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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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☒

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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For the quarterly period ended September 30, 2019

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or

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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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For the transition period from                     to                  

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Commission File Number:  001-36677

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DIPLOMAT PHARMACY, INC.

(Exact name of Registrant as specified in its charter)

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Michigan

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38-2063100

(State or other jurisdiction of
incorporation or organization)

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(IRS employer
identification number)

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4100 S. Saginaw Street, Flint, Michigan

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48507

(Address of principal executive offices)

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(Zip Code)

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(888) 720-4450

(Registrant’s telephone number, including area code)

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Securities registered pursuant to Section 12(b) of the Act:

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​

​

​

​

Title of each class

    

Trading Symbol(s)

    

Name of each exchange on which registered

Common Stock, no par value per share

​

DPLO

​

New York Stock Exchange

​

​

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 ⌧   No ◻

​

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧   No ◻

​

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

​

Large accelerated filer ⌧

Accelerated filer ◻

Non-accelerated filer ◻

Smaller reporting company ☐

​

Emerging growth company ☐

​

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ◻

​

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ☐   No ☒

​

As of November 8, 2019, there were 75,973,963 outstanding shares of the registrant’s no par value common stock.

​

​

​

​

DIPLOMAT PHARMACY, INC.

​

Form 10-Q

INDEX

​

​

​

    

Page No.

Part I — Financial Information

​

3

Item 1 — Financial Statements

​

3

Condensed Consolidated Balance Sheets (Unaudited)

​

3

Condensed Consolidated Statements of Comprehensive (Loss) Income (Unaudited)

​

4

Condensed Consolidated Statements of Cash Flows (Unaudited)

​

5

Condensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

​

6

Notes to Condensed Consolidated Financial Statements (Unaudited)

​

7

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

​

25

Item 3 — Qualitative and Quantitative Disclosures about Market Risk

​

38

Item 4 — Controls and Procedures

​

38

​

​

​

Part II — Other Information

​

40

Item 1 — Legal Proceedings

​

40

Item 1A — Risk Factors

​

40

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds

​

42

Item 6 — Exhibits

​

43

Signatures

​

44

​

​

​

​

2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

DIPLOMAT PHARMACY, INC.

Condensed Consolidated Balance Sheets (Unaudited)

(Dollars in thousands)

​

​

​

​

​

​

​

​

​

​

​

September 30, 

​

December 31, 

​

​

    

2019

    

2018

​

ASSETS

​

​

​

​

​

​

​

Current assets:

​

​

​

​

​

​

​

Cash and equivalents

​

$

8,420

​

$

9,485

​

Receivables, net

​

 

338,321

​

 

326,602

​

Inventories

​

 

181,401

​

 

210,573

​

Prepaid expenses and other current assets

​

 

14,035

​

 

9,596

​

Total current assets

​

​

542,177

​

​

556,256

​

​

​

​

​

​

​

​

​

Property and equipment

​

​

54,462

​

​

55,929

​

Accumulated depreciation

​

​

(26,258)

​

​

(21,404)

​

Property and equipment, net

​

 

28,204

​

 

34,525

​

Capitalized software for internal use, net

​

​

28,899

​

​

30,506

​

Operating lease right-of-use assets

​

 

26,863

​

 

—

​

Goodwill

​

 

371,569

​

 

609,592

​

Definite-lived intangible assets, net

​

 

155,798

​

 

240,810

​

Assets held for sale

​

​

3,642

​

​

—

​

Other noncurrent assets

​

 

5,451

​

 

4,670

​

Total assets

​

$

1,162,603

​

$

1,476,359

​

​

​

​

​

​

​

​

​

LIABILITIES AND SHAREHOLDERS’ EQUITY

​

​

​

​

​

​

​

Current liabilities:

​

​

​

​

​

​

​

Accounts payable

​

$

368,410

​

$

308,084

​

Rebates payable to PBM customers

​

​

23,459

​

​

23,264

​

Borrowings on revolving line of credit

​

​

105,000

​

​

176,300

​

Current portion of long-term debt

​

 

443,324

​

 

11,500

​

Current portion of operating lease liabilities

​

​

4,566

​

​

—

​

Accrued expenses:

​

​

​

​

​

​

​

Compensation and benefits

​

​

13,481

​

​

13,348

​

Contingent consideration

​

 

5,523

​

 

5,075

​

Other

​

 

27,779

​

 

21,014

​

Total current liabilities

​

 

991,542

​

 

558,585

​

​

​

​

​

​

​

​

​

Long-term debt, less current portion

​

 

—

​

 

438,369

​

Noncurrent operating lease liabilities

​

​

23,538

​

​

—

​

Deferred income taxes

​

​

1,459

​

​

2,781

​

Contingent consideration

​

​

4,948

​

​

1,820

​

Derivative liability

​

​

10,084

​

​

4,292

​

Deferred gain

​

​

—

​

​

5,175

​

Other

​

 

—

​

 

253

​

Total liabilities

​

​

1,031,571

​

​

1,011,275

​

​

​

​

​

​

​

​

​

Shareholders’ equity:

​

​

​

​

​

​

​

Preferred stock (10,000,000 shares authorized; none issued and outstanding)

​

​

—

​

​

—

​

Common stock (no par value; 590,000,000 shares authorized; 75,973,963 and 74,474,677 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively)

​

​

641,557

​

​

629,411

​

Additional paid-in capital

​

 

55,529

​

 

50,544

​

Accumulated deficit

​

 

(555,970)

​

 

(210,579)

​

Accumulated other comprehensive loss

​

​

(10,084)

​

​

(4,292)

​

Total shareholders' equity

​

 

131,032

​

 

465,084

​

Total liabilities and shareholders' equity

​

$

1,162,603

​

$

1,476,359

​

​

See Accompanying Notes to Condensed Consolidated Financial Statements.

​

3

DIPLOMAT PHARMACY, INC.

Condensed Consolidated Statements of Comprehensive (Loss) Income (Unaudited)

(Dollars in thousands, except per share amounts)

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended

​

Nine Months Ended

​

​

​

September 30, 

​

September 30, 

​

​

    

2019

    

2018

    

2019

    

2018

​

Net sales

​

$

1,301,197

​

$

1,373,334

​

$

3,845,629

​

$

4,131,896

​

Cost of sales

​

 

(1,237,812)

​

 

(1,279,976)

​

 

(3,630,297)

​

 

(3,849,743)

​

Gross profit

​

 

63,385

​

​

93,358

​

 

215,332

​

 

282,153

​

Selling, general and administrative expenses

​

 

(74,993)

​

 

(83,419)

​

 

(238,677)

​

 

(255,705)

​

Goodwill impairments

​

​

(122,076)

​

​

—

​

​

(244,967)

​

​

—

​

Impairments of definite-lived intangible assets

​

​

(34,173)

​

​

—

​

​

(52,152)

​

​

—

​

(Loss) income from operations

​

 

(167,857)

​

 

9,939

​

 

(320,464)

​

 

26,448

​

Other (expense) income:

​

​

​

​

​

​

​

​

​

​

​

​

​

Interest expense

​

 

(11,659)

​

 

(10,179)

​

 

(32,044)

​

 

(30,998)

​

Impairment of non-consolidated entities

​

 

—

​

 

(286)

​

 

—

​

 

(329)

​

Other

​

 

149

​

 

574

​

 

431

​

 

1,385

​

Total other expense

​

​

(11,510)

​

​

(9,891)

​

​

(31,613)

​

​

(29,942)

​

(Loss) income before income taxes

​

​

(179,367)

​

​

48

​

​

(352,077)

​

​

(3,494)

​

Income tax benefit (expense)

​

​

2,087

​

​

121

​

​

1,034

​

​

(750)

​

Net (loss) income

​

$

(177,280)

​

$

169

​

$

(351,043)

​

$

(4,244)

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Other comprehensive (loss) income, net of tax

​

​

(307)

​

​

918

​

​

(5,792)

​

​

(44)

​

Total comprehensive (loss) income

​

$

(177,587)

​

$

1,087

​

$

(356,835)

​

$

(4,288)

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

(Loss) income per common share, basic and diluted

​

$

(2.35)

​

$

0.00

​

$

(4.69)

​

$

(0.06)

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Weighted average common shares outstanding

​

​

​

​

​

​

​

​

​

​

​

​

​

Basic

​

 

75,509,088

​

​

74,386,386

​

 

74,904,776

​

​

74,181,869

​

Diluted

​

 

75,509,088

​

​

74,741,511

​

 

74,904,776

​

​

74,181,869

​

​

See Accompanying Notes to Condensed Consolidated Financial Statements.

​

​

4

DIPLOMAT PHARMACY, INC.

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)

(Dollars in thousands) ollars in thousands)

​

​

​

​

​

​

​

​

​

​

​

Nine Months Ended

​

​

​

September 30, 

​

​

    

2019

    

2018

​

Cash flows from operating activities:

​

​

​

​

​

​

​

Net loss

​

$

(351,043)

​

$

(4,244)

​

Adjustments to reconcile net loss to net cash provided by operating activities:

​

​

​

​

​

​

​

Depreciation and amortization

​

 

58,518

​

 

72,547

​

Goodwill impairments

​

​

244,967

​

​

—

​

Impairments of definite-lived intangible assets

​

​

52,152

​

​

—

​

Insurance proceeds received on settlement of claim

​

​

(14,100)

​

​

—

​

Payment on settlement of claim

​

​

14,100

​

​

—

​

Share-based compensation expense

​

​

12,632

​

​

15,771

​

Net provision for doubtful accounts

​

​

9,090

​

​

5,862

​

Write-off of debt issuance costs

​

​

731

​

​

—

​

Amortization of debt issuance costs

​

​

3,101

​

​

3,703

​

Write-down on assets held for sale to net realizable value

​

​

1,654

​

​

—

​

Changes in fair value of contingent consideration

​

 

49

​

 

2,419

​

Contingent consideration payments

​

 

(1,298)

​

 

(3,181)

​

Deferred income tax benefit

​

​

(1,322)

​

​

(2,034)

​

Impairment of non-consolidated entities

​

​

—

​

​

329

​

Other

​

​

(7)

​

​

(43)

​

Changes in operating assets and liabilities, net of business acquisition

​

​

​

​

​

​

​

Accounts receivable

​

 

(13,871)

​

 

(31,090)

​

Inventories

​

 

29,668

​

 

36,717

​

Accounts payable

​

 

57,759

​

 

(73,227)

​

Rebates payable

​

​

195

​

​

1,209

​

Other assets and liabilities

​

 

5,070

​

 

8,469

​

Net cash provided by operating activities

​

 

108,045

​

 

33,207

​

​

​

​

​

​

​

​

​

Cash flows from investing activities:

​

​

​

​

​

​

​

Expenditures for property and equipment

​

 

(3,961)

​

 

(7,880)

​

Expenditures for capitalized software for internal use

​

 

(14,050)

​

 

(8,736)

​

Payments to acquire businesses, net of cash acquired

​

​

(7,048)

​

​

(1,139)

​

Other

​

​

22

​

​

46

​

Net cash used in investing activities

​

 

(25,037)

​

 

(17,709)

​

​

​

​

​

​

​

​

​

Cash flows from financing activities:

​

​

​

​

​

​

​

Net payments on revolving line of credit

​

 

(71,300)

​

 

(10,000)

​

Payments on long term debt

​

 

(8,625)

​

 

(82,625)

​

Payments of debt issuance costs

​

​

(2,471)

​

​

(821)

​

Proceeds from issuance of stock upon stock option exercises

​

​

600

​

​

3,999

​

Contingent consideration payments

​

​

(2,277)

​

​

(2,088)

​

Net cash used in financing activities

​

 

(84,073)

​

 

(91,535)

​

Net decrease in cash and equivalents

​

 

(1,065)

​

 

(76,037)

​

Cash and equivalents at beginning of period

​

 

9,485

​

 

84,251

​

Cash and equivalents at end of period

​

$

8,420

​

$

8,214

​

​

​

​

​

​

​

​

​

Supplemental disclosures of cash flow information:

​

​

​

​

​

​

​

Cash paid for interest

​

$

28,212

​

$

27,707

​

Cash paid for income taxes

​

$

2,354

​

$

2,142

​

Noncash investing and financing activities:

​

​

​

​

​

​

​

Right-of-use assets obtained in exchange for new operating lease liabilities

​

$

2,101

​

$

—

​

​

See Accompanying Notes to Condensed Consolidated Financial Statements.

​

​

5

DIPLOMAT PHARMACY, INC.

Condensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(Dollars in thousands)

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Retained

​

Accumulated

​

​

​

​

​

​

​

​

​

​

Additional

​

Earnings

​

Other

​

Total

​

​

Common Stock

​

Paid-In

​

(Accumulated

​

Comprehensive

​

Shareholders'

​

    

Shares

    

Amount

    

Capital

    

Deficit)

    

Loss

    

Equity

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Balance at January 1, 2018

​

73,871,424

​

$

619,235

​

$

38,450

​

$

91,816

​

$

—

​

$

749,501

Cumulative effect adjustment, revenue recognition standard

​

—

​

​

—

​

​

—

​

​

(126)

​

​

—

​

​

(126)

Net loss

​

—

​

​

—

​

​

—

​

​

(450)

​

​

—

​

​

(450)

Stock issued upon stock option exercises

​

200,677

​

​

2,461

​

​

(552)

​

​

—

​

​

—

​

​

1,909

Share-based compensation

​

—

​

​

—

​

​

3,161

​

​

—

​

​

—

​

​

3,161

Stock issued upon vesting of restricted stock units

​

10,705

​

​

157

​

​

(157)

​

​

—

​

​

—

​

​

—

Balance at March 31, 2018

​

74,082,806

​

​

621,853

​

​

40,902

​

​

91,240

​

​

—

​

​

753,995

Net loss

​

—

​

​

—

​

​

—

​

​

(3,964)

​

​

—

​

​

(3,964)

Stock issued upon stock option exercises

​

129,722

​

​

1,831

​

​

(389)

​

​

—

​

​

—

​

​

1,442

Share-based compensation

​

—

​

​

—

​

​

6,961

​

​

—

​

​

—

​

​

6,961

Stock issued upon vesting of restricted stock units

​

47,683

​

​

1,109

​

​

(1,109)

​

​

—

​

​

—

​

​

—

Restricted stock award activity

​

21,924

​

​

561

​

​

(561)

​

​

—

​

​

—

​

​

—

Other comprehensive loss, net of tax

​

—

​

​

—

​

​

—

​

​

—

​

​

(962)

​

​

(962)

Balance at June 30, 2018

​

74,282,135

​

​

625,354

​

​

45,804

​

​

87,276

​

​

(962)

​

​

757,472

Net income

​

—

​

​

—

​

​

—

​

​

169

​

​

—

​

​

169

Stock issued upon stock option exercises

​

41,420

​

​

896

​

​

(248)

​

​

—

​

​

—

​

​

648

Share-based compensation

​

—

​

​

—

​

​

5,649

​

​

—

​

​

—

​

​

5,649

Stock issued upon vesting of restricted stock units

​

124,875

​

​

3,033

​

​

(3,033)

​

​

—

​

​

—

​

​

—

Other comprehensive income, net of tax

​

—

​

​

—

​

​

—

​

​

—

​

​

918

​

​

918

Balance at September 30, 2018

​

74,448,430

​

$

629,283

​

$

48,172

​

$

87,445

​

$

(44)

​

$

764,856

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Balance at January 1, 2019

​

74,474,677

​

$

629,411

​

$

50,544

​

$

(210,579)

​

$

(4,292)

​

$

465,084

Cumulative effect adjustment, leasing standard (Notes 2 and 14)

​

—

​

​

—

​

​

—

​

​

5,652

​

​

—

​

​

5,652

Net loss

​

—

​

​

—

​

​

—

​

​

(14,301)

​

​

—

​

​

(14,301)

Share-based compensation

​

—

​

​

—

​

​

3,572

​

​

—

​

​

—

​

​

3,572

Stock issued upon vesting of restricted stock units

​

244,948

​

​

4,766

​

​

(4,766)

​

​

—

​

​

—

​

​

—

Restricted stock award activity

​

(5,929)

​

​

37

​

​

(37)

​

​

—

​

​

—

​

​

—

Other comprehensive loss, net of tax

​

—

​

​

—

​

​

—

​

​

—

​

​

(2,127)

​

​

(2,127)

Balance at March 31, 2019

​

74,713,696

​

​

634,214

​

​

49,313

​

​

(219,228)

​

​

(6,419)

​

​

457,880

Net loss

​

—

​

​

—

​

​

—

​

​

(159,462)

​

​

—

​

​

(159,462)

Stock issued upon stock option exercises

​

27,313

​

​

148

​

​

(30)

​

​

—

​

​

—

​

​

118

Share-based compensation

​

—

​

​

—

​

​

4,283

​

​

—

​

​

—

​

​

4,283

Stock issued upon vesting of restricted stock units

​

65,988

​

​

1,544

​

​

(1,544)

​

​

—

​

​

—

​

​

—

Restricted stock award activity

​

186,969

​

​

425

​

​

(425)

​

​

—

​

​

—

​

​

—

Other comprehensive loss, net of tax

​

—

​

​

—

​

​

—

​

​

—

​

​

(3,358)

​

​

(3,358)

Balance at June 30, 2019

​

74,993,966

​

​

636,331

​

​

51,597

​

​

(378,690)

​

​

(9,777)

​

​

299,461

Net loss

​

—

​

​

—

​

​

—

​

​

(177,280)

​

​

—

​

​

(177,280)

Issuance of shares of common stock as consideration for InTouch Pharmacy LLC acquisition (Note 4)

​

836,431

​

​

3,899

​

​

—

​

​

—

​

​

—

​

​

3,899

Stock issued upon stock option exercises

​

104,653

​

​

582

​

​

(100)

​

​

—

​

​

—

​

​

482

Share-based compensation

​

—

​

​

—

​

​

4,777

​

​

—

​

​

—

​

​

4,777

Stock issued upon vesting of restricted stock units

​

38,913

​

​

745

​

​

(745)

​

​

—

​

​

—

​

​

—

Other comprehensive loss, net of tax

​

—

​

​

—

​

​

—

​

​

—

​

​

(307)

​

​

(307)

Balance at September 30, 2019

​

75,973,963

​

$

641,557

​

$

55,529

​

$

(555,970)

​

$

(10,084)

​

$

131,032

​

See Accompanying Notes to Condensed Consolidated Financial Statements.

​

​

6

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts)

​

1.  DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

​

Description of Business

​

Diplomat Pharmacy, Inc. and its consolidated subsidiaries (the “Company”) is the largest independent provider of specialty pharmacy and infusion services in the United States of America (“U.S.”). The Company is focused on improving the lives of patients with complex chronic diseases while also delivering unique solutions for manufacturers, hospitals, payors and providers. The Company’s patient-centric approach positions it at the center of the healthcare continuum for the treatment of complex chronic disease states, including oncology, specialty infusion therapies, immunology, hepatitis, multiple sclerosis and many other serious or long-term conditions. The Company operates in two reportable segments - Specialty and Pharmacy Benefit Management (“PBM”). The Specialty segment offers a broad range of innovative solutions to address the dispensing, delivery, dosing and reimbursement of clinically intensive, high-cost specialty drugs and a wide range of applications. The PBM segment provides services designed to help customers reduce the cost and manage the complexity of their prescription drug programs. The Company dispenses to patients in all U.S. states and territories through its advanced distribution centers and manages centralized clinical call centers to deliver localized services on a national scale.

​

Basis of Presentation

​

Liquidity and Going Concern

​

Beginning in latter half of 2018, the Company began experiencing operating results below expectations and deteriorating forecasts for future revenue growth.  Competitive challenges in its core specialty pharmacy business, impact of continued customer contract losses in the PBM business, and uncertainties and challenges facing the health care industry continue to create increasing headwinds for the Company’s operating results.

​

The continued availability of funding under our credit agreement is contingent on compliance with, among other things, certain financial debt covenants consisting of a total net leverage ratio and interest coverage ratio.  Effective August 2019, the Company amended the terms of its credit facility, in particular these specific ratios, which made these debt covenants less restrictive for the period September 30, 2019 through December 31, 2020, but thereafter returns to the originally agreed upon ratios.  The Company has been monitoring and evaluating the impact of these changes and originally expected to be in compliance with the amended covenants but it has determined, given recent operating results and deteriorated forecasts, that it is probable that the Company will be in violation of these covenants at December 31, 2019. If we were to violate our covenants, our lenders would have the right to terminate funding of our credit facility, accelerate our indebtedness (under the revolving credit facility and term loans), or foreclose on our assets.  While we believe that we would be able to obtain waivers for any such breach of covenants to prevent an acceleration of the outstanding indebtedness, the Company cannot conclude with certainty that it will have the ability to restructure its credit agreement, obtain necessary waivers or negotiate less restrictive debt covenants with its lenders. If the covenant violations are not waived and our access to the credit facility is terminated or the indebtedness thereunder is accelerated,  the Company may be unable to repay the obligations due under the credit agreement which would have a material adverse impact on the Company’s liquidity and business.  Accordingly, management’s assessment indicates, due to these conditions, there is uncertainty regarding the Company’s ability to maintain liquidity sufficient to operate its business effectively, which raises substantial doubt as to the Company’s ability to continue as a going concern within one year after the date that these consolidated financial statements were filed.

​

The Company’s operations are funded primarily through cash generated from operations, cash and equivalents on hand, and available borrowings under its revolving credit facility. As of September 30, 2019, the Company had $8.4 million in cash and equivalents, $105 million in borrowings under its revolving credit facility and $456 million outstanding under its

7

​

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

term loans. At September 30, 2019, the Company had $95 million of available borrowing capacity under its revolving line of credit.  For the nine months ended September 30, 2019, the Company generated $108 million of cash from operations.

The Company is reviewing strategic alternatives related to its future business operations which include, but are not limited to, a sale or merger of the Company, pursuing value enhancing initiatives or undertaking structural changes as a standalone company, or the sale or disposition of certain of the Company’s business or assets.  Additionally, the Company plans to work with its lenders to amend the credit agreement and continue to pursue cost-cutting initiatives.  However, given many of the mitigating plans are reliant on third parties and therefore outside the Company’s control, it is not considered probable that any of these alternatives will be effectively implemented in the near term.  Therefore, these plans do not mitigate the substantial doubt raised surrounding the Company’s ability to continue as a going concern.

​

Unaudited Condensed Consolidated Financial Statements

​

The condensed consolidated balance sheet as of September 30, 2019, and the condensed consolidated statements of comprehensive loss, changes in shareholders’ equity and cash flows for the three and nine months ended September 30, 2019 and 2018 are unaudited.  These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”) and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments of a normal recurring nature necessary for a fair presentation of the financial position, results of operations, cash flows and changes in shareholders’ equity for the periods presented. The results of operations for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019 or for any future annual or interim period. The consolidated balance sheet at December 31, 2018 included herein was derived from the audited financial statements as of that date.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

​

2.  NEW ACCOUNTING STANDARDS

​

Adoption of New Accounting Standard

​

Leases

​

The Company adopted Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842) and all subsequent amendments as of January 1, 2019.  Topic 842 requires a lessee to recognize the following for all leases, except short-term leases, at the commencement date: (1) a lease liability which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Topic 842 also requires expanded disclosures.

​

The Company adopted Topic 842 as of January 1, 2019 using the optional transition method, which allowed entities to apply the new guidance at the adoption date and record a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, and not to restate the comparative periods presented. Therefore, the comparative financial information has not been restated and continues to be reported under the accounting standards in effect for those periods.  The adoption of the standard resulted in the recognition of net operating lease right-of-use assets of approximately $28,400 and operating lease liabilities of approximately $29,300 on the condensed consolidated balance sheet as of January 1, 2019 primarily related to its real estate operating leases. The operating lease right-of-use assets includes the impact of deferred rent. The Company does not have any finance leases.

​

Also, upon adoption, the Company recorded a cumulative-effect adjustment, after tax, of $5,652 (a valuation allowance was established against the full amount of the net deferred taxes of $1,387) to increase retained earnings for the amount of a previously deferred gain on a sale-leaseback transaction that closed in 2018. Such gain recorded on the sale-leaseback transaction would have been fully recognized under Topic 842.

​

8

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

The Company elected to apply the package of practical expedients upon transition, which includes no reassessment of whether existing contracts are or contain leases and allowed for the lease classification for existing leases to be retained. The Company did not elect the practical expedient to use hindsight, and accordingly the initial lease term did not differ under the new standard versus prior accounting practice.  After transition, in certain instances, the cost of renewal options will be recognized earlier in the term of the lease than under the previous lease accounting rules.  The operating lease agreements include lease and non-lease components for which the Company elected the practical expedient to not separate non-lease components from the lease components but instead to combine them and account for them as a single lease component and will continue to do so for its real estate operating leases. The Company has selected as its accounting policy to keep leases with a term of twelve months or less off the balance sheet and recognize these lease payments on a straight-line basis over the lease term.

​

The Company has recorded operating lease right-of-use assets and operating lease liabilities in its condensed consolidated balance sheet at September 30, 2019. The lessors’ rate implicit in the operating leases was not available to the Company and was not determinable from the terms of the lease.  Therefore, the Company used its incremental borrowing rate to determine the present value of the future lease payments. The incremental borrowing rates were not observable and therefore, the rates were estimated primarily using a methodology dependent on the Company’s financial condition, creditworthiness, and availability of certain observable data.  In particular, the Company considered its actual cost of borrowing for collateralized loans and its credit rating, along with the corporate bond yield curve in estimating its incremental borrowing rates. These estimated incremental borrowing rates were applied to future lease payments to determine the present value of the operating lease liability for each lease.    

​

The new standard did not have a significant impact on the timing or measurement of lease expense in the condensed consolidated statements of comprehensive (loss) income and had no impact on the condensed consolidated statements of cash flows for the nine months ended September 30, 2019. As noted above, the comparative prior period information for the nine months ended September 30, 2018 has not been adjusted and continues to be reported under the Company’s historical lease recognition policies under ASC Topic 840, Leases.

​

The disclosure requirements of Topic 842 are included within Note 14, Leases.

​

Accounting Standards Issued But Not Yet Adopted

​

Credit Losses

​

In September 2016, the Financial Accounting Standards Board issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which is intended to improve financial reporting by requiring the recording of credit losses on financial assets, including receivables, on a more timely basis. The guidance will replace the current incurred loss accounting model with an expected loss approach. The new methodology requires an entity to estimate the credit losses expected over the life of an exposure based on historical experience, current conditions, and reasonable and supportable forecasts. The guidance requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses. ASU No. 2016-13 is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2019. The effect of adoption of the standard is required as an adjustment to the opening balance of retained earnings as of the beginning of the first reporting period in which ASU No. 2016-13 is effective.   The Company is currently evaluating the impact of the adoption of this accounting standard and has not yet determined the magnitude of any such one-time adjustment or the overall impact of ASU No. 2016-13 on its consolidated financial statements.

​

​

3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

​

Principles of Consolidation

​

The condensed consolidated financial statements include the accounts of Diplomat Pharmacy, Inc., and its wholly owned subsidiaries.

​

9

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

All intercompany transactions and balances have been eliminated in consolidation.

​

Use of Estimates

​

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported therein. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based upon amounts that differ from these estimates.

​

Receivables, net

​

Receivables, net consisted of the following:

​

​

​

​

​

​

​

​

​

​

​

September 30, 

​

December 31, 

​

​

    

2019

    

2018

​

Trade receivables, net of allowances of $(31,344) and $(25,342), respectively

​

$

329,141

​

$

299,407

​

Rebate receivables

​

 

6,450

​

 

22,375

​

Other receivables

​

 

2,730

​

 

4,820

​

​

​

$

338,321

​

$

326,602

​

​

Trade receivables are stated at the invoiced amount. Trade receivables primarily include amounts due from clients, third-party pharmacy benefit managers and insurance providers and are based on contracted prices. Trade receivables are unsecured and require no collateral. Trade receivable terms vary by payor, but generally are due within 30 days after the sale of the product or performance of the service.

​

Rebate receivables are amounts due from pharmaceutical manufacturers related to drug purchases by participants of the various pharmacy benefit plans that the Company manages, a portion of which, depending on contract terms, are paid back to the Company’s customers. The Company estimates these rebates at period-end based on its contractual arrangements with its manufacturers and such rebates are recorded as a reduction of cost of sales.

​

Inventories

​

Inventories consist of prescription and over-the-counter medications and are stated at the lower of cost or net realizable value. Cost is determined using the first-in, first-out method. Prescription medications are returnable to the Company’s vendors and fully refundable before nine months of expiration, and any remaining expired medication is relieved from inventory on a quarterly basis.

​

4. ACQUISITION OF INTOUCH PHARMACY LLC

​

On July 22, 2019, the Company acquired all of the outstanding equity interests of InTouch Pharmacy LLC (“InTouch”), a national specialty home infusion pharmacy based in Atlanta, Georgia with two additional locations in Tennessee and South Carolina. The Company accounted for the acquisition using the acquisition method.  The results of operations of InTouch are included in the condensed consolidated financial statements from the acquisition date.

​

The assets acquired and liabilities assumed in the InTouch acquisition, including identifiable intangible assets, were based on their estimated fair values as of the acquisition date.  The excess of the purchase price over the estimated fair value of the net tangible and identifiable intangible assets acquired was recorded as goodwill.  The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, specifically related to identifiable intangible assets. These estimates are preliminary and subject to change primarily due to the fair values of the acquired identifiable intangibles assets of $6,660 and the contingent consideration arrangement of $7,102 are provisional pending receipt of the final valuations for those assets and information to finalize the opening

10

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

working capital adjustments is not yet available. The following table summarizes the consideration transferred to acquire InTouch:

​

​

​

​

​

Cash

​

$

7,491

Restricted common stock (836,431 shares)

​

​

3,899

Contingent consideration at fair value

​

​

7,102

​

​

$

18,492

​

The fair value of the 836,431 restricted common shares issued as part of the consideration paid at closing, in accordance with the purchase agreement, was determined using a per share closing price of the Company’s common stock on the acquisition date ($5.18) and multiplied by 90 percent to account for the restricted nature of the shares.

​

The purchase price includes a contingent consideration arrangement that requires the Company to pay the former owners additional cash payouts of up to $8,000 if certain gross profit targets, as defined in the arrangement, are met in each of the next three years. The Company recorded an estimated liability equal to the fair value of the contingent consideration obligation of $7,102 as of the acquisition date.  The estimated fair value of the contingent consideration obligation was determined using a probability weighted discounted cash flow model. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurements.

​

The Company incurred acquisition related costs of $174 which were charged to Selling, general and administrative expenses during the three months ended September 30, 2019.

​

The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the acquisition date:

​

​

​

​

​

Cash

​

$

443

Receivables

​

​

6,939

Inventories

​

​

496

Other current assets

​

​

40

Definite-lived intangibles assets

​

​

6,660

Other noncurrent assets

​

​

24

Accounts payable

​

​

(2,567)

Accrued expenses - compensation and benefits

​

​

(625)

Total identifiable net assets

​

​

11,410

Goodwill

​

​

7,082

​

​

$

18,492

​

The estimated fair value of the definite-lived intangible assets that were acquired and their respective useful lives are as follows:

​

​

​

​

​

​

​

​

​

Useful

​

​

​

​

    

Life

    

Amount

Patient relationships

 

8 years

​

$

4,400

Non-compete employment agreements

 

5 years

​

 

260

Trade names and trademarks

 

5 years

​

 

2,000

​

​

​

​

$

6,660

11

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

​

The estimated fair value of the accounts receivable acquired is $6,939, with the gross contractual amount being $7,695. The Company expects $756 to be uncollectible.

​

The unaudited pro forma operating results have not been presented since the effect of the InTouch acquisition was not significant to the condensed consolidated financial statements.

​

5. FAIR VALUE MEASUREMENTS

​

The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based upon assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a three-tier fair value hierarchy was established, which prioritizes the inputs used in measuring fair value as follows:

​

Level 1: Observable inputs such as quoted prices in active markets;

​

Level 2: Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and

​

Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

​

An asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used should maximize the use of observable inputs and minimize the use of unobservable inputs.

​

Assets and liabilities measured at fair value are based on one or more of the following three valuation techniques:

​

A. Market approach: Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

​

B. Cost approach: Amount that would be required to replace the service capacity of an asset (replacement cost).

​

C. Income approach: Techniques to convert future amounts to a single present amount based upon market expectations (including present value techniques, option-pricing and excess earnings models).

​

The following table presents the placement in the fair value hierarchy of liabilities that are measured and disclosed at fair value on a recurring basis:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Asset /

​

​

Valuation

​

​

Valuation

​

​

​

    

(Liability)

    

Level 2

    

Level 3

     

Technique

September 30, 2019:

​

​

​

​

​

​

​

​

​

​

​

Contingent consideration

 

$

(10,471)

 

$

—

​

$

(10,471)

 

C

Interest rate swaps (Note 8)

​

​

(10,084)

​

​

(10,084)

​

​

—

 

A

​

​

​

​

​

​

​

​

​

​

​

​

December 31, 2018:

​

​

​

​

​

​

​

​

​

​

​

Contingent consideration

 

$

(6,895)

 

$

—

​

$

(6,895)

 

C

Interest rate swaps (Note 8)

​

​

(4,292)

​

​

(4,292)

​

​

—

 

A

​

12

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

The following table sets forth the change in contingent consideration (Level 3 measurements) for the nine months ended September 30, 2019:

​

​

​

​

​

​

​

Contingent

​

    

Consideration

Balance at January 1, 2019

​

$

(6,895)

InTouch Acquisition

​

​

(7,102)

Change in fair value

​

​

(49)

Payments

​

 

3,575

Balance at September 30, 2019

​

$

(10,471)

​

The carrying amount of the Company’s debt approximates fair value due to variable interest rates at customary terms and rates the Company could obtain in current financing.

​

6. GOODWILL AND DEFINITE-LIVED INTANGIBLE ASSETS

​

Goodwill

​

Goodwill is not amortized but it is reviewed for impairment annually in the fourth quarter of each year using data as of December 31 of that year, or more frequently if facts or circumstances indicate that the carrying value of a reporting unit’s goodwill may not be recoverable.  The Company has three reporting units – Diplomat Specialty Pharmacy (“DSP”) and Diplomat Specialty Infusion Group (“DSIG”), which are within the Specialty segment, and PBM. The following table sets forth the changes in the carrying amount of goodwill and accumulated impairment losses, by segment, for the nine months ended September 30, 2019:

​

​

​

​

​

​

​

​

​

​

​

​

    

Specialty

    

PBM(a)

    

Total

Balance at January 1, 2019

​

​

​

​

​

​

​

​

​

Goodwill

​

$

386,436

​

$

448,122

 

$

834,558

Accumulated impairment losses

​

​

(45,776)

​

​

(179,190)

​

​

(224,966)

​

 

 

340,660

​

​

268,932

 

​

609,592

Goodwill acquired with InTouch acquisition

​

​

7,082

​

​

—

​

​

7,082

Impairment losses (second quarter)

​

​

(68,218)

​

​

(54,673)

​

​

(122,891)

Impairment losses (third quarter)

 

 

—

​

​

(122,076)

 

​

(122,076)

Other

​

​

—

​

​

(138)

​

​

(138)

Balance at September 30, 2019

​

​

​

​

​

​

​

​

​

Goodwill

​

​

393,518

​

​

447,984

​

​

841,502

Accumulated impairment losses

​

​

(113,994)

​

​

(355,939)

​

​

(469,933)

​

​

$

279,524

​

$

92,045

 

$

371,569

​

(a) The goodwill in the PBM segment was recorded as a result of two separately acquired entities (i) Pharmaceutical Technologies, Inc. d/b/a National Pharmaceutical Services, acquired in November 27, 2017, and (ii) LDI Holding Company, LLC, acquired December 20, 2017.

​

The Company determined, due to lower than expected second quarter of 2019 results and the resulting negative impact on future forecasts, that there was an indication of impairment for the Specialty and PBM segments and, as a result, tested goodwill, at the reporting unit level, in the interim period at June 30, 2019. The impairment test consists of comparing the reporting unit’s fair value to its carrying value. Based on the interim impairment test as of June 30, 2019, the Company determined that the fair value of DSP reporting unit and PBM reporting unit were less than their respective carrying value. As a result, in the second quarter of 2019, the Company recorded total goodwill impairment charges of $122,891 and impairments to definite-lived intangible assets of $17,979.

​

13

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

For the DSP reporting unit, as of and for the second quarter of 2019, the Company experienced lower than expected results, which had impacted the outlook for the remainder of 2019 and into 2020. The lowered outlook for the DSP reporting unit included slower than anticipated brand to generic conversions and delays in the release of generic versions of certain drugs which tend to provide higher margin contribution. Additionally, anticipated cost savings were running behind forecast primarily due to delays in the implementation of ScriptMed, our new specialty operating platform, which we deliberately slowed to minimize any disruptive impact of the transition to providers and patients. While the previous outlook assumed additional investment in the Company’s payor sales team which would have resulted in new business opportunities that would offset anticipated negative impacts to volume, the Company saw limited impacts from this investment on 2019 results through June 30, 2019. Lastly, while it was believed the business environment would stabilize, the Company continued to see volumes in the DSP reporting unit business being negatively impacted by member channel management and increased competition from larger, vertically-integrated peers and a reimbursement environment in specialty pharmacy that was driving continued downward pressure on margins. As such, these conditions resulted in downward revisions of the forecasts on current and future projected earnings and cash flows from the DSP reporting unit. During the second quarter of 2019, the Company recorded a goodwill impairment in the Specialty segment of $68,218, which was allocated to the DSP reporting unit. The impairment charge is not deductible for income tax purposes.

​

Also, in the second quarter of 2019, the PBM business experienced lower than expected results driven by continued business losses and lower earned rebates due to drug mix and slightly lower rebate retention. These lower than expected results, and a reduced outlook in 2020 and beyond, resulted in downward revisions of the forecasts on current and future projected earnings and cash flows of the PBM reporting unit. During the second quarter of 2019, the Company recorded a goodwill impairment charge of $54,673 in the PBM segment which is not deductible for income tax purposes.

​

In the third quarter of 2019, the Company determined, due to downward revisions on future forecasts, there was an additional indication of impairment for the PBM segment and, as a result, tested goodwill, at the reporting unit level, in the interim period at September 30, 2019. During the third quarter of 2019, the Company recorded a goodwill impairment charge in the PBM segment of $122,076. The impairment charge resulted primarily from lower than anticipated success rate in converting potential sales opportunities into new customer contracts during the third quarter and into the fourth quarter for the upcoming 2020 calendar year contracts and continued customer contract losses impacting 2020 forecasts occurring in the third quarter beyond those anticipated at the time of our second quarter impairment assessment. An additional factor driving the impairment charge was our inability to meet certain contractual membership level requirements, which was communicated in August 2019 from one of our PBM aggregators, that resulted in a rebate penalty impacting the full year of 2019.

​

The estimated fair value for each of the reporting units was determined using the income approach. Fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. Internal forecasts are used to estimate future cash flows and include an estimate of long-term growth rates based on management’s most recent views of the long-term outlook for each reporting unit. Such projections contain management’s best estimates of growth rates in revenue and costs, and future expected changes in operating margins and cash expenditures, which are based on factors including the best estimates of economic and market conditions over the projected period. The projection of estimated operating results and cash flows are discounted using a weighted average cost of capital that reflects current market conditions appropriate to each reporting unit. The discount rate is sensitive to changes in interest rates and other market rates in place at the time the assessment is performed. The discount rates used in the valuations of the reporting units as of June 30, 2019 were 10.5% for the DSP reporting unit and 11.75% for the PBM reporting unit, and 13.5% for the PBM reporting unit as of September 30, 2019.  The discount rate was increased to 13.5% for the PBM reporting unit due to the increased risk in the Company’s ability to forecast future sales volumes.

​

Also, the Company in connection with the goodwill impairment analyses performed as of June 30, 2019 and September 30, 2019 assessed whether the carrying amounts of the reporting units long-lived assets may not be recoverable and therefore may be impaired. To assess the recoverability at the DSP reporting unit and PBM segment asset group level, the undiscounted cash flows of the DSP and PBM businesses were analyzed over a range of potential remaining useful lives. As a result, the Company determined that certain trade names and trademarks, certain customer and physician relationships in the DSP and PBM reporting units and certain non-compete employment agreements in its DSP reporting unit were not recoverable and were impaired. During the second quarter of 2019, the Company recorded an impairment charge of

14

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DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

$16,772 to fully impair the remaining intangible assets in the DSP reporting unit and an impairment charge of $1,207 to further impair those intangible assets at the PBM reporting unit. During the third quarter of 2019, the Company recorded an additional impairment charge of $34,173 to further impair certain trade names and trademarks, and customer relationship intangibles in the PBM reporting unit. Refer to the additional discussion below.

​

Definite-lived intangible assets

​

Definite-lived intangible assets consisted of the following:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

 

September 30, 2019

​

​

Weighted

​

​

​

​

​

​

​

​

​

​

 

Average

 

Gross

​

​

​

 

Net

​

 

Amortization

 

Carrying

 

Accumulated

 

Carrying

​

    

Period Remaining

    

Amount

    

Amortization

    

Amount

Customer relationships

​

9.3

​

$

52,000

​

$

—

 

$

52,000

Patient relationships

​

5.3

​

​

174,500

​

​

(81,535)

​

​

92,965

Trade names and trademarks

 

2.7

 

 

29,620

​

​

(25,171)

 

​

4,449

Non-compete employment agreements

 

1.3

 

 

51,659

​

​

(45,275)

 

​

6,384

Total definite-lived intangible assets

​

​

​

$

307,779

​

$

(151,981)

 

$

155,798

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

December 31, 2018

​

​

Weighted

​

​

​

​

​

​

​

​

​

​

​

Average

 

Gross

​

​

​

 

Net

​

​

Amortization

 

Carrying

 

Accumulated

 

Carrying

​

    

Period Remaining

    

Amount

    

Amortization

    

Amount

Customer relationships

​

9.8

​

$

100,200

​

$

(1,238)

 

$

98,962

Patient relationships

​

5.9

​

​

170,100

​

​

(67,964)

​

​

102,136

Trade names and trademarks

​

1.8

​

 

30,650

​

​

(20,270)

 

​

10,380

Non-compete employment agreements

​

1.6

​

 

61,389

​

​

(44,100)

 

​

17,289

Physician relationships

​

4.8

​

​

21,700

​

​

(9,657)

​

​

12,043

Total definite-lived intangible assets

​

​

​

$

384,039

​

$

(143,229)

 

$

240,810

​

As disclosed above, certain intangible assets, consisting of certain trade names and trademarks, certain customer and physician relationships, and certain non-compete employment agreements, were impaired in the second and third quarter of 2019. The Company performed a valuation to determine the fair values of these intangible assets and as a result, the Company recorded non-cash impairment charges of $34,173 and $52,152 in the three and nine months ended September 30, 2019, respectively. In conjunction with the valuations performed, management also reviewed the useful lives of the trade names and trademarks, and customer relationships.  As a result of the review, no significant changes were necessary to the remaining estimated useful lives.

​

The Company recorded amortization expense on the definite-lived intangible assets of $11,962 and $17,190 for the three months ended September 30, 2019 and 2018, respectively, and $39,520 and $51,360 for the nine months ended September 30, 2019 and 2018, respectively.

​

15

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DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

7. DEBT

​

Total outstanding debt consisted of the following:

​

​

​

​

​

​

​

​

​

​

​

September 30, 

​

December 31, 

​

​

    

2019

    

2018

​

Short-term debt, borrowings on revolving line of credit

​

$

105,000

​

$

176,300

​

Term loan notes:

​

​

​

​

 

​

​

Term Loan A

​

$

136,875

​

$

142,500

​

Term Loan B

​

 

319,000

​

 

322,000

​

Total

​

 

455,875

​

 

464,500

​

Unamortized debt issuance costs

​

 

(12,551)

​

 

(14,631)

​

Total term loan notes

​

​

443,324

​

​

449,869

​

Less: current portion

​

​

443,324

​

​

11,500

​

Long-term debt, less current portion

​

$

—

​

$

438,369

​

​

The Company has a credit agreement with JP Morgan Chase Bank, N.A., and Capital One, N.A. that provides for a revolving line of credit and a $150,000 Term Loan A and $400,000 Term Loan B (“credit facility”). The credit agreement also provides for issuances of letters of credit of up to $10,000 and swingline loans up to $20,000.  On July 19, 2019, the Company agreed to a first amendment to the credit facility, effective August 6, 2019, which permanently reduced the commitment on its revolving line of credit from $250,000 to $200,000. In addition, the first amendment modified the financial debt covenants for the total net leverage ratio and the interest coverage ratio for the period September 30, 2019 through December 31, 2020. The first amendment makes these financial debt covenants less restrictive during the stated period and thereafter returns to the originally agreed upon ratios. The revolving line of credit and Term Loan A mature on December 20, 2022 and Term Loan B matures on December 20, 2024.

​

Interest on the revolving line of credit and Term Loan A is accrued at a rate equal to (i) the monthly LIBOR plus an applicable margin or (ii) a base rate that is the highest of the U.S. prime rate, federal funds rate (plus ½ of 1 percent) and LIBOR (plus 1 percent), at the Company’s option. The applicable margin is adjusted quarterly based on the Company’s leverage ratio. At September 30, 2019, the applicable margin was 2.50 percent for LIBOR loans and 1.50 percent for base rate loans. Interest on the Term Loan B is accrued similarly to Term Loan A, except the applicable margin is fixed at 4.50 percent for LIBOR loans and 3.50 percent for base rate loans.  The Company’s Term Loan A and Term Loan B interest rates were 4.55 percent and 6.55 percent, respectively, at September 30, 2019 and 4.78 percent and 7.03 percent, respectively, at December 31, 2018. The interest rate on the revolving line of credit was 4.55 percent and 5.19 percent at September 30, 2019 and December 31, 2018, respectively. The Company is charged a monthly unused commitment fee ranging from 0.3 percent to 0.4 percent on the average unused daily balance on its $200,000 revolving line of credit.

​

The Company had weighted average borrowings on its revolving line of credit of $137,521 and $163,380 and maximum borrowings on its revolving line of credit of $196,300 and $231,200 during the nine months ended September 30, 2019 and 2018, respectively. The Company had $95,000 and $73,700 available to borrow on its revolving line of credit at September 30, 2019 and December 31, 2018, respectively.  The revolving line of credit-related unamortized debt issuance costs were $4,964 and $4,246 as of September 30, 2019 and December 31, 2018, respectively.  In July 2019, the Company incurred $2,346 in debt issuance costs with the first amendment and wrote-off $731 in debt issuance costs, due to the permanent reduction in the borrowing commitment under the credit facility, to interest expense.  Such debt issuance costs, are classified within “Other noncurrent assets” in the condensed consolidated balance sheets.

​

The Term Loan A and Term Loan B requires quarterly principal payments of $1,875 and $1,000, plus accrued interest, respectively.  During the nine months ended September 30, 2018, the Company made a voluntary prepayment of $74,000 on the Term Loan B.

​

The credit facility is collateralized by substantially all of the Company’s assets.  The credit facility contains covenants that requires the Company, among other things, to provide financial and other information reporting, and to provide notice upon certain events. These covenants also place restrictions on the Company’s ability to incur additional indebtedness,

16

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DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

pay dividends or make other distributions, redeem or repurchase capital stock, make investments and loans, and enter into certain transactions, including selling assets, engaging in mergers or acquisitions, or engaging in transactions with affiliates. The Company was in compliance with all such covenants as of September 30, 2019. Although the Company was in compliance with its financial debt covenants at September 30, 2019, it was in compliance due to the modification of the financial debt covenants that became effective in August 2019.  As disclosed in Note 1, “Description of Business and Basis of Presentation, Liquidity and Going Concern,” management believes it is probable that the Company will be in violation of the less restrictive covenants at December 31, 2019.  Therefore, the Company has classified the outstanding balance under Term Loan A and Term Loan B as of September 30, 2019 as current in the condensed consolidated balance sheet.

​

8.  INTEREST RATE SWAPS

​

The Company enters into interest rate swap contracts to hedge variable interest rate risk related to certain variable rate borrowings. These interest rate swap contracts are designated as cash flow hedges for the purposes of hedge accounting treatment and any unrealized gains or losses that result from changes in the fair value of the interest rate swap contracts are reported in “Accumulated other comprehensive loss” as a component of shareholders’ equity. The Company measures hedge effectiveness on a quarterly basis. The Company does not use derivative financial instruments for speculative purposes.

​

In 2018, the Company entered into two pay-fixed and receive-floating interest rate swaps, which were effective on March 29, 2019 and terminate on March 31, 2022. The combined notional amount of the interest rate swaps was $286.1 million and $290.6 million at September 30, 2019 and December 31, 2018, respectively. At September 30, 2019 and December 31, 2018, the fair value of the interest rate swaps (derivative liability) was $10,084 and $4,292, respectively (a valuation allowance was established against the full amount of the net deferred tax benefit of $2,582 and $1,099, respectively). During the three months ended September 30, 2019 and 2018, the Company recognized other comprehensive (loss) income of $(307) and $918, respectively, and during the nine months ended September 30, 2019 and 2018, the Company recognized other comprehensive loss of $(5,792) and $(44), respectively.

​

9.  REVENUE

​

The following table disaggregates net sales by therapeutic categories for the Specialty segment and by product and service distribution channels for the PBM segment:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended

​

Nine Months Ended

​

​

​

September 30, 

​

September 30, 

​

​

    

2019

    

2018

    

2019

    

2018

​

Specialty Segment:

​

​

​

​

​

​

​

​

​

​

​

​

​

Oncology

​

$

718,859

​

$

701,206

​

$

2,123,574

​

$

2,094,394

​

Specialty infusion

​

 

209,767

​

 

178,890

​

 

580,254

​

 

525,857

​

Immunology

​

 

135,740

​

 

135,397

​

 

412,268

​

 

413,948

​

Other

​

 

179,082

​

 

196,805

​

 

511,486

​

 

564,824

​

Total Specialty segment

​

​

1,243,448

​

​

1,212,298

​

​

3,627,582

​

​

3,599,023

​

PBM Segment:

​

​

​

​

​

​

​

​

​

​

​

​

​

Retail networks

​

​

48,604

​

​

126,082

​

​

173,800

​

​

417,370

​

Specialty pharmacy

​

​

23,156

​

​

22,470

​

​

57,323

​

​

67,784

​

Mail order

​

​

7,976

​

​

16,019

​

​

30,758

​

​

50,029

​

Other

​

​

2,764

​

​

5,362

​

​

8,849

​

​

14,965

​

Total PBM segment

​

​

82,500

​

​

169,933

​

​

270,730

​

​

550,148

​

Inter-segment eliminations

​

​

(24,751)

​

​

(8,897)

​

​

(52,683)

​

​

(17,275)

​

Total net sales

​

$

1,301,197

​

$

1,373,334

​

$

3,845,629

​

$

4,131,896

​

​

Rebates retained, which represents the difference between the manufacturers’ rebates earned and rebates incurred to customers, approximated (5.5%) and 22.1% of total gross profit for the three months ended September 30, 2019 and 2018,

17

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

respectively and 5.9% and 17.2% of total gross profit for the nine months ended September 30, 2019 and 2018, respectively.

​

Rebates retained was negatively impacted for the three and nine months ended September 30, 2019.  In the third quarter of 2019, manufacturers’ rebates earned, recorded in Cost of sales, includes an approximate $9,000 adjustment due to the Company’s inability to meet certain contractual membership level requirements in 2019, as included in the PBM aggregator’s contract, necessary to maintain contractual rebate rates.  The Company had met the membership requirements for this standard contract for the years 2017 and 2018.  At the end of the second quarter of 2019, the Company was in negotiations with the aggregator, as required by the contract, regarding contract renewals (including the potential for adjustments to rebate pricing in the future and retroactively to January 1, 2019). In late August 2019, negotiations concluded with the aggregator assessing a rebate penalty of approximately $9,000 of which approximately $6,000 related to the six months ended June 30, 2019.  The aggregator began withholding from monthly rebate payments in September and October of 2019 to recover the penalty amount.  

​

Additionally, as of September 30, 2019, the Company recorded against Net sales, the recognition of an accrual for litigation of $3,900 relating to a rebate dispute with a terminated customer.

​

10.  SHARE-BASED COMPENSATION

​

Stock Options

​

A summary of the Company’s stock option activity as of and for the nine months ended September 30, 2019 is as follows:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Weighted

​

​

​

​

​

​

​

Weighted

​

Average

​

​

​

​

​

​

​

Average

​

Remaining

​

Aggregate

​

​

Number

​

Exercise

​

Contractual

​

Intrinsic

​

    

of Options

    

Price

    

Life

    

Value

​

​

​

​

​

​

​

(Years)

​

​

​

Outstanding at January 1, 2019

​

5,186,025

​

$

18.42

​

8.0

​

$

2,910

Granted

 

453,808

​

 

5.19

​

​

​

​

​

Exercised

​

(131,966)

​

​

4.54

​

​

​

​

​

Expired/cancelled

 

(1,732,525)

​

 

17.40

​

​

​

​

​

Outstanding at September 30, 2019

 

3,775,342

​

$

17.57

​

7.6

​

$

26

​

​

​

​

​

​

​

​

​

​

​

Exercisable at September 30, 2019

 

1,670,724

​

$

21.25

​

7.1

​

$

0

​

The Company recorded share-based compensation expense associated with stock options of $946 and $2,073 for the three months ended September 30, 2019 and 2018, respectively and $3,588 and $6,225 for the nine months ended September 30, 2019 and 2018, respectively. At September 30, 2019, the total compensation cost related to nonvested options not yet recognized was $7,985 which will be recognized over a weighted average period of 1.8 years, assuming all employees complete their respective service periods for vesting of the options.

​

The Company granted annual awards of 366,330 options under its 2014 Omnibus Incentive Plan (the “2014 Plan”) and an inducement award of 87,478 options to purchase common stock to key employees during the nine months ended September 30, 2019, which options become exercisable in installments of 33.3 percent, per year, beginning on the first anniversary of the grant date. These options have a maximum term of ten years.

​

Options to purchase 453,808 shares of common stock were granted during the nine months ended September 30, 2019 and have a weighted average grant date fair value of $2.53 per option. The grant date fair values of these stock option awards

18

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

were estimated using the Black Scholes-Merton option pricing model using the assumptions set forth in the following table:

​

​

​

​

​

​

​

​

​

​

Exercise price

​

​

$4.81 - $5.94

​

​

​

​

​

Expected volatility

 

​

49.12% - 49.47%

​

​

​

​

​

Expected dividend yield

 

​

0%

​

​

​

​

​

Risk-free rate for expected term

​

​

1.95% - 2.38%

​

​

​

​

​

Expected life (in years)

​

​

6.00

​

​

​

​

​

​

Estimating grant date fair values for employee stock options requires management to make assumptions regarding expected volatility of the value of those underlying shares, the risk-free rate over the expected life of the stock options and the date on which share-based payments will be settled. Expected volatility is based on a weighted average of the Company’s historic volatility and an implied volatility for a group of industry-relevant healthcare companies as of the measurement date. Risk-free rate is determined based upon U.S. Treasury rates over the estimated expected option lives. Expected dividend yield is zero as the Company does not anticipate that any dividends will be declared during the expected term of the options. The expected term of options granted is calculated using the simplified method (the midpoint between the end of the vesting period and the end of the maximum term). Forfeitures are accounted for when they occur.

​

Restricted Stock Units (“RSU” or “RSUs”)

​

A summary of the Company’s RSU activity as of and for the nine months ended September 30, 2019 is as follows:

​

​

​

​

​

​

​

​

​

​

​

Weighted

​

​

​

​

Average

​

​

Number

​

Grant Date

​

    

of RSUs

    

Fair Value

Nonvested at January 1,2019

 

1,869,029

​

$

21.67

Granted

 

5,908,924

​

 

5.30

Vested and issued

​

(349,849)

​

​

20.17

Cancelled /expired

 

(1,124,650)

​

 

19.13

Nonvested at September 30, 2019

 

6,303,454

​

$

6.78

​

Performance Based RSUs (shares reflected at maximum earn-out potential)

​

The Company granted an award of 1,498,500 performance-based RSUs as a sign-on inducement award to an executive during the second quarter of 2018. The award will be earned or forfeited based upon the Company’s performance relative to specified cumulative Adjusted EBITDA and revenue goals for the years ending December 31, 2018 and 2019 and the executive’s completion of the service condition. In January 2019, the performance goals were measurable and determinable, therefore, a grant date for accounting purposes was established. During the second quarter of 2019, these performance-based RSUs were modified by (1) adjusting the performance goals so that earning or forfeiture will be based upon the Company’s actual 2018 performance and projected 2019 performance, and (2) including a new performance goal that provides for full vesting at the maximum amount in the event the Company’s stock price increases by a specified percentage over a specified period of time during the 2019 fiscal year as a result of corporate actions taken during the 2019 performance year. The Company accounted for this modification pursuant to ASC Topic 718, “Compensation – Stock Compensation”, as a Type III (Improbable to Probable) modification and changed its estimate of the number of shares that will be earned from 0 percent to 30 percent.

​

During the second quarter of 2019, the Company granted annual awards of 1,835,000 performance-based RSUs under the 2014 Plan and 172,838 performance-based RSUs as an inducement award to key employees. These awards will be earned or forfeited based upon the Company’s performance relative to specified cumulative Adjusted EBITDA and revenue goals, as applicable, for the years ending December 31, 2019 and/or 2020, as applicable, and the completion of the service condition. The Company is currently accounting for these performance-based RSUs under the current estimate that 28.7 percent of the award shares will be earned. The Company recorded share-based compensation expense associated with

19

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

performance-based RSUs of $1,080 and $1,034 for the three months ended September 30, 2019 and 2018, respectively, and $2,154 and $1,886 for the nine months ended September 30, 2019 and 2018, respectively. At September 30, 2019, the total compensation expense related to nonvested performance-based RSUs not yet recognized, assuming 29.8 percent of the shares will be earned, was $2,947, which will be recognized over a weighted average remaining term of 1.2 years, assuming all employees also complete their respective service periods for vesting of the RSUs.

​

Service Based RSUs

​

The Company granted 2,159,377 service-based RSUs under its 2014 Plan and 243,209 service-based RSUs as inducement awards to key employees during the nine months ended September 30, 2019. The value of an RSU is determined by the market value of the Company’s common stock at the date of grant. This value is recorded as compensation expense on a straight-line basis over the vesting period, which ranges from one year to three years from grant date.

​

The Company recorded share-based compensation expense associated with service-based RSUs of $2,460 and $2,404 for the three months ended September 30, 2019 and 2018, respectively, and $6,258 and $7,245 for the nine months ended September 30, 2019 and 2018, respectively. At September 30, 2019, the total compensation cost related to nonvested RSUs not yet recognized was $20,762, which will be recognized over a weighted average remaining term of 2.1 years, assuming all employees complete their respective service periods for vesting of the service-based RSUs.

​

Restricted Stock Awards (“RSA” or RSAs”)

​

A summary of the Company’s RSA activity as of and for the nine months ended September 30, 2019 is as follows:

​

​

​

​

​

​

​

​

​

Number

​

Weighted

​

​

of Shares

​

Average

​

​

Subject to

​

Grant Date

​

    

Restriction

    

Fair Value

Nonvested at January 1, 2019

 

43,355

​

$

20.91

Granted

​

186,969

​

​

4.51

Vested

 

(20,829)

​

 

22.20

Forfeited

 

(5,929)

​

 

21.63

Nonvested at September 30, 2019

​

203,566

​

​

5.69

​

Under the 2014 Plan, the Company issued 186,969 RSAs to non-employee directors. The value of a RSA is determined by the market value of the Company’s common stock at the date of grant. The value of a RSA is recorded as share-based compensation expense on a straight-line basis over the vesting period, which is typically one year.

​

The Company recorded share-based compensation expense associated with RSAs of $291 and $138 for the three months ended September 30, 2019 and 2018, respectively, and $632 and $415 for the nine months ended September 30, 2019 and 2018, respectively. At September 30, 2019, the total compensation cost related to nonvested RSAs not yet recognized was $568 which will be recognized over a weighted average remaining term of 0.7 years, assuming the non-employee directors complete their service period for vesting of the RSAs.

​

11.  LOSS PER COMMON SHARE

​

Basic loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted income per common share further includes any common shares available to be issued upon exercise of outstanding service-based stock options; exercise of outstanding performance-based stock options for which all performance conditions were satisfied; and satisfaction of all contingent consideration performance conditions; and RSAs and RSUs, if such inclusions would be dilutive. The potentially dilutive common shares are determined for inclusion in diluted income per common share using the treasury stock method. For periods of net loss, basic and diluted per common share information are the same.

​

20

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

The following table sets forth the computation of basic and diluted loss per common share:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended

​

Nine Months Ended

​

​

​

September 30, 

​

September 30, 

​

​

    

2019

    

2018

    

2019

    

2018

​

Numerator:

​

​

​

​

​

​

​

​

​

​

​

​

​

Net (loss) income

​

$

(177,280)

​

$

169

​

$

(351,043)

​

$

(4,244)

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Denominator:

​

 

​

​

 

​

​

 

​

​

 

​

​

Weighted average common shares outstanding, basic

​

​

75,509,088

​

​

74,386,386

​

​

74,904,776

​

​

74,181,869

​

Weighted average dilutive effect of stock options, RSAs and RSUs

​

​

—

​

​

355,125

​

​

—

​

​

—

​

Weighted average common shares outstanding, diluted

​

​

75,509,088

​

​

74,741,511

​

​

74,904,776

​

​

74,181,869

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

(Loss) income per common share, basic and diluted

​

$

(2.35)

​

$

0.00

​

$

(4.69)

​

$

(0.06)

​

​

The Company had a net loss for the three months ended September 30, 2019 and nine months ended September 30, 2019 and 2018.  As a result, basic and diluted loss per common share were the same as any potentially dilutive securities would be anti-dilutive.  In the absence of a net loss, the weighted average dilutive effect of stock options, RSUs and RSAs would have been 235,830 for the three months ended September 30, 2019 and 399,746 and 383,742 for the nine months ended September 30, 2019 and 2018, respectively.

​

The weighted average effect of certain common stock equivalents including stock options, RSUs and RSAs were excluded from the computation of weighted average diluted shares outstanding as inclusion of such items would be anti-dilutive, are summarized as follows:

​

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended

​

Nine Months Ended

​

​

September 30, 

​

September 30, 

​

    

2019

    

2018

    

2019

    

2018

Service-based and earned performance-based stock options

 

3,634,546

 

3,907,277

 

3,556,237

 

3,983,767

Unearned performance-based stock options

 

574,138

 

574,138

 

574,138

​

574,138

Weighted average service-based RSUs

 

663,653

 

285,386

 

804,761

​

367,970

Weighted average performance based RSUs

 

—

 

2,267,384

 

—

​

1,015,331

Weighted average RSAs

 

—

 

21,924

 

17,726

 

9,717

Total

 

4,872,337

 

7,056,109

 

4,952,862

 

5,950,923

​

​

12. INCOME TAXES

​

The reconciliation of income taxes computed at the U.S. federal statutory tax rate to income tax expense is as follows:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended

​

Nine Months Ended

​

​

​

September 30, 

​

September 30, 

​

​

    

2019

    

2018

​

2019

    

2018

​

Income tax benefit (expense) at U.S. statutory rate

 

$

37,656

​

$

(10)

​

$

73,925

​

$

734

​

Tax effect from:

​

​

​

​

​

​

​

​

​

​

​

​

​

Valuation allowance

​

 

(29,438)

​

 

—

​

 

(61,861)

​

 

—

​

Share-based compensation

​

​

(906)

​

​

(86)

​

​

(2,298)

​

​

456

​

State income taxes, net of federal benefit

​

​

(206)

​

​

8

​

​

(754)

​

​

(755)

​

State income taxes, valuation allowance

​

​

1,575

​

​

—

​

​

1,637

​

​

—

​

Non-deductible employee compensation in excess of $1,000

​

​

(12)

​

​

183

​

​

(173)

​

​

(975)

​

Non-deductible goodwill impairment

​

​

(6,568)

​

​

—

​

​

(9,214)

​

​

—

​

Other

​

​

(14)

​

​

26

​

​

(228)

​

​

(210)

​

Income tax benefit (expense)

​

$

2,087

​

$

121

​

$

1,034

​

$

(750)

​

​

21

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

In determining the requirement for a valuation allowance against its deferred tax assets, the Company considers its historical and projected financial results of the legal entity or consolidated group recording the net deferred tax asset, along with other available positive and negative evidence. Due primarily to the parent company, along with several of its subsidiaries, being in a three-year cumulative loss from continuing operations position at September 30, 2019, the Company has determined it more likely than not its consolidated deferred tax asset and a substantial portion of separate entities’ deferred tax assets established for state loss carryforwards, will not be realized as a benefit in the future.  Accordingly, the Company has increased its valuation allowance against these net deferred tax assets by $60,224 at September 30, 2019.

​

13.  RELATED PARTY TRANSACTION

​

In December 2018, the Company signed a definitive agreement with ReactiveCore, Inc. (“ReactiveCore”) pursuant to which ReactiveCore provides information technology services to the Company over a period of three years, which commenced on January 1, 2019. Kenneth Klepper, a director of the Company’s Board of Directors (the “Board”), is the co-founder, chairman and chief executive officer of ReactiveCore. Prior to the signing of this agreement, the Board reviewed and approved this transaction in accordance with the Company’s related persons transaction policy.

​

The Company will pay base fees to ReactiveCore of approximately $2,400 over the term of the agreement and will pay additional fees for the provision of additional services. In the first quarter of 2019, the Company incurred a three-year licensing fee of $1,946 for the term of the agreement. Implementation fees of $819 were incurred for the three and nine months ended September 30, 2019.  All amounts incurred in connection with this agreement have been recorded in capitalized software for internal use, net in the condensed consolidated balance sheet at September 30, 2019.

​

​

14.  LEASES

​

The Company leases many of its pharmacy locations, office facilities, distribution centers, and certain office equipment through noncancelable operating lease contracts. Such noncancelable operating lease contracts convey the right to control such property for a period of time in exchange for consideration.  The operating leases have initial terms ranging from three to twelve years and generally have options to extend for one or two five-year periods. Additionally, most frequently, the lease contracts include a provision for early termination after a specified time period along with payment of a termination fee. Beginning in 2019, the lease term, for accounting purposes, will include renewal option periods when it is reasonably certain that the option to extend the lease will be exercised based on the facts and circumstances at lease commencement. The lease agreements, most often, provide for rental payments that increase over the lease term based on a fixed percentage or specified amount.  Additionally, the Company, in most cases, is required to pay real estate taxes, insurance costs and other occupancy costs such as common area maintenance that vary over the lease term.  

​

Rent expense was $2,265 and $6,291 for the three and nine months ended September 30, 2018. The components of lease expense in the condensed consolidated statements of comprehensive loss for the three and nine months ended September 30, 2019, were as follows:

​

​

​

​

​

​

​

​

​

​

Three Months Ended

​

Nine Months Ended

​

​

September 30, 

​

September 30, 

​

​

2019

​

2019

Operating lease cost

    

$

1,775

    

$

5,082

Variable lease cost

​

​

218

 

​

1,409

Short-term lease cost

​

​

107

 

​

348

Total

 

$

2,100

​

$

6,839

​

22

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

Maturities of lease liabilities for each of the next five years and thereafter, including reconciliation to the lease liabilities, were as follows:

​

​

​

​

​

2019 (excluding the nine months ended September 30, 2019)

    

$

1,663

2020

​

​

6,218

2021

​

​

5,387

2022

​

 

4,612

2023

​

 

3,499

Thereafter

​

 

14,933

Total future lease payments

​

 

36,312

Less: imputed interest costs (a)

​

 

(8,208)

Lease liabilities

 

$

28,104

(a) Computed using the estimated incremental borrowing rate for each lease

​

Other information related to the Company's leases as of and for the nine months ended September 30, 2019 are as follows:

​

​

​

​

​

​

​

Cash paid for amounts included in the measurement of lease liabilities

    

​

​

 

Operating cash flows for operating leases

​

$

3,552

 

Weighted average remaining lease term (in years)

​

 

7.34

​

Weighted average discount rate

​

 

6.76

%

​

​

​

​

​

15.  CONTINGENCIES

​

On November 10, 2016, a putative class action complaint was filed in the U.S. District Court for the Eastern District of Michigan against Diplomat Pharmacy, Inc. and certain former officers of the Company. Following the appointment of lead plaintiffs and lead counsel, an amended complaint was filed on April 11, 2017. The amended complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 in connection with public filings made between February 29, 2016 and November 3, 2016 (the “potential class period”). The plaintiffs sought to represent a class of shareholders who purchased stock in the potential class period. The complaint seeks unspecified monetary damages and other relief. The Company filed a motion to dismiss the amended complaint on May 26, 2017. The court issued orders denying the Company’s motion to dismiss on January 19, 2018 and the Company’s motion for reconsideration of its motion to dismiss on August 9, 2018. The parties reached an agreement-in-principle on April 22, 2019 to resolve the litigation for a payment of $14,100 which was fully covered by the Company’s insurance policies. The court approved the settlement on August 20, 2019. The settlement, as a result of coverage provided, did not have a material impact on the Company’s results of operations, financial condition or cash flows. The settlement was subsequently paid during the quarter ended September 30, 2019.

​

On February 24, 2019 and March 6, 2019, in the U.S. District Court for the Central District of California and on March 12, 2019 in the U.S. District Court for the Northern District of Illinois, putative class action complaints were filed against Diplomat Pharmacy, Inc. and certain current and former officers of the Company. The complaints alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 in connection with public filings made between February 26, 2018 and February 21, 2019 (the “potential class period”). The plaintiffs each sought to represent a class of shareholders who purchased stock in the potential class period. The complaints sought unspecified monetary damages and other relief. The cases were subsequently transferred and consolidated into a single proceeding in the Northern District of Illinois. The court appointed a lead plaintiff and lead counsel on July 19, 2019, and the lead plaintiff has sought leave until December 6, 2019 to file an amended complaint. The Company believes the complaints and allegations to be without merit and intends to vigorously defend itself against the action. The Company is unable at this time to determine whether the outcome of the litigation would have a material impact on its results of operations, financial condition or cash flows.

​

The Company’s business of providing specialized pharmacy services and other related services may subject it to litigation and liability for damages in the ordinary course of business. Nevertheless, the Company believes there are no other legal

23

Table of Contents

DIPLOMAT PHARMACY, INC.

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Dollars in thousands, except per share amounts) (continued)

​

proceedings, the outcome of which, if determined adversely to the Company, would individually or in the aggregate be reasonably expected to have a material adverse effect on its business, financial position, cash flows, or results of operations.

​

16.  SEGMENT REPORTING

​

The Company reports in two reportable segments: Specialty and PBM. The Specialty segment offers a broad range of innovative solutions to address the dispensing, delivery, dosing and reimbursement of clinically intensive, high-cost specialty drugs and a wide range of applications and the PBM segment provides services designed to help the Company’s customers reduce the cost and manage the complexity of their prescription drug programs. The chief operating decision maker evaluates segment performance principally upon net sales and gross profit. Net sales, cost of sales and gross profit information by segment are as follows:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended September 30, 

​

​

Net Sales

​

Cost of Sales

​

Gross Profit

​

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

Specialty

​

$

1,243,448

​

$

1,212,298

​

$

(1,178,918)

​

$

(1,145,288)

​

$

64,530

​

$

67,010

PBM

​

 

82,500

​

 

169,933

​

 

(83,645)

​

 

(143,585)

​

 

(1,145)

​

 

26,348

Inter-segment eliminations

​

​

(24,751)

​

​

(8,897)

​

​

24,751

​

​

8,897

​

​

—

​

​

—

​

​

$

1,301,197

​

$

1,373,334

​

$

(1,237,812)

​

$

(1,279,976)

​

$

63,385

​

$

93,358

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Nine Months Ended September 30, 

​

​

Net Sales

​

Cost of Sales

​

Gross Profit

​

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

Specialty

​

$

3,627,582

​

$

3,599,023

​

$

(3,432,506)

​

$

(3,386,653)

​

$

195,076

​

$

212,370

PBM

​

 

270,730

​

 

550,148

​

 

(250,474)

​

 

(480,365)

​

 

20,256

​

 

69,783

Inter-segment eliminations

​

​

(52,683)

​

​

(17,275)

​

​

52,683

​

​

17,275

​

​

—

​

​

—

​

​

$

3,845,629

​

$

4,131,896

​

$

(3,630,297)

​

$

(3,849,743)

​

$

215,332

​

$

282,153

​

Total assets by segment are as follows:

​

​

​

​

​

​

​

​

​

    

September 30, 

    

December 31, 

​

​

2019

​

2018

Specialty

​

$

968,956

​

$

1,045,174

PBM

​

 

193,647

​

 

431,185

​

​

$

1,162,603

​

$

1,476,359

​

​

​

24

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

​

(Dollars in thousands, except per share, per patient, and per prescription data)

​

The following Management’s Discussion and Analysis of financial condition and results of operations (“MD&A”) should be read in conjunction with the unaudited condensed consolidated financial statements, related notes, and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2018, which was filed on March 18, 2019 with the Securities and Exchange Commission (“SEC”).

​

Forward-Looking Statements

​

Certain statements contained or incorporated in this Quarterly Report on Form 10-Q which are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give current expectations or forecasts of future events or our future financial or operating performance. Words such as “anticipate,” “assume,” “believe,” “continue,” “could,” “estimate,” “expect,” “future,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “will,” and similar terms and phrases, or the negative thereof, utilized in discussions of future operating or financial performance signify forward-looking statements.

​

The forward-looking statements contained in this report are based on management’s good-faith belief and reasonable judgment based on current information. The forward-looking statements are qualified by important factors, risks, and uncertainties, many of which are beyond our control, that could cause our actual results to differ materially from those in the forward-looking statements, including those described in “Part II, Other Information - Item 1A. Risk Factors” and elsewhere in this report, as well as in our Annual Report on Form 10-K for the year ended December 31, 2018 and subsequent reports filed with or furnished to the SEC. Any forward-looking statement made by us in this report speaks only as of the date hereof or as of the date specified in such forward-looking statement. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments, or otherwise, except as may be required by any applicable laws or regulations.

​

Overview

​

Diplomat Pharmacy, Inc. (the “Company,” “Diplomat,” “our,” “us,” or “we”) is the largest independent provider of specialty pharmacy and infusion services in the United States of America (“U.S.”). We are focused on improving the lives of patients with complex chronic diseases while also delivering unique solutions for manufacturers, hospitals, payors and providers. Our patient-centric approach positions us at the center of the healthcare continuum for the treatment of complex chronic diseases. We offer a broad range of innovative solutions to address the dispensing, delivery, dosing and reimbursement of clinically intensive, high-cost specialty drugs (many of which can cost more than $100,000 per patient, per year) and a wide range of applications. We also provide PBM services, including administering pharmacy benefits, conducting quarterly and annual plan reviews and analyzing and modeling plan and formulary changes, designed to help our customers reduce the cost and manage the complexity of their prescription drug programs. We have expertise across a broad range of specialty therapeutic categories, including oncology, specialty infusion therapies, immunology, multiple sclerosis, hepatitis, and many other serious or long-term conditions. We dispense to patients in all U.S. states and territories through our advanced distribution centers and manage centralized clinical call centers to deliver localized services on a national scale. Diplomat opened its doors in 1975 as a neighborhood pharmacy with one essential tenet: “Take good care of patients and the rest falls into place.” Today, that tradition continues—always focused on improving patient care and clinical adherence.

​

Our revenues are derived from: (i) customized care management programs we deliver to our patients, surrounding the dispensing of their specialty medications and (ii) PBM services that we provide to our customers. Our specialty pharmacy services revenue growth has historically been primarily driven by manufacturer price inflation, new drugs coming to market, new indications for existing drugs, volume growth with current clients, and the addition of new clients. For the three and nine months ended September 30, 2019 and 2018, our revenues were primarily derived from the dispensing of drugs.

25

Strategic Alternatives Review

​

On August 9, 2019, the Company announced that, at the direction of its Board of Directors, it is reviewing strategic alternatives focused on maximizing shareholder value and this review remains ongoing. Financial and legal advisors are actively engaged to assist in this process. The strategic alternatives the Company is exploring include, but are not limited to, a sale or merger of the Company, continuing to pursue value-enhancing initiatives or undertaking structural changes as a standalone company, or the sale or other disposition of certain of the Company’s businesses or assets. There can be no assurance that this process will result in the approval or completion of any particular strategic alternative or transaction in the future or that any such strategic alternative or transaction, if approved or completed, will yield additional shareholder value.  Further, the process of exploring, reviewing and pursuing strategic alternatives, the public announcement of such process or any decision or transaction resulting from such process could adversely impact our business and our stock price.  

​

Specialty Segment Operating Results and Outlook

​

Our Specialty segment revenues were $1,243,448 and $3,627,582 for the three and nine months ended September 30, 2019, respectively, and $1,212,298 and $3,599,023 for the three and nine months ended September 30, 2018, respectively. Revenue generated in our Specialty segment has largely been driven by our position as a leader in the oncology, specialty infusion therapies and immunology therapeutic categories. We generated approximately 85 to 87 percent of our Specialty segment revenues in these categories for each of the three and nine months ended September 30, 2019 and 2018.

​

In the second quarter of 2019, our Specialty segment recorded a non-cash goodwill impairment charge of $68,218 and non-cash definite-lived intangible asset impairment charge of $16,772 to fully impair the remaining goodwill and intangible assets in our DSP reporting unit, primarily due to variances to our original 2019 forecast, which occurred during the second quarter of 2019. These variances were due to slower than anticipated brand to generic conversions and delays in the release of generic versions of certain drugs which tend to provide higher margin contribution and forecasted growth in volumes that were based on investments made in our payor sales team not yet coming to fruition. The variances also resulted from expected efficiencies not being achieved as quickly as originally expected due to delays in the implementation of ScriptMed, our new specialty operating system, which we deliberately slowed to minimize any disruptive impact of the transition to providers and patients. Additionally, the Company continues to experience pressure on reimbursement rates from certain payors and a less favorable medication drug mix than originally forecasted for 2019 which reduced profitability. As such, these conditions resulted in downward revisions of the forecasts on current and future projected earnings and cash flows in the DSP reporting unit of our Specialty segment.

​

In our Specialty segment, in the near-term we expect future revenue and profits will be negatively impacted by increased competitive pressures which are expected to drive reduced prescription volumes. We also believe we may continue to be negatively affected by a less favorable drug mix. Increased market consolidation has created opportunities for healthcare companies or PBMs to move patients to preferred pharmacies and narrow their networks on the commercial side. We expect this activity to continue to increase. As a result, we continue to observe and expect to continue to experience negative volume impacts connected to increasingly narrow or exclusive networks by large PBMs and health plans as well as less favorable drug mix due to payor formulary changes, brand versus generic mix and associated generic conversion rates. In addition, in both our commercial and Medicare businesses, we are observing that larger, vertically-integrated competitors, as well as health plans that own specialty pharmacies, are increasingly implementing aggressive member channel management techniques. Additionally, there continues to be pressure on reimbursement rates from payors which tend to reset annually, although these rates may also reset periodically throughout the year. As reimbursement rates have decreased, this decrease has compressed our profit margin. We have continued to see reimbursement rates decrease in our payor contracts. Subsequently, the Company was unable to reach an agreement on pricing to renew reimbursement rates with one of our largest specialty pharmacy network payors. As a result, effective November 28, 2019, the Company will no longer participate in the substantial majority of the retail and specialty pharmacy networks associated with this payor in which we currently participate.  We expect that for the full year of 2019, these networks will generate approximately $700,000 in revenue and be approximately breakeven at the operating income level, including the associated corporate costs.  Related prescription volume is approximately 100,000 scripts per year.  As such, we would expect to see a small reduction in volume and revenue during the remainder of 2019 and a significant reduction in volume and revenue in 2020. Although revenue and volume are expected to decline significantly in 2020, we expect exiting this contract and certain

26

associated networks to have an insignificant impact on profitability given severe pricing compression. In addition, as a result of lost volume, we expect to undertake further restructuring initiatives to reduce costs. Unless we successfully implement restructuring initiatives we would expect selling, general and administrative expense pertaining to personnel costs to significantly increase as a percentage of revenue. Furthermore, expected efficiencies which lagged due to second quarter delays in the implementation of ScriptMed, our new specialty operating system, are now expected to be significantly completed by the end of 2019 and fully implemented in the first quarter of 2020. However, because of the prior delay, expected cost savings will likely not be achieved in 2019 and may not be fully realized until the second half of 2020.  In addition, while cost saving efforts have resulted in efficiencies in certain areas, the expected margins have been offset through reinvestment in the sales team, an increase nursing labor costs for infusion therapies and increased facility costs from opening our new facility in Chandler, Arizona.

​

Longer-term, we believe that we can partially offset industry competitive pressures and market consolidation with an expanding breadth of services, our continued expectation of infusion therapy growth, and our access to limited-distribution drugs to help us achieve sustainable revenue in the future. However, we cannot predict the impact of any significant loss of volume on our access to limited-distribution prescription drugs.  The Company offers a range of specialty services, from simple limited-distribution drug clinical wrap-around services to a full specialty carve-out. We also provide a combined specialty pharmacy, infusion and PBM service offering designed to reduce specialty costs under both the pharmacy and medical benefit. We can also find value for patients and payors by offering comprehensive care management focused on optimized utilization and improved care outcomes. We also expect future revenue opportunities to be driven by favorable demographic trends (i.e., aging population and increasing prescription drug spend), advanced clinical developments, expanding drug pipelines, earlier detection of chronic diseases, improved access to medical care, long-term industry mix shift toward higher-cost specialty drugs and manufacturer price increases.

​

PBM Segment Results and Outlook

​

Our PBM segment revenues were $82,500 and $270,730 for the three and nine months ended September 30, 2019, respectively, and $169,933 and $550,148 for the three and nine months ended September 30, 2018, respectively. We continue to expect revenues for our PBM segment will decline significantly in 2019 and into 2020 due to substantial lost customer contracts, as currently reflected in the results for the three and nine months ended September 30, 2019 as compared to the same period of 2018, primarily as a result of service issues experienced while transitioning to a new claims processing platform in 2018, third-party acquisitions of clients, contract non-renewals, pricing compression, terminations prior to expiration as well as other factors. While we believe the service and execution issues are in the past and our PBM segment service performance remains consistent with industry standards, our PBM segment continues to be significantly challenged. Our ability to grow revenue in the PBM segment will depend on our ability to offset customer contract losses, and win new business, although, as we started to realize in the third quarter of 2019, we have not been as successful as anticipated in converting potential sales opportunities into new customer contracts, and we have continued to experience further contract non-renewals further depressing performance. We expect our revenue growth opportunities to be driven by rising drug prices and a growth in specialty drug spend, as well as a shift in the marketplace of drug coverage from a medical benefit to a pharmacy benefit, and the increasing complexity and required support for Medicare Part D programs.  In addition, we expect to implement a new rebate agreement with a new third-party beginning in 2020 with rates that we expect will favorably impact our anticipated rebate values going forward.

​

During the second quarter of 2019, our PBM segment recorded $54,673 of the non-cash goodwill impairment and non-cash definite-lived intangible asset impairment charges of $1,207. The impairment charges were taken as a result of lower than expected results driven by continued customer contract losses, and lower earned rebates due to drug mix and lower rebate retention all resulting in a reduced outlook in 2020 and beyond than was reflected in our previous guidance.

​

During the third quarter of 2019, our PBM segment recorded a non-cash goodwill impairment of $122,076 and a non-cash definite-lived intangible asset impairment charges of $34,173. The impairment charges were taken as a result of further downward revisions of the forecasts on current and future projected earnings and cash flows resulting partially from continued unanticipated client losses occurring in the third quarter of 2019, the lower than anticipated success in converting potential sales opportunities into new customer contracts to offset customer contract losses incurred, and continued margin erosion to retain existing customers. Additionally, driving the impairment charge was our inability to meet certain

27

contractual membership level requirements that resulted in a $12,000 reduction in anticipated rebate value for the full year 2019 which became known in the third quarter.

​

Key Performance Metrics

​

We regularly review a number of metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends, formulate financial projections and make strategic decisions:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended

​

Nine Months Ended

​

​

​

September 30, 

​

September 30, 

​

​

    

2019

    

2018

    

2019

    

2018

​

Specialty

 

​

  

 

​

  

​

​

  

 

​

  

​

Prescriptions dispensed

 

​

237,000

 

​

230,000

​

​

697,000

 

​

689,000

​

Net sales per prescription dispensed

​

$

5,221

​

$

5,256

​

$

5,189

​

$

5,206

​

Gross profit per prescription dispensed

​

$

268

​

$

287

​

$

276

​

$

303

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

PBM

​

 

  

​

 

  

​

 

  

​

 

  

​

Prescriptions filled (adjusted to 30-day equivalent)(1)(2)

​

 

922,000

​

 

1,931,000

​

 

2,908,000

​

 

6,235,000

​

Gross profit per prescription filled

​

$

(1)

​

$

14

​

$

7

​

$

11

​

(1) A 90-day prescription is counted as three 30-day prescriptions filled.
(2) Prescriptions filled is defined as prescriptions dispensed in our mail order facility as well as prescriptions adjudicated in our retail network.

​

Prescription Data (rounded to the nearest thousand)

​

Specialty segment prescriptions dispensed represent prescriptions filled and dispensed to patients or, in rare cases, to physicians. Our Specialty segment volume for the three and nine months ended September 30, 2019 was 237,000 and 697,000 prescriptions dispensed, which was slightly up compared to the three and nine months ended September 30, 2018. Despite the slight increase in volume, we expect to see continued pressure on volume due to increasingly narrow or exclusive networks by large PBMs and health plans. In addition, in both our commercial and Medicare businesses, we are observing that larger, vertically-integrated competitors, as well as health plans that own specialty pharmacies, are increasingly implementing aggressive member channel management techniques. Also, the Company was unable to reach an agreement on pricing to renew reimbursement rates with one of our largest specialty pharmacy payers. As a result, effective November 28, 2019, the Company will no longer participate in a certain retail and specialty pharmacy network. While this is expected to have a significant impact on volume, with related prescription volume being approximately 100,000 scripts per year, we expect this contract and certain associated networks to have an insignificant impact on profitability given severe pricing compression.  In addition, as a result of lost volume, we expect to undertake further restructuring initiatives to reduce costs.  We believe that our focus on direct contracting with health plans for specialty carveout business will partially offset these continued volume pressures. Prescriptions dispensed adjusted to a 30-day equivalent by our PBM were approximately 922,000 and 1,931,000 for the three months ended September 30, 2019 and 2018, respectively, and 2,908,000 and 6,235,000 for the nine months ended September 30, 2019 and 2018, respectively. These volume decreases were primarily due to the impact of customer contract losses in late 2018 and the continued customer contract losses throughout 2019. Although the PBM segment has won some new business, but not as much as was originally forecasted for the year, the net impact of the contract terminations and new contract wins is unfavorable at this time.

​

Other Metrics

​

Other key metrics used in analyzing our business are net sales per prescription dispensed and gross profit per prescription dispensed. Net sales per prescription dispensed represent total prescription revenue from prescriptions dispensed divided by the number of prescriptions dispensed. Gross profit per prescription dispensed represents gross profit from prescriptions dispensed divided by the number of prescriptions dispensed. Total prescription revenue from prescriptions dispensed includes all revenue collected from patients, third-party payors and various patient assistance programs, as well as revenue collected from pharmaceutical manufacturers for data and other services directly tied to the actual dispensing of their

28

drug(s). Gross profit represents total prescription revenue from prescriptions dispensed less the cost of the drugs purchased, including performance-related rebates paid by manufacturers to us that are recorded as a reduction to cost of sales, shipping and handling costs incurred at our dispensing sites, and nursing support services.

Components of Results of Operations

​

Net Sales

​

Our Specialty segment recognizes revenue for a dispensed prescription drug at the time of delivery (when control transfers) and at prescription adjudication (which approximates the fill date) for patient pick up at open door or retail pharmacy locations. We can earn revenue from multiple sources for any one claim, including the primary insurance plan, the secondary insurance plan, the tertiary insurance plan, the patient co-pay and patient assistance programs. The net sales in our Specialty segment also include revenue from pharmaceutical manufacturers and other outside companies for data reporting or additional services rendered for dispensed prescriptions. Service revenue is primarily derived from fees earned by us from hospital pharmacies for patient support that is provided by us to those non-Diplomat pharmacies to dispense specialty drugs to patients. The hospital pharmacies dispense the drug and pay us a service fee for clinically and administratively servicing their patients. These services constituted less than 1 percent of our revenues in each of the three and nine months ended September 30, 2019 and 2018, respectively.

​

Our PBM segment recognizes revenue from the sale of prescription drugs by its mail order pharmacy service when the drugs are physically delivered (when control transfers) and by its retail pharmacy network when the claim is adjudicated. The Company records revenue, net of manufacturers’ rebates, which are earned by and paid to its clients based on their plan members’ utilization of brand-name formulary drugs. Our PBM segment recognizes revenue on a gross basis since they act as principal in the arrangement, exercise pricing latitude and independently have a contractual obligation to pay their network pharmacy providers for benefits provided to their clients’ members, and assuming primary responsibility for fulfilling the promise to provide prescription drugs to their client plan members while also performing the related pharmacy benefit management services. Our PBM segment includes the total prescription price (drug ingredient cost plus dispensing fee) they have contracted with their clients as revenue, including member co-payments to pharmacies.

​

Cost of Sales

​

Cost of sales in our Specialty segment primarily represents the purchase price of the drugs that we ultimately dispense. These drugs are purchased directly from the manufacturer or from an authorized wholesaler and the purchase price is negotiated with the selling entity. Cost of sales in our PBM segment primarily represents the purchase price of the drugs that we dispense from our mail order services and the amount that we reimburse to pharmacies for prescriptions adjudicated in our retail network. In general, there is a relationship between cost of sales and net sales for prescription dispensing transactions. This is due to the mathematical relationship between average wholesale price (“AWP”) and wholesale acquisition cost (“WAC”), where most commonly AWP equals WAC multiplied by 1.20, and our contractual relationships to purchase at a discount off WAC and receive reimbursement at a discount off AWP. The discounts off AWP and WAC that we receive vary significantly by drug and by contract. Rebates we receive from manufacturers are reflected as reductions to cost of sales when they are earned. In certain of our contracts with aggregators, these rebates could be returned if set membership levels are not met for a period of time. Other expenses contained in cost of sales consist of shipping and handling costs incurred at our dispensing pharmacies and nursing support services.

​

SG&A

​

Our operating expenses primarily consist of employee and employee-related costs inclusive of share-based compensation, amortization expense from definite-lived intangible assets associated with our acquired entities and amortization expense from capitalized software for internal use. Other operating expenses consist of occupancy and other indirect costs, insurance costs, professional fees and other general overhead expenses.

​

29

Other (Expense) Income

​

Other expense primarily consists of interest expense associated with our debt. Other income includes rental income from leased space in properties we own.

​

RESULTS OF OPERATIONS

​

Three Months Ended September 30, 2019 versus Three Months Ended September 30, 2018

​

Consolidated Results

​

The following table provides our condensed consolidated statements of comprehensive (loss) income data for each of the periods presented:

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended

​

​

​

September 30, 

​

​

    

2019

    

2018

​

Net sales

​

$

1,301,197

​

$

1,373,334

​

Cost of sales

​

 

(1,237,812)

​

 

(1,279,976)

​

Gross profit

​

 

63,385

​

 

93,358

​

SG&A

​

 

(74,993)

​

 

(83,419)

​

Goodwill impairments

​

 

(122,076)

​

 

—

​

Impairments of definite-lived intangible assets

​

 

(34,173)

​

 

—

​

(Loss) income from operations

​

 

(167,857)

​

 

9,939

​

Other (expense) income:

​

 

  

​

 

  

​

Interest expense

​

 

(11,659)

​

 

(10,179)

​

Impairment of non-consolidated entities

​

 

—

​

 

(286)

​

Other

​

 

149

​

 

574

​

Total other expense

​

 

(11,510)

​

 

(9,891)

​

(Loss) income before income taxes

​

 

(179,367)

​

 

48

​

Income tax benefit

​

 

2,087

​

​

121

​

Net (loss) income

​

$

(177,280)

​

$

169

​

​

Net Sales

​

Net sales for the three months ended September 30, 2019 were $1,301,197, a $72,137, or 5.3 percent, decrease compared to $1,373,334 for the three months ended September 30, 2018. This decrease was primarily due to the continued impact of the loss of customer contracts at our PBM segment, as well as payor reimbursement compression, and increased conversion of certain brand name drugs to their generic equivalents. The decreases were partially offset by the impact of manufacturer price inflation and growth in infusion therapies versus the comparable prior period.

​

Cost of Sales

​

Cost of sales for the three months ended September 30, 2019 was $1,237,812, a $42,164, or 3.3 percent, decrease compared to $1,279,976 for the three months ended September 30, 2018. This decrease was primarily the result of the loss of customer contracts at our PBM segment, and conversion of certain brand name drugs to their generic equivalent in our Specialty segment over the same period and a $9,000 impact due to the rebate penalty with a certain aggregator due to not meeting contractual membership level requirements. Cost of sales was 95.1 percent and 93.2 percent of net sales for the three months ended September 30, 2019 and 2018, respectively. The decrease in gross margin from 6.8 percent to 4.9 percent for the three months ended September 30, 2018 and 2019, respectively, was primarily due to the rebate penalty in our PBM segment, as well as payor reimbursement compression in our Specialty segment.

​

30

SG&A

​

SG&A expenses for the three months ended September 30, 2019 were $74,993, a $8,426 decrease compared to $83,419 for the three months ended September 30, 2018. The decrease is primarily the result of a $7,416 decrease in amortization expense primarily due to the amortization of intangible assets due to the impairment of these assets in the fourth quarter of 2018 and the second and third quarter of 2019, and a $872 decrease in share-based compensation expense.

​

Impairment Charges on Goodwill and Other Intangibles

​

As a result of an interim impairment test for goodwill for our PBM segment as of September 30, 2019, performed as a result of continued customer contract losses, but more importantly from our lower than anticipated success in converting potential sales opportunities into significant new customer contracts during our calendar 2020 selling season which typically occurs in the late third and fourth quarters of 2019, we recorded a non-cash impairment charge against goodwill of $122,076 and relatedly, an impairment charge of $34,173 of certain definite-lived intangible assets, primarily certain trade names and trademarks, certain customer relationships in our PBM segment. The impairment charges were taken as a result of lower than expected results and a reduced outlook in 2020 driven by continued unanticipated customer contract losses in the third quarter of 2019 and slower than anticipated success in converting potential sales opportunities into significant new customer contracts. See “Management Discussion and Analysis – Overview” above for additional information regarding these impairment charges.

​

Other Expense

​

Our other expense was $11,510 and $9,891 for the three months ended September 30, 2019 and 2018, respectively, and is primarily comprised of interest expense. The $1,619 increase in other expense was primarily due to the write-off of debt issuance costs of $731 and the impact of monthly settlement payments on unfavorable floating-to-fixed interest rate hedges entered into in 2018, which became effective in the second quarter of 2019, in the three months ended September 30, 2019 compared to the same period in 2018.

​

Income Tax Benefit

​

Our income tax benefit for the three months ended September 30, 2019 and 2018 was $2,087 and $121, respectively. Income tax benefit for the three months ended September 30, 2019 includes establishing an additional valuation allowance against deferred tax assets related to net operating losses due to our cumulative loss position and non-cash goodwill impairment charges that are not deductible for tax purposes.

​

Segment Results

​

Net sales, cost of sales and gross profit information by segment are as follows:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Three Months Ended September 30, 

​

​

​

Net Sales

​

Cost of Sales

​

Gross Profit

​

​

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

​

Specialty

​

$

1,243,448

​

$

1,212,298

​

$

(1,178,918)

​

$

(1,145,288)

​

$

64,530

​

$

67,010

​

PBM

​

 

82,500

​

 

169,933

​

 

(83,645)

​

 

(143,585)

​

 

(1,145)

​

 

26,348

​

Inter-segment eliminations

​

 

(24,751)

​

 

(8,897)

​

 

24,751

​

 

8,897

​

 

—

​

 

—

​

​

​

$

1,301,197

​

$

1,373,334

​

$

(1,237,812)

​

$

(1,279,976)

​

$

63,385

​

$

93,358

​

​

Net Sales — Specialty

​

Net sales for the three months ended September 30, 2019 were $1,243,448, a $31,150 or 2.6 percent increase compared to $1,212,298 for the three months ended September 30, 2018. The increase was primarily the result of growth in our infusion therapies and manufacturer price inflation.  The increase was partially offset by payor reimbursement compression and the conversion of certain brand name drugs to their generic equivalent in the comparable prior period.

​

31

Cost of Sales — Specialty

​

Cost of sales for the three months ended September 30, 2019 was $1,178,918, a $33,630 or 2.9 percent increase, compared to $1,145,288 for the three months ended September 30, 2018. This increase was primarily the result of the same factors that drove the increase in Specialty’s Net sales over the same time. Cost of sales was 94.8 percent and 94.5 percent of Net sales for the three months ended September 30, 2019 and 2018, respectively.

​

Net Sales & Cost of Sales — PBM

​

Net sales for the three months ended September 30, 2019 were $82,500, a decrease of $87,433, compared to $169,933 for the three months ended September 30, 2018. Cost of sales for the three months ended September 30, 2019 were $83,645, a decrease of $59,940, compared to $143,585 for the three months ended September 30, 2018. The decrease in Net sales by our PBM segment was the result of the effect of customer contract losses that began in late 2018 and have continued through the third quarter of 2019 and the recognition of an accrual for litigation of $3,900 relating to a rebate dispute with a terminated customer. Cost of sales was 101 percent and 84 percent of Net sales for the three months ended September 30, 2019 and 2018, respectively. The change in Cost of sales as a percentage of net sales was driven by a rebate penalty with a certain aggregator due to not meeting contractual membership level requirements that resulted in a $9,000 negative impact to Cost of sales.

​

Nine Months Ended September 30, 2019 versus Nine Months Ended September 30, 2018

​

Consolidated Results

​

The following table provides our condensed consolidated statements of comprehensive loss data for each of the periods presented:

​

​

​

​

​

​

​

​

​

​

​

Nine Months Ended

​

​

​

September 30, 

​

​

    

2019

    

2018

​

Net sales

​

$

3,845,629

​

$

4,131,896

​

Cost of sales

​

 

(3,630,297)

​

 

(3,849,743)

​

Gross profit

​

 

215,332

​

 

282,153

​

SG&A

​

 

(238,677)

​

 

(255,705)

​

Goodwill impairments

​

 

(244,967)

​

 

—

​

Impairments of definite-lived intangible assets

​

 

(52,152)

​

 

—

​

(Loss) income from operations

​

 

(320,464)

​

 

26,448

​

Other (expense) income:

​

 

  

​

 

  

​

Interest expense

​

 

(32,044)

​

 

(30,998)

​

Impairment of non-consolidated entities

​

 

—

​

 

(329)

​

Other

​

 

431

​

 

1,385

​

Total other expense

​

 

(31,613)

​

 

(29,942)

​

Loss before income taxes

​

 

(352,077)

​

 

(3,494)

​

Income tax benefit (expense)

​

 

1,034

​

 

(750)

​

Net loss

​

$

(351,043)

​

$

(4,244)

​

​

Net Sales

​

Net sales for the nine months ended September 30, 2019 were $3,845,629, a $286,267, or 6.9 percent, decrease compared to $4,131,896 for the nine months ended September 30, 2018. This decrease was primarily due to loss of customer contracts and price compression to retain current business and win new business at our PBM segment, as well as payor reimbursement compression, brand to generic conversion, and volume declines in certain therapeutic areas in our Specialty segment. The decreases were partially offset by the impact of manufacturer price increases and growth in our infusion therapies versus the comparable prior period.

​

32

Cost of Sales

​

Cost of sales for the nine months ended September 30, 2019 was $3,630,297, a $219,446, or 5.7 percent, decrease compared to $3,849,743 for the nine months ended September 30, 2018. This decrease was primarily the result of the same factors that drove the decrease in our Net sales over the same period. Cost of sales was 94.4 percent and 93.2 percent of net sales for the nine months ended September 30, 2019 and 2018, respectively. The decrease in gross margin from 6.8 percent to 5.6 percent for the nine months ended September 30, 2018 and 2019, respectively, was primarily due to a price compression to retain current business and win new business at our PBM segment, a $9,000 impact to Cost of sales due to a rebate penalty to a certain aggregator at our PBM segment for not meeting certain contractual membership level requirements, a $3,900 accrual for litigation related to a rebate dispute with a terminated customer, a $2,500 rebate payment to a terminated customer in the second quarter of 2019 in our PBM segment, and payor reimbursement compression, as well as an additional liability for sales and use taxes, and gross receipt taxes of $2,985  in our specialty segment.

​

SG&A

​

SG&A expenses for the nine months ended September 30, 2019 were $238,677, a $17,028 decrease compared to $255,705 for the nine months ended September 30, 2018. The decrease is primarily the result of a $14,336 decrease in amortization expense primarily due to the amortization of intangible assets due to the impairment of these assets in the fourth quarter of 2018 and the second quarter of 2019, a $4,353 decrease in acquisition-related costs, and a $3,139 decrease in share-based compensation expense. The decrease in share-based compensation expense was primarily due to the impact in the second quarter of 2018 of the vesting of an award which vests based on the achievement of market performance criteria for an RSU grant awarded to an executive in the prior year. These decreases were partially offset by slight increases in employee costs, insurance, and facility expenses.

​

Impairment Charges on Goodwill and Other Intangibles

​

As a result of our interim impairment tests of goodwill as of September 30, 2019 and June 30, 2019, we recorded non-cash impairment charges against goodwill of $244,967 and relatedly, impairment charges of $52,152 of certain definite-lived intangible assets, primarily certain trade names and trademarks, certain customer and physician relationships in both segments, and certain non-compete employment agreements in our Specialty segment.

​

Our Specialty segment recorded $68,218 of the goodwill impairment and non-cash definite-lived intangible asset impairment charges of $16,772, primarily due to variances to our original forecast in the second quarter of 2019 caused by slower than anticipated brand to generic conversions and delays in the release of generic versions of certain drugs which tend to provide higher margin contribution, our previously forecasted volume growth not yet coming to fruition and expected efficiencies not being recognized as early as originally forecasted. Our PBM segment recorded $176,749 of the goodwill impairment charge and non-cash definite-lived intangible asset impairment charges of $35,380 during the nine months ended September 30, 2019. The impairment charges were taken in both the second and third quarters of 2019 as a result of lower than expected results and the lowering of our outlook for 2020 in both quarters driven by continued business losses, slower than anticipated success in converting potential sales opportunities into significant new customer contracts, and lower earned rebates due to drug mix and slightly lower rebate retention. See “Management Discussion and Analysis – Overview” above for additional information regarding these impairment charges.

​

Other Expense

​

Our other expense was $31,613 and $29,942 for the nine months ended September 30, 2019 and 2018, respectively, and is primarily comprised of interest expense. The $1,671 increase in other expense was due to the write-off of debt issuance costs of $731 and the impact of monthly settlement payments on unfavorable floating-to-fixed interest rate hedges entered into 2018, which became effective in the second quarter of 2019, partially offset by lower interest charges due to decreased average borrowings.

​

33

Income Tax Benefit (Expense)

​

Our income tax benefit (expense) for the nine months ended September 30, 2019 and 2018 was $1,034 and ($750), respectively. Income tax benefit for the nine months ended September 30, 2019 includes establishing an additional valuation allowance against deferred tax assets related to net operating losses due to our cumulative loss position and non-cash goodwill impairment charges that are not tax deductible.

​

Segment Results

​

Net sales, cost of sales and gross profit information by segment are as follows:

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

​

Nine Months Ended September 30, 

​

​

​

Net Sales

​

Cost of Sales

​

Gross Profit

​

​

    

2019

    

2018

    

2019

    

2018

    

2019

    

2018

​

Specialty

​

$

3,627,582

​

$

3,599,023

​

$

(3,432,506)

​

$

(3,386,653)

​

$

195,076

​

$

212,370

​

PBM

​

 

270,730

​

 

550,148

​

 

(250,474)

​

 

(480,365)

​

 

20,256

​

 

69,783

​

Inter-segment eliminations

​

 

(52,683)

​

​

(17,275)

​

​

52,683

​

​

17,275

​

​

—

​

​

—

​

​

​

$

3,845,629

​

$

4,131,896

​

$

(3,630,297)

​

$

(3,849,743)

​

$

215,332

​

$

282,153

​

​

Net Sales — Specialty

​

Net sales for the nine months ended September 30, 2019 were $3,627,582, a $28,559, or 0.8 percent, increase compared to $3,599,023 for the nine months ended September 30, 2018. The increase was primarily driven by growth in our infusion therapies and manufacturer price increases.  The increases were partially offset by reimbursement compression, the conversion of some brand drugs to their generic equivalent, and volume declines in certain therapeutic areas versus the comparable prior period.

​

Cost of Sales — Specialty

​

Cost of sales for the nine months ended September 30, 2019 was $3,432,506, a $45,853, or 1.4 percent, increase compared to $3,386,653 for the nine months ended September 30, 2018. This increase was primarily the result of manufacturer price increases and an additional liability for sales and use taxes, and gross receipt taxes of $2,985 which was recorded in 2019. Cost of sales was 94.6 percent and 94.1 percent of net sales for the nine months ended September 30, 2019 and 2018, respectively.

​

Net Sales & Cost of Sales — PBM

​

Net sales for the nine months ended September 30, 2019 were $270,730, a decrease of $279,418, compared to $550,148 for the nine months ended September 30, 2018. The decrease in our PBM segment was the result of continued customer contract losses that started in late 2018 and have continued into the third quarter of 2019, retail price compression to retain current business and win new business, a $3,900 accrual for litigation related to a rebate dispute with a terminated customer, and a $2,500 rebate payment to a terminated customer in the second quarter of 2019. Cost of sales for the nine months ended September 30, 2019 were $250,474, a decrease of $229,891, compared to $480,365 for the nine months ended September 30, 2018. The decrease in our PBM Cost of sales was the result of the continued customer contract losses partially offset by a $9,000 rebate penalty due to a certain aggregator for not meeting contractual membership level requirements for 2019. Cost of sales was 92.5 percent and 87.3 percent of Net sales for the nine months ended September 30, 2019 and 2018, respectively. The increase in Cost of sales as a percentage of Net sales was due primarily to the $9,000 impact of the rebate penalty.

​

34

Liquidity and Capital Resources

​

Overview

​

Our primary uses of cash include funding our ongoing working capital needs, debt service, acquiring and maintaining property and equipment, and internal use software, and business acquisitions. Our primary source of liquidity for our working capital is cash flows generated from operations. At various times during the course of the year, we may be in an operating cash usage position, which may require us to borrow on our revolving line of credit. We continuously monitor our working capital position and associated cash requirements and explore opportunities to more effectively manage our inventory and capital spending. As of September 30, 2019 and December 31, 2018, we had $8,420 and $9,485, respectively, of cash and cash equivalents. We had $105,000 and $176,300 outstanding on our revolving line of credit at September 30, 2019 and December 31, 2018, respectively. Our available borrowing capacity under our revolving line of credit was $95,000 and $73,700 at September 30, 2019 and December 31, 2018, respectively.

​

We believe that funds generated from operations, cash and equivalents on hand, and available borrowing capacity under our credit facility will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months and that we will be able to continue to service our debt and other trade obligations in the ordinary course of business; however, as our results for 2019 and future forecasts have deteriorated, we believe that it is probable that we will be in violation of certain financial debt covenants in our credit agreement, specifically the total net leverage and interest coverage ratio covenants, for the period ending December 31, 2019, absent the consummation of  our mitigating plans (i.e., execution of potential strategic alternatives or renegotiating or refinancing our credit agreement), which violation would give the lenders the right to terminate funding of our credit facility, accelerate our debt (including amounts under our term loans), or foreclose on our assets, if our mitigating plans are not executed prior to such date. The Company’s plan is to alleviate any potential violation of its financial debt covenants through the execution of potential strategic alternatives, as discussed above. In addition, the Company intends to actively work with its lenders to renegotiate its covenants or restructure its credit agreement, as appropriate.

​

Although we may breach certain of the financial debt covenants, the Company has a history of positive cash flow from operations and positive adjusted EBITDA. Despite recent performance below expectations and deteriorating forecasts, the Company continues to expect to have positive adjusted EBITDA, positive cash flows from operations, and positive working capital balances. In addition, the events driving net losses recently reported by the Company mainly include various non-cash items such as impairment losses, significant stock compensation and depreciation and amortization costs. In the event the Company were to breach its financial debt covenants and the revolving line of credit were terminated or the indebtedness thereafter was accelerated, the Company would not have sufficient liquidity to pay its indebtedness without raising additional debt or equity to refinance such indebtedness, which may be available only on onerous terms if it is available at all. As noted, the Company intends to actively work with the lenders to renegotiate its debt covenants or restructure its debt in the fourth quarter of 2019.

​

While we believe that we would be able to obtain waivers for any such breach of covenants to prevent an acceleration of the outstanding indebtedness, the Company cannot conclude with certainty that it will have the ability to restructure its credit agreement, obtain necessary waivers or negotiate less restrictive debt covenants with its lenders. If the covenant violations are not waived and our access to the credit facility is terminated or the indebtedness thereunder is accelerated, the Company may be unable to repay the obligations due under the credit agreement which would have a material adverse impact on the Company’s liquidity and business.  Accordingly, management’s assessment indicates, due to these conditions, there is uncertainty regarding the Company’s ability to maintain liquidity sufficient to operate its business effectively, which raises substantial doubt as to the Company’s ability to continue as a going concern.

​

The Company is reviewing strategic alternatives related to its future business operations which include, but are not limited to, a sale or merger of the Company, pursuing value enhancing initiatives or undertaking structural changes as a standalone company, or the sale or disposition of certain of the Company’s business or assets.  Additionally, the Company plans to work with its lenders to amend the credit agreement and continue to pursue cost-cutting initiatives.  However, given many of the mitigating plans are reliant on third parties and therefore outside the Company’s control, it is not considered probable that any of these alternatives will be effectively implemented in the near term.  Therefore, these plans do not mitigate the substantial doubt raised surrounding the Company’s ability to continue as a going concern.

35

​

The following table and summaries below provide cash flow data for each of the periods presented:

​

​

​

​

​

​

​

​

​

​

​

Nine Months Ended

​

​

​

September 30, 

​

​

    

2019

    

2018

​

Net cash provided by operating activities

​

$

108,045

​

$

33,207

​

Net cash used in investing activities

​

 

(25,037)

​

 

(17,709)

​

Net cash used in financing activities

​

 

(84,073)

​

 

(91,535)

​

Net decrease in cash and equivalents

​

$

(1,065)

​

$

(76,037)

​

​

Cash Flows from Operating Activities

​

Cash flows from operating activities consists of net loss, adjusted for noncash items, and changes in various working capital items, including accounts receivable, inventories, accounts payable and other assets/liabilities.

​

The $74,838 increase in cash provided by operating activities for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018 was due to a $136,743 change in net working capital flows primarily due to concentrated efforts to manage and reduce inventory levels and increased payables driven by the change in payment terms for a key supplier, offset by a $346,799 increase in net loss which was primarily driven by non-cash impairment charges of goodwill of $244,967 and certain definite-lived intangible assets of $52,152, and a $12,225 decrease in non-cash adjustments to net loss.

​

Cash Flows from Investing Activities

​

Our primary investing activities consisted of cash payments made to purchase InTouch, labor and other costs associated with capitalized software for internal use, capital expenditures to purchase computer equipment, software, furniture and fixtures, as well as building improvements to support the expansion of our infrastructure and workforce. As costs related to the implementation of our new specialty pharmacy software platform begin to wind down, we expect our capital expenditures to decrease in the long-term.

​

The $7,328 increase in cash used in investing activities during the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018 was primarily related to cash payments made to purchase InTouch and cash used in the ongoing implementation of a new specialty pharmacy software platform with more costs being incurred on the software project than in the prior year period.

​

Cash Flows from Financing Activities

​

Our primary financing activities consisted of debt borrowings and repayments, payment of debt issuance costs and proceeds from stock option exercises.

​

The $7,462 decrease in cash used in financing activities during the nine months ended September 30, 2019 as compared to the nine months ended September 30, 2018 was primarily related to a voluntary prepayment of $74,000 on our Term Loan B in 2018.  Offsetting this decrease, in the nine months ended September 30, 2019, our net payments on our revolving line of credit increased $61,300 from the comparable period in 2018.

​

Debt

​

The Company has a credit agreement with JP Morgan Chase Bank, N.A., and Capital One, National Association, that currently provides for a $200,000 revolving line of credit and a $150,000 Term Loan A and $400,000 Term Loan B (“credit facility”). The credit agreement also provides for issuances of letters of credit of up to $10,000 and swingline loans up to $20,000. The revolving line of credit and Term Loan A mature on December 20, 2022 and Term Loan B matures on December 20, 2024.

​

36

Interest on the revolving line of credit and Term Loan A is accrued at a rate equal to (i) the monthly LIBOR rate plus an applicable margin or, (ii) a base rate that is the highest of the U.S. prime rate, federal funds rate (plus ½ of 1 percent) and LIBOR (plus 1 percent), at our option. The applicable margin is adjusted quarterly based on our leverage ratio. At September 30, 2019, the applicable margin was 2.50 percent for LIBOR loans and 1.50 percent for base rate loans. Interest on the Term Loan B is accrued similarly to Term Loan A, except the applicable margin is fixed at 4.50 percent for LIBOR loans and 3.50 percent for base rate loans. The Term Loan A and Term Loan B interest rates were 4.55 percent and 6.55 percent, respectively, at September 30, 2019 and 4.78 percent and 7.03 percent, respectively, at December 31, 2018. The interest rate on the revolving line of credit was 4.55 percent and 5.19 percent at September 30, 2019 and December 31, 2018, respectively. We are charged a monthly unused commitment fee ranging from 0.3 percent to 0.4 percent on the average unused daily balance on our $200,000 revolving line of credit.

​

Our weighted average borrowings on the revolving line of credit was $137,521 and $163,380 and maximum borrowings on the revolving line of credit was $196,300 and $231,200 during the nine months ended September 30, 2019 and 2018, respectively. We had $95,000 and $73,700 available borrowing capacity on our revolving line of credit at September 30, 2019 and December 31, 2018, respectively. We had $455,875 and $464,500 in outstanding term loans as of September 30, 2019 and December 31, 2018, respectively. We also had $105,000 and $176,300 outstanding on our revolving line of credit as of September 30, 2019 and December 31, 2018, respectively.

​

The Term Loan A and Term Loan B requires quarterly principal payments of $1,875 and $1,000, plus accrued interest, respectively. During 2018, the Company made a voluntary prepayment of $74,000 on the Term Loan B.

​

Our credit facility contains certain financial and non-financial covenants, including covenants imposing (i) a maximum total net leverage ratio and (ii) a minimum interest coverage ratio limiting the amount of debt that the Company may have outstanding.  Effective August 9, 2019, the Company amended its credit agreement and revised the total net leverage ratio covenant which is now set at 6.00 to 1.0 as of September 30, 2019, stepping up to 6.75 to 1.0 as of December 31, 2019 through March 31, 2020, with subsequent step downs thereafter to the ratios as originally issued. The minimum interest coverage ratio was also revised concurrently and set at 2.50 to 1.0 as of September 30, 2019, stepping down to 2.25 to 1.0 as of December 31, 2019 through March 31, 2020, and eventually stepping back up to 3.00 to 1.0 as of March 31, 2021 and thereafter. In order to effect the amendment, the Company permanently reduced its revolving line of credit from $250,000 to $200,000. In addition, the amendment to the credit agreement contained certain covenant trigger events that include: investments in or loans to non-guarantor parties, the incurrence of certain indebtedness, the creation of unrestricted subsidiaries and the making of certain distributions or prepayment of indebtedness, and failure to deliver quarterly projected financial statements and require the use of net cash proceeds realized from certain assets dispositions to prepay term loans. Should a covenant trigger event occur, the total net leverage ratio covenant level shall be reduced by 3.00 to 1.00 and the interest coverage ratio level will be increased by 3.00 to 1.00. As of September 30, 2019, the Company is in compliance with all such covenants.  Although the Company was in compliance with its financial debt covenants at September 30, 2019, it was in compliance due to the modification of the financial debt covenants that became effective in August 2019.  Management believes it is probable that the Company will be in violation of the less restrictive covenants at December 31, 2019.  Therefore, the Company has classified the outstanding balances under Term Loan A and Term Loan B as of September 30, 2019 as current in the condensed consolidated balance sheet.

​

Based on our results for 2019 and future forecasts, however, the Company may breach its debt covenants for the period ending December 31, 2019. Despite this potential breach, the Company expects to continue to service its debt and other trade obligations in the ordinary course. Furthermore, the Company plans to alleviate the issues related to its debt covenants through the execution of strategic alternatives, actively working with its lenders to renegotiate its covenants or restructure its credit agreement, as appropriate, and continuing to pursue cost-cutting initiatives. While the Company currently believes that these actions should be completed prior to breaching the debt covenants and, if completed, could  successfully mitigate the conditions that would give rise to the potential breach of its debt covenants, the execution of these plans is reliant upon third-parties and, therefore, outside the control of the Company, it cannot be considered probable that management will be able to effectively implement its plans and avoid the potential breach of its debt covenants. See “Liquidity and Capital Resources—Overview” for additional information.

​

37

Critical Accounting Policies and Estimates

​

Our condensed consolidated financial statements have been prepared in accordance with U.S. GAAP. Application of these principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenue and expenses. In accordance with U.S. GAAP, we base our estimates on historical experience and on various other assumptions that management believes are reasonable under the circumstances. Actual results might differ from these estimates under different assumptions or conditions and, to the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.

​

During the nine months ended September 30, 2019, there were no significant changes to our critical accounting policies and use of estimates, which are disclosed in our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2018.

​

Recently Issued Accounting Guidance

​

Refer to Note 2, New Accounting Standards, to our unaudited condensed consolidated financial statements included in Item 1. Financial Statements, for a discussion of recently issued accounting guidance and related impact on our financial condition and results of operations.

​

ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

​

Our operations are solely in the United States of America (“U.S.”) and U.S. Territories and are exposed to market risks in the ordinary course of our business, which consists of interest rate risk. We are exposed to interest rate fluctuations with regard to future issuances of fixed-rate debt, and existing and future issuances of floating-rate debt. Primary exposures include the LIBOR, the Federal Funds Effective Rate, the Overnight Bank Funding Rate and our administrative agent’s prime rate in effect at its principal office in New York City related to debt outstanding under our credit facility. A 100-basis point change in 2019 interest rates would have changed our pre-tax loss for the three and nine months ended September 30, 2019 by approximately $1.4 million and $4.5 million, respectively.

​

In an effort to manage our exposure to interest rate fluctuations, in 2018, we became a party to two pay-fixed and receive-floating interest rate swaps, which were effective on March 29, 2019 and terminate on March 31, 2022. The combined notional amount of the interest rate swaps was $286,125 at September 30, 2019.

​

ITEM 4. CONTROLS AND PROCEDURES

​

Disclosure Controls and Procedures

​

We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in our reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the specified time periods in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

​

As previously disclosed in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2018, management concluded that a material weakness in internal control over financial reporting exists for LDI Holding Company LLC, doing business as LDI Integrated Pharmacy Services (“LDI”), acquired in December 2017 and Pharmaceutical Technologies, Inc., doing business as National Pharmaceutical Services (“NPS”) acquired in November 2017, which comprise our PBM segment. Specifically, the material weakness relates to the operating effectiveness of our evaluation and review of initial client set up and monitoring of changes to customer contract terms; revenue reconciliations; rebate accruals and reconciliations;  monitoring of client performance guarantees; completeness

38

and accuracy of reports and spreadsheets used in the operation of certain internal controls over financial reporting for revenues; and user access administration and program change reviews related to revenue applications.

​

Our management, with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) promulgated under the Exchange Act) as of September 30, 2019. Based on these evaluations, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures required by paragraph (b) of Rule 13a-15 or 15d-15 were not effective as of September 30, 2019.

​

Notwithstanding the identified material weakness, our management has concluded that the condensed consolidated financial statements included in this quarterly report on Form 10-Q, fairly presents, in all material respects, our financial position, results of operations, cash flows, and changes in shareholders’ equity in accordance with U.S. GAAP.

​

Remediation Plan

​

Management is actively implementing a remediation plan to ensure that deficiencies contributing to the material weakness are remediated such that these controls will operate effectively, which includes enhancement of the management review controls over revenue reconciliations and monitoring of client performance. The remediation actions we are taking also include: (i) assessing management resources in various departments, including finance and accounting, at LDI and NPS to ensure there is an appropriate level of knowledge, experience and training as well as the appropriate reporting structure to establish and maintain adequate internal control over financial reporting; and (ii) enhancement of the LDI and NPS quality assurance review process over initial contract pricing setup and ongoing changes. We have also engaged a consultant to assist in the remediation process and implementation of internal controls.

​

We believe that these actions, and the improvements we expect to achieve as a result, will effectively remediate the material weakness. However, until the remediated controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively, the material weakness in our internal control over financial reporting and disclosure controls and procedures will not be considered remediated. While we were targeting completion of the remediation of this material weakness by the end of 2019, we now believe that remediation of this material weakness will not be successful until 2020.

​

Changes in Internal Control over Financial Reporting

​

We continue to implement internal controls in conjunction with our remediation plan as described above. There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the three months ended September 30, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

​

39

PART II – OTHER INFORMATION

​

ITEM 1. LEGAL PROCEEDINGS

​

On November 10, 2016, a putative class action complaint was filed in the U.S. District Court for the Eastern District of Michigan against Diplomat Pharmacy, Inc. and certain former officers of the Company. Following the appointment of lead plaintiffs and lead counsel, an amended complaint was filed on April 11, 2017. The amended complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 in connection with public filings made between February 29, 2016 and November 3, 2016 (the “potential class period”). The plaintiffs sought to represent a class of shareholders who purchased stock in the potential class period. The complaint seeks unspecified monetary damages and other relief. The Company filed a motion to dismiss the amended complaint on May 26, 2017. The court issued orders denying the Company’s motion to dismiss on January 19, 2018 and the Company’s motion for reconsideration of its motion to dismiss on August 9, 2018. The parties reached an agreement-in-principle on April 22, 2019 to resolve the litigation for a payment of $14.1 million which was fully covered by the Company’s insurance policies. The court approved the settlement on August 20, 2019. The settlement, as a result of coverage provided, did not have a material impact on the Company’s results of operations, financial condition or cash flows. The settlement was subsequently paid during the quarter ended September 30, 2019.

​

On February 24, 2019 and March 6, 2019, in the U.S. District Court for the Central District of California and on March 12, 2019 in the U.S. District Court for the Northern District of Illinois, putative class actions complaints were filed against Diplomat Pharmacy, Inc. and certain current and former officers of the Company. The complaints alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 in connection with public filings made between February 26, 2018 and February 21, 2019 (the “potential class period”). The plaintiffs each sought to represent a class of shareholders who purchased stock in the potential class period. The complaints sought unspecified monetary damages and other relief. The cases were subsequently transferred and consolidated into a single proceeding in the Northern District of Illinois. The court appointed a lead plaintiff and lead counsel on July 19, 2019, and the lead plaintiff has sought leave until December 6, 2019 to file an amended complaint. The Company believes the complaints and allegations to be without merit and intends to vigorously defend itself against the action. The Company is unable at this time to determine whether the outcome of the litigation would have a material impact on its results of operations, financial condition or cash flows.

​

The Company’s business of providing specialized pharmacy services and other related services may subject it to litigation and liability for damages in the ordinary course of business. Nevertheless, the Company believes there are no other legal proceedings, the outcome of which, if determined adversely to the Company, would individually or in the aggregate be reasonably expected to have a material adverse effect on its business, financial position, cash flows, or results of operations.

​

ITEM 1A. RISK FACTORS

​

The additional risk factors listed below updates our risk factors that were disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2018.

We may breach certain financial debt covenants in our credit agreement in the near term which raises substantial doubt about our ability to continue as a going concern and may negatively impact our liquidity.

Our forecasts have deteriorated, and we believe it is probable that we will breach certain financial debt covenants in our credit agreement, specifically the total net leverage and interest coverage ratio covenants, for the period ending December 31, 2019, absent the consummation of our mitigating plans (i.e., execution of potential strategic alternatives or renegotiating or refinancing our credit agreement). In the event the Company were to violate its debt covenants, we would be in default thereunder, and our lenders have the right to terminate funding of our revolving credit facility, accelerate the indebtedness, including our outstanding term loans, or foreclose on our assets.

The Company plans to alleviate the potential breach of its financial debt covenants through its mitigation plans of the execution of potential strategic alternatives, working with its lenders to renegotiate its covenants or restructure its credit agreement, as appropriate, and continuing to pursue cost-cutting initiatives. There can be no assurance that these efforts will be successful. In the event that the Company breaches the financial debt covenants in the credit agreement and the Company is unable to renegotiate or restructure its credit agreement, we would be in default thereunder and the Company’s

40

indebtedness may be accelerated and become immediately due and payable. The Company does not have sufficient liquidity to pay its indebtedness if it is accelerated and becomes immediately due and payable.

​

Under such circumstances, other sources of capital may not be available to us on reasonable terms or at all. There is no guarantee the Company will be able to repay or replace its indebtedness. Our ability to arrange additional financing or refinancing will depend on, among other factors, our financial position and performance, as well as prevailing market conditions and other factors beyond our control. There can be no assurance that we will be able to obtain additional financing or refinancing and failure to obtain such additional financing or refinancing could have a material adverse impact on our operations. Furthermore, any of these actions may not be sufficient to allow us to service our debt obligations or may have an adverse impact on our business. Our inability to refinance existing indebtedness or otherwise access the credit markets could have a material adverse effect on our business and results of operations and your investment in our common stock. If the Company is not successful in its plans to renegotiate the covenants in its credit agreement or execute on potential strategic alternatives, we could not assure you of our ability to continue operations and may need to seek protection under applicable bankruptcy or insolvency laws.

​

Our failure to execute our mitigation plans may cause us to experience liquidity issues and result in uncertainty about our business.

​

Should we experience liquidity issues it may cause, among other things:

 

 

•

 

third parties to lose confidence in our ability to provide our services and meet our contractual obligations, resulting in a significant decline in our revenues, profitability and cash flow;

 

 

•

 

difficulty retaining, attracting or replacing key employees;

 

 

•

 

employees to be distracted from performance of their duties or more easily attracted to other career opportunities; and

 

 

•

 

our suppliers, vendors, hedge counterparties and service providers to renegotiate the terms of our agreements, terminate their relationship with us or require financial assurances from us.

​

These events may have a material adverse effect on our business and operations.

​

Our review of strategic alternatives may result in significant transaction expenses and unexpected liabilities and could adversely impact our business and our stock price.

​

On August 9, 2019, the Company announced that, at the direction of its Board of Directors, it is reviewing strategic alternatives focused on maximizing shareholder value. The strategic alternatives expected to be considered include, but are not limited to, a sale or merger of the Company, continuing to pursue value-enhancing initiatives or undertaking structural changes as a standalone company, or the sale or other disposition of certain of the Company’s businesses or assets. There can be no assurance that this process will result in the approval or completion of any particular strategic alternative or transaction in the future or that any such strategic alternative or transaction, if approved or completed, will yield additional shareholder value.  The Board and the Company may determine to suspend or terminate the review of strategic alternatives at any time due to various factors. In addition, the review of strategic alternatives is dependent upon a number of factors that may be beyond our control, including among other factors, market conditions, industry trends, regulatory limitations, the interest of third parties in our business and the availability of financing to potential buyers on reasonable terms.

​

Further, the process of exploring, reviewing and pursuing strategic alternatives, the public announcement of such process or any decision or transaction resulting from such process could adversely impact our business and our stock price. We may devote a significant amount of time and resources to identifying, evaluating and pursuing potential strategic alternatives, which could result in the diversion of management’s attention from our existing businesses and focus on our current strategy. In connection with the review and pursuit of strategic alternatives, we may incur significant transaction

41

expenses (including equity compensation, severance pay and legal, accounting and financial advisory fees); fail to retain or attract key personnel; and fail to strengthen or maintain our business and relationships with our vendors, clients or customers.  As a result, we may fail to achieve financial or operating objectives, which may have a material adverse effect on our business and our stock price.

​

We do not intend to disclose developments or provide updates on the progress or status of our review of strategic alternatives unless and until required or when the Company determines appropriate. As such, perceived uncertainties related to the future of the Company and speculation regarding the review of strategic alternatives and related developments may result in the loss of potential business opportunities and may make it more difficult for us to attract and retain key personnel and business partners or cause our stock price to fluctuate significantly.

​

The specialty pharmacy and PBM industries are highly litigious, and our review of strategic alternatives may heighten our exposure to potential litigation in connection with this process and effecting any transaction or strategic alternative.

​

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

​

On July 22, 2019, in connection with the closing of our acquisition of InTouch Pharmacy LLC (“InTouch”), the Company issued 836,431 shares of its common stock to the former owner of InTouch. No cash proceeds were received by the Company as the shares represent a portion of the consideration for the acquisition. The 836,431 shares of common stock were issued and sold pursuant to exemptions from registration under Section 4(a)(2) of the Securities Act of 1933, as amended, and/or Rule 506 of Regulation D promulgated thereunder by the Securities and Exchange Commission.

​

42

ITEM 6.EXHIBITS

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Incorporated by Reference

Exhibit
Number

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Exhibit Description

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Filed
Herewith

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Form

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Period
Ending

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Exhibit /
Appendix
Number

​

Filing Date

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10.1*

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Amended and Restated Diplomat Pharmacy, Inc. 2014 Omnibus Incentive Plan

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X

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10.2*

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Form of Omnibus Amendment to Award Agreement

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X

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10.3

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Amendment No.1 to Credit Agreement, dated July 19, 2019, by and among the Company, the Lenders and JPMorgan Chase Bank, N.A., as Administrative Agent, effective August 6, 2019

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8-K

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10.1

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August 6, 2019

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31.1

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Section 302 Certification — CEO

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X

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31.2

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Section 302 Certification — CFO

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X

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32.1**

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Section 906 Certification — CEO

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32.2**

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Section 906 Certification — CFO

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X

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101.INS

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XBRL Instance Document [the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document]

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101.SCH

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XBRL Taxonomy Extension Schema Document

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101.CAL

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XBRL Taxonomy Extension Calculation Linkbase

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101.DEF

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XBRL Taxonomy Extension Definition Linkbase

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101.LAB

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XBRL Taxonomy Extension Label Linkbase

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101.PRE

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XBRL Taxonomy Extension Presentation Linkbase

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X

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104

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Cover Page Interactive Data File – the cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

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X

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*     Indicates a management contract or compensatory plan or arrangement.

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**   This certification is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

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43

SIGNATURES

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Pursuant to the requirements of Section 13 or 15(d) 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.

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DIPLOMAT PHARMACY, INC.

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(Registrant)

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By:

/s/ DANIEL DAVISON

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Daniel Davison

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Chief Financial Officer and Treasurer

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(Principal Financial Officer and

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Principal Accounting Officer)

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Date: November 12, 2019

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44

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