of 16 years. Additional intangible assets consist of trade names in the amount of $273.0 million with an estimated weighted average amortization period of 10 years and miscellaneous intangible assets of $8.7 million with an estimated weighted average amortization period of 5 years. The acquired intangible assets have been preliminarily valued using an income approach and are being amortized on a basis that approximates the pattern of benefit.

The excess of purchase price over tangible net assets and identified intangible assets acquired has been preliminarily allocated to goodwill in the amount of $23,897.2 million. The majority of the goodwill recognized as part of the Medco acquisition is reported under our PBM segment and reflects our expected synergies from combining operations, such as improved economies of scale and cost savings. None of the goodwill recognized is expected to be deductible for income tax purposes and is not amortized.

As a result of the Merger on April 2, 2012, we acquired the receivables of Medco. The gross contractual amounts receivable and fair value of these receivables as of the acquisition date are shown below. Of the gross amounts due under the contracts as of the date of acquisition, we estimated $20.6 million related to client accounts receivables to be uncollectible.

(in millions)	Gross Contractual Amounts Receivable		Fair Value
Manufacturer Accounts Receivables	$	1,895.2	$	1,895.2
Client Accounts Receivables		2,432.2		2,389.0
Total	$	4,327.4	$	4,284.2

ESI and Medco each retain a one-sixth ownership in SureScripts. As a result of the Merger, the combined companies in total retain a one-third ownership in SureScripts. Due to the increased ownership percentage, we now account for the investment in SureScripts using the equity method and have recorded an undistributed gain of $5.1 million and $9.4 million, respectively, for the three months and nine months ended September 30, 2012.