3. Changes in business
Acquisitions. 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 Express Scripts stock, which is listed on the Nasdaq. Upon closing of the Merger, former ESI stockholders owned approximately 59% of Express Scripts and former Medco stockholders owned approximately 41% of Express Scripts. 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:
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| | | |
(in millions) | |
Cash paid to Medco stockholders(1) | $ | 11,309.6 |
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Value of shares of common stock issued to Medco stockholders(2) | 17,963.8 |
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Value of stock options issued to holders of Medco stock options(3)(4) | 706.1 |
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Value of restricted stock units issued to holders of Medco restricted stock units(3) | 174.9 |
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Total consideration | $ | 30,154.4 |
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(1) | Equals Medco outstanding shares multiplied by $28.80 per share. |
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(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. |
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(3) | In accordance with applicable accounting guidance, the fair value of replacement awards attributable to pre-combination service is recorded as part of the consideration transferred in the Merger, while the fair value of replacement awards attributable to post-combination service is recorded separately from the business combination and recognized as compensation cost in the post-acquisition period over the remaining service period. |
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(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 consolidated statement of operations for Express Scripts for the year ended December 31, 2012 following consummation of the Merger on April 2, 2012 includes Medco’s total revenues for continuing operations of $45,763.5 million and net income of $290.7 million, which includes integration expense and amortization.
The following unaudited pro forma information presents a summary of Express Scripts’ combined results of continuing operations for the years ended December 31, 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:
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| | | | | | | |
| Year Ended December 31, |
(in millions, except per share data) | 2012 | | 2011 |
Total revenues | $ | 109,639.2 |
| | $ | 115,463.4 |
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Net income attributable to Express Scripts | 1,345.5 |
| | 719.8 |
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Basic earnings per share from continuing operations | 1.69 |
| | 0.88 |
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Diluted earnings per share from continuing operations | $ | 1.66 |
| | $ | 0.87 |
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Pro forma net income for the year ended December 31, 2011 includes total non-recurring amounts of $1,192.2 million related to severance payments, accelerated stock-based compensation and transaction and integration costs incurred in connection with the Merger.
The Merger was accounted for under the acquisition method of accounting with ESI treated as the acquirer for accounting purposes. The purchase price was allocated based on the estimated fair value of net assets acquired and liabilities assumed at the date of the acquisition.
During the first quarter ended March 31, 2013, the Company made refinements to its preliminary allocation of purchase price related to accrued liabilities due to the finalization of assumptions utilized to value the liabilities acquired. These adjustments had the effect of increasing current assets and other noncurrent liabilities and decreasing goodwill, deferred tax liabilities and current liabilities.
Express Scripts finalized the purchase price allocation and push down accounting as of March 31, 2013. The following table summarizes Express Scripts’ estimates of the fair values of the assets acquired and liabilities assumed in the Merger:
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| | | |
(in millions) | Amounts Recognized as of Acquisition Date |
Current assets | $ | 6,934.9 |
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Property and equipment | 1,390.6 |
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Goodwill | 23,965.6 |
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Acquired intangible assets | 16,216.7 |
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Other noncurrent assets | 48.3 |
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Current liabilities | (8,966.4 | ) |
Long-term debt | (3,008.3 | ) |
Deferred income taxes | (5,875.2 | ) |
Other noncurrent liabilities | (551.8 | ) |
Total | $ | 30,154.4 |
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A portion of the excess of purchase price over tangible net assets acquired was 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 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 was allocated to goodwill in the amount of $23,965.6 million. The majority of the goodwill recognized as part of the Merger is reported under our PBM segment and reflects our expected synergies from combining operations, such as improved economies of scale and cost savings. Goodwill recognized is not 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 $43.6 million related to client accounts receivables to be uncollectible.
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| | | | | | | |
(in millions) | Gross Contractual Amounts Receivable | | Fair Value |
Manufacturer Accounts Receivables | $ | 1,895.2 |
| | $ | 1,895.2 |
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Client Accounts Receivables | 2,432.2 |
| | 2,388.6 |
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Total | $ | 4,327.4 |
| | $ | 4,283.8 |
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ESI and Medco each retained a one-sixth ownership in Surescripts, resulting in a combined one-third ownership in Surescripts. Due to the increased ownership percentage following the Merger, we account for the investment in Surescripts using the equity method and have recorded equity income of $32.8 million and $14.9 million for the years ended December 31, 2013 and 2012, respectively. Our investment in Surescripts (approximately $30.2 million and $11.9 million as of December 31, 2013 and 2012, respectively) is recorded in “Other assets” in our consolidated balance sheet.
