DPLO Diplomat Pharmacy Inc

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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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or

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Commission File Number:   001-36677

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( 888 ) 720-4450

(Registrant’s telephone number, including area code)

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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  ◻

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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  ◻

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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.

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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.   ◻

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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ☐    No  ☒

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As of August 2, 2019, there were 75,830,397 outstanding shares of the registrant’s no par value common stock.

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DIPLOMAT PHARMACY, INC.

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Form 10-Q

INDEX

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See accompanying Notes to Condensed Consolidated Financial Statements.

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See accompanying Notes to Condensed Consolidated Financial Statements.

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See accompanying Notes to Condensed Consolidated Financial Statements.

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DIPLOMAT PHARMACY, INC.

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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.

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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.

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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.

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The Company has recorded operating lease right-of-use assets and operating lease liabilities in its Condensed Consolidated Balance Sheets at June 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.    

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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 and had no impact on the Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2019. As noted above, the comparative prior period information for the six months ended June 30, 2018 has not been adjusted and continues to be reported under the Company’s historical lease recognition policies under ASC Topic 840, Leases.

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The disclosure requirements of Topic 842 are included within Note 13, Leases.

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Accounting Standards Issued But Not Yet Adopted

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Credit Losses

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In June 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 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.

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3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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Principles of Consolidation

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The Condensed Consolidated Financial Statements include the accounts of Diplomat Pharmacy, Inc., and its wholly owned subsidiaries.

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All intercompany transactions and balances have been eliminated in consolidation.

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Use of Estimates

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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.

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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.

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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.

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Inventories

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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 six months of expiration, and any remaining expired medication is relieved from inventory on a quarterly basis.

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4. FAIR VALUE MEASUREMENTS

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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:

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

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

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

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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.

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

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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:

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

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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.

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5. GOODWILL AND DEFINITE-LIVED INTANGIBLE ASSETS

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Goodwill

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Goodwill is not subject to amortization and is reviewed at least annually in the fourth quarter of each year using data as of December 31 of that year, or earlier if an event occurs or circumstances change and there is an indication of impairment. The Company determined, due to lower than expected second quarter results and the resulting impact on future forecasts, that there was an indication of impairment for both the Specialty and PBM segments and, as a result, tested goodwill in the interim period at June 30, 2019 at the reporting unit level. The impairment test consists of comparing a reporting unit’s

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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 the Diplomat Specialty Pharmacy (“DSP”) and PBM reporting units were less than their respective carrying value. As a result, the Company recorded total non-cash impairment charges of $122,891 to goodwill and $17,979 to definite-lived intangible assets.

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The estimated fair value for each of the reporting units was determined using the income approach. With the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We use our internal forecasts to estimate future cash flows and include an estimate of long-term growth rates based on our 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 our best estimates of economic and market conditions over the projected period. Our 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 reporting unit valuations as of June 30, 2019 were 10.5% for the DSP reporting unit and 11.75% for the PBM reporting unit.

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For the DSP reporting unit, as of and for the second quarter of 2019, the Company experienced lower than expected results, which have impacted the outlook for the remainder of 2019 and into 2020. The lowered outlook for the DSP reporting unit includes 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 are running behind forecast primarily due to delays in the implementation of ScriptMed, our new specialty operating platform and while the previous outlook assumed additional investment in the Company’s payor sales team would have resulted in new business opportunities that would offset anticipated negative impacts to volume, the Company has seen limited impacts from this investment on 2019 results through June 30, 2019. Lastly, while it was believed the business environment would stabilize, the Company continues to see volumes in our 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 is 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.

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During the second quarter of 2019, the Company recorded a non-cash goodwill impairment of $68,218 for the Specialty segment, all of which was allocated solely to the DSP reporting unit. The non-cash impairment charge is not deductible for income tax purposes. The impairment loss is recorded in the caption “Goodwill impairments” in the Condensed Consolidated Statements of Comprehensive Loss. After the impairment charge, the adjusted carrying value of the Specialty segment goodwill was $272,442 at June 30, 2019, of which zero was allocated to the DSP reporting unit.

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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.

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For the PBM reporting unit, in the second quarter of 2019, the Company 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 resulted in downward revisions of the forecasts on current and future projected earnings and cash flows of the PBM reporting unit and a more conservative outlook in 2020 and beyond.

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During the second quarter of 2019, the Company recorded a non-cash goodwill impairment of $54,673 for the PBM segment, which is not deductible for income tax purposes. The impairment loss is recorded in the caption “Goodwill impairment” in the Condensed Consolidated Statements of Comprehensive Loss. After the impairment charge, the adjusted carrying value of the PBM segment goodwill was $214,121 at June 30, 2019.

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Also, the Company in connection with the goodwill impairment analysis 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

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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. The Company recorded an impairment loss of $16,772 to therefore fully impair the remaining intangible assets at the DSP reporting unit, which is part of the Specialty segment, and an impairment loss of $1,207 to further impair those intangible assets at the PBM reporting unit, which is the only reporting unit in the PBM segment. Refer to the additional discussion below.

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Definite-lived intangible assets

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Definite-lived intangible assets consisted of the following:

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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. The Company performed a valuation to determine the fair value of these intangible assets and as a result recorded a total non-cash impairment charge of $17,979 which is recorded in the caption “Impairments of definite-lived intangible assets” in the Condensed Consolidated Statements of Comprehensive Loss.

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The Company recorded amortization expense of $13,753 and $17,160 for the three months ended June 30, 2019 and 2018, respectively, and $27,558 and $34,170 for the six months ended June 30, 2019 and 2018, respectively.

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