10. Employee benefit plans and stock-based compensation plans
Retirement savings plans. We sponsor retirement savings plans under Section 401(k) of the Internal Revenue Code for substantially all of our full-time employees. Upon consummation of the Merger, the Company assumed sponsorship of the plans historically sponsored by ESI (the “ESI 401(k) Plan”) and Medco (the “Medco 401(k) Plan”).
Effective January 1, 2013, the Medco 401(k) Plan merged into the ESI 401(k) Plan. The combined plan (the “Express Scripts 401(k) Plan”) is applicable to all full-time and part-time employees of the Company. Under the Express Scripts 401(k) Plan, eligible employees may elect to contribute up to 50% of their salary, and the Company matches up to 6% of the employees’ compensation contributed to the plan for substantially all employees after one year of service.
Prior to January 1, 2013, under the ESI 401(k) Plan, employees were able to elect to enter into a salary deferral agreement under which a maximum of 25% of their salary could be contributed to the plan. Under the Medco 401(k) Plan, employees were able to elect to contribute up to 50% of their salary. The Company matched 200% of the first 1% and 100% of the next 3% of the employees’ compensation contributed to the plan for substantially all employees under the ESI 401(k) Plan after one year of service. The Company matched up to 6% of the employees’ compensation contributed to the plan for substantially all employees under the Medco 401(k) Plan.
For the years ended December 31, 2013, 2012 and 2011, we had contribution expense of approximately $79.9 million, $67.6 million and $25.7 million, respectively. The increase for the year ended December 31, 2012 is the result of contributions to the Medco 401(k) Plan from the date of the Merger. Contributions under all plans are subject to aggregate limits required under the Internal Revenue Code.
Employee stock purchase plan. We offer an employee stock purchase plan that qualifies under Section 423 of the Internal Revenue Code and permits all domestic employees, excluding certain management level employees, to purchase shares of our common stock. Participating employees may contribute up to 10% of their salary to purchase common stock at the end of each monthly participation period at a purchase price equal to 95% of the fair market value of our common stock on the last business day of the participation period. During 2013, 2012 and 2011, approximately 289,000, 229,000 and 200,000 shares of our common stock were issued under the plan, respectively. Our common stock reserved for future employee purchases under the plan is approximately 1.9 million shares at December 31, 2013.
Deferred compensation plan. We maintain a non-qualified deferred compensation plan (the “Executive Deferred Compensation Plan”) that provides benefits payable to eligible key employees at retirement, termination or death. Benefit payments are funded by a combination of contributions from participants and us. Participants may elect to defer up to 50% of their base earnings and 100% of specific bonus awards. Participants become fully vested in our contributions on the third anniversary of the end of the plan year for which the contribution is credited to their account. For 2013, our contribution was equal to 6% of each qualified participant’s total annual compensation, with 25% being allocated as a hypothetical investment in our common stock and the remaining being allocated to a variety of investment options elected by the participants. We have chosen to fund our liability for this plan through investments in trading securities, which primarily consist of mutual funds (see Note 1 - Summary of significant accounting policies). We incurred net compensation expense of approximately $1.2 million, $1.0 million and $0.6 million in 2013, 2012 and 2011, respectively. At December 31, 2013, approximately 5.9 million shares of our common stock have been reserved for future issuance under the plan. We have $0.3 million and $0.2 million of unearned compensation related to unvested shares that are part of our deferred compensation plan at December 31, 2013 and 2012, respectively.
Stock-based compensation plans in general. In March 2011, ESI’s Board of Directors adopted the ESI 2011 Long-Term Incentive Plan (the “2011 LTIP”), which provides for the grant of various equity awards with various terms to our officers, directors and key employees selected by the Compensation Committee of the Board of Directors. The 2011 LTIP was approved by ESI’s stockholders in May 2011 and became effective June 1, 2011. Upon consummation of the Merger, the Company assumed sponsorship of the 2011 LTIP. Under the 2011 LTIP, we may issue stock options, stock-settled stock appreciation rights (“SSRs”), restricted stock units, restricted stock awards, performance share awards and other types of awards. The maximum number of shares available for awards under the 2011 LTIP is 30.0 million. The maximum term of stock options, SSRs, restricted stock units, restricted stock awards and performance shares granted under the 2011 LTIP is 10 years. As of December 31, 2013, approximately 22.6 million shares of our common stock are available for issuance under this plan.
Subsequent to the effective date of the 2011 LTIP, no additional awards have been or will be granted under the 2000 Long-Term Incentive Plan (the “2000 LTIP”), which provided for the grant of various equity awards with various terms to ESI’s officers, directors and key employees selected by the Compensation Committee. However, this plan is still in existence as there are outstanding grants under this plan. Under the 2000 LTIP, ESI issued stock options, SSRs, restricted stock units, restricted stock awards and performance share awards, which awards were converted into awards relating to Express Scripts common stock upon closing of the Merger. Prior to the Merger, awards were typically settled using treasury shares. Upon close of the Merger, treasury shares of ESI were cancelled and subsequent awards were settled by issuance of new shares. The maximum term of stock options, SSRs, restricted stock units, restricted stock awards and performance shares granted under the 2000 LTIP is 10 years.
The provisions of both the 2000 LTIP and 2011 LTIP allow employees to use shares to cover tax withholding on stock awards. Upon vesting of restricted stock and performance shares, employees have taxable income subject to statutory withholding requirements. The number of shares issued to employees may be reduced by the number of shares having a market value equal to our minimum statutory withholding for federal, state and local tax purposes.
The tax benefit related to employee stock compensation recognized during the years ended December 31, 2013, 2012 and 2011 was $60.0 million, $153.9 million and $17.7 million, respectively.
Effective upon the closing of the Merger, the Company assumed the sponsorship of the Medco Health Solutions, Inc. 2002 Stock Incentive Plan (the “2002 Stock Incentive Plan”), allowing Express Scripts to issue awards under this plan. As of December 31, 2013, 13.5 million shares are available under this plan. Under the Medco Health Solutions, Inc. 2002 Stock Incentive Plan, Medco granted, and, following the Merger, Express Scripts has granted and may continue to grant, stock options, restricted stock units and other types of awards to officers, employees and directors. Medco’s awards granted under the 2002 Stock Incentive Plan are subject to accelerated vesting upon change in control and termination.
As part of the consideration transferred in the Merger, Express Scripts issued 41.5 million replacement stock options to holders of Medco stock options, valued at $706.1 million, and 7.2 million replacement restricted stock units to holders of Medco restricted stock units, valued at $174.9 million. See Note 3 - Changes in business, for further discussion of valuation.
Restricted stock units and performance shares. Express Scripts grants restricted stock units to certain officers, directors and employees and performance shares to certain officers and employees. Express Scripts’ and ESI’s restricted stock units have three-year graded vesting and performance shares cliff vest at the end of three years. In 2011, 0.5 million restricted units were awarded which cliff vest two years from the closing date of the Merger (the “merger restricted shares”). In addition to the two-year service requirement, vesting of the merger restricted shares was contingent upon completion of the Merger. As this vesting condition did not meet probability thresholds indicated by authoritative accounting guidance, no expense was recorded for the merger restricted shares until consummation of the Merger. Prior to vesting, shares are subject to forfeiture to us without consideration upon termination of employment under certain circumstances. The number of performance shares that ultimately vest is dependent upon achieving specific performance targets. The original value of the performance share grants is subject to a multiplier of up to 2.5 based on certain performance metrics. Medco’s restricted stock units and performance shares granted under the 2002 Stock Incentive Plan prior to the Merger generally cliff vest over three years.
Unearned compensation relating to these awards is amortized to non-cash compensation expense over the estimated vesting periods. As of December 31, 2013 and 2012, unearned compensation related to restricted stock units and performance shares was $52.5 million and $99.4 million, respectively. We recorded pre-tax compensation expense related to restricted stock units and performance share grants of $87.4 million, $190.0 million and $13.9 million in 2013, 2012 and 2011, respectively. The fair value of restricted stock units vested during the years ended December 31, 2013, 2012 and 2011 was $136.7 million, $213.8 million and $20.9 million, respectively. The increase in pre-tax compensation expense and fair value of restricted shares vested for the year ended December 31, 2012 resulted from acceleration of stock-based compensation expense and award vesting associated with the termination of certain Medco employees following the Merger. The weighted-average remaining recognition period for restricted stock units and performance shares is 1.1 years.
A summary of the status of restricted stock units and performance shares as of December 31, 2013, and changes during the year ended December 31, 2013, is presented below.
|
| | | | | | |
| Shares (in millions) | | Weighted-Average Grant Date Fair Value Per Share |
Outstanding at beginning of year | 4.7 |
| | $ | 54.57 |
|
Granted | 1.1 |
| | 58.31 |
|
Other(1) | 0.1 |
| | 49.72 |
|
Released | (2.5 | ) | | 53.70 |
|
Forfeited/cancelled | (0.3 | ) | | 54.04 |
|
Outstanding at December 31, 2013 | 3.1 |
| | 56.58 |
|
Vested and deferred at December 31, 2013 | 0.1 |
| | 56.49 |
|
Non-vested at December 31, 2013 | 3.0 |
| | $ | 56.58 |
|
| |
(1) | Represents additional performance shares issued above the original value for exceeding certain performance metrics. |
Stock options and SSRs. Express Scripts grants stock options and SSRs to certain officers, directors and employees to purchase shares of Express Scripts Holding Company common stock at fair market value on the date of grant. Express Scripts’ and ESI’s SSRs and stock options generally have three-year graded vesting, with the exception of 1.0 million awards granted during the fourth quarter of 2011 which cliff vest two years from the closing date of the Merger. Medco’s options granted under the 2002 Stock Incentive Plan generally vest on a graded basis over three years.
Due to the nature of the awards, we use the same valuation methods and accounting treatments for SSRs and stock options. As of December 31, 2013 and 2012, unearned compensation related to SSRs and stock options was $43.8 million and $74.4 million, respectively. We recorded pre-tax compensation expense related to SSRs and stock options of $77.3 million, $220.0 million and $34.6 million in 2013, 2012 and 2011, respectively. The increase for the year ended December 31, 2012 resulted from stock-based compensation expense acceleration associated with the termination of certain Medco employees. The weighted-average remaining recognition period for stock options and SSRs is 1.3 years.
A summary of the status of stock options and SSRs as of December 31, 2013, and changes during the year ended December 31, 2013, is presented below.
|
| | | | | | | | | | | | |
| Shares (in millions) | | Weighted- Average Exercise Price Per Share | | Weighted- Average Remaining Contractual Life | | Aggregate Intrinsic Value (in millions)(1) |
Outstanding at beginning of year | 44.2 |
| | $ | 40.71 |
| | | | |
Granted | 3.3 |
| | 58.34 |
| | | | |
Exercised | (14.6 | ) | | 37.56 |
| | | | |
Forfeited/cancelled | (1.0 | ) | | 54.11 |
| | | | |
Outstanding at end of period | 31.9 |
| | 43.56 |
| | 5.3 | | $ | 852.3 |
|
Awards exercisable at period end | 23.7 |
| | $ | 40.26 |
| | 5.0 | | $ | 709.8 |
|
| |
(1) | Amount by which the market value of the underlying stock exceeds the exercise price of the option. |
For the year ended December 31, 2013, the windfall tax benefit related to stock options exercised during the year was $42.7 million and is classified as a financing cash inflow on the consolidated statement of cash flows.
The fair value of options and SSRs granted is estimated on the date of grant using a Black-Scholes multiple option-pricing model with the following weighted-average assumptions:
|
| | | | | |
| 2013 | | 2012 | | 2011 |
Expected life of option | 4-5 years | | 2-5 years | | 2-5 years |
Risk-free interest rate | 0.6%-1.7% | | 0.3%-0.9% | | 0.3%-2.2% |
Expected volatility of stock | 27%-37% | | 29%-38% | | 30%-39% |
Expected dividend yield | None | | None | | None |
Weighted-average volatility of stock | 34.1% | | 35.5% | | 36.6% |
The Black-Scholes model requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term and forfeiture rate of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior as well as expected behavior on outstanding options. The risk-free rate is based on the U.S. Treasury rates in effect during the corresponding period of grant. The expected volatility is based on the historical volatility of our stock price. These factors could change in the future, which would affect the stock-based compensation expense in future periods.
Cash proceeds, intrinsic value related to total stock options exercised, and weighted-average fair value of stock options granted during the years ended December 31, 2013, 2012 and 2011 are provided in the following table:
|
| | | | | | | | | | | |
(in millions, except per share data) | 2013 | | 2012 | | 2011 |
Proceeds from stock options exercised | $ | 524.0 |
| | $ | 401.1 |
| | $ | 35.9 |
|
Intrinsic value of stock options exercised | 362.0 |
| | 359.6 |
| | 82.8 |
|
Weighted-average fair value per share of options granted during the year | $ | 17.17 |
| | $ | 15.13 |
| | $ | 14.74 |
|
