Quarterly Report (10-q)

Date : 11/12/2019 @ 9:09PM
Source : Edgar (US Regulatory)
Stock : Diplomat Pharmacy Inc (DPLO)
Quote : 4.0  0.0 (0.00%) @ 12:00AM
Diplomat Pharmacy share price Chart

Quarterly Report (10-q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2019

or

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

For the transition period from                     to                  

Commission File Number:  001-36677

DIPLOMAT PHARMACY, INC.

(Exact name of Registrant as specified in its charter)

Michigan

38-2063100

(State or other jurisdiction of
incorporation or organization)

(IRS employer
identification number)

4100 S. Saginaw Street, Flint, Michigan

48507

(Address of principal executive offices)

(Zip Code)

(888) 720-4450

(Registrant’s telephone number, including area code)

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

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

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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.

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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

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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

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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

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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.

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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

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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.

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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,

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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,

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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

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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