2.BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Financial Statement Presentation

The accompanying 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”).

Principles of Consolidation

The consolidated financial statements include the accounts of Diplomat Pharmacy, Inc., its wholly owned subsidiaries, and a 51 percent owned subsidiary, formed in August 2014, which the Company controlled and which was dissolved during the fourth quarter of 2017. The Company also owns a 22 percent interest in a non-consolidated entity which is accounted for under the equity method of accounting since the Company does not control the entity but has the ability to exercise significant influence over its operating and financial policies. This equity method investment was fully impaired during the fourth quarter of 2014 (Note 8). An investment in an entity in which the Company owns less than 20 percent and does not have the ability to exercise significant influence is accounted for under the cost method. This cost method investment was impaired during the fourth quarter of 2016 (Note 8). In addition, the Company paid $100 to acquire an 11.1 percent interest in a non-consolidated entity during 2017, which is accounted for under the cost method, as the Company owns less than 20 percent and does not have the ability to exercise significant influence over the entity.

Noncontrolling interest in a consolidated subsidiary in the consolidated balance sheets represents the minority shareholders’ proportionate share of the equity in such subsidiary. Consolidated net income (loss) is allocated to the Company and noncontrolling interests (i.e., minority shareholders) in proportion to their percentage ownership.

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.

Concentrations of Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash on deposit with banks or other financial institutions and trade accounts receivable.

A federal program provides non-interest bearing cash balances insurance coverage up to $250 per depositor at each financial institution. The Company’s cash balances often exceed federally insured limits.

Concentration of credit risk with respect to trade accounts receivable is limited by the large number of patients comprising the Company’s customer base and their dispersion across multiple payers and multiple geographic areas. No single payer customer accounted for more than 10 percent of net sales for any period presented or trade accounts receivable at December 31, 2017 and 2016.

The Company purchases a significant portion of its prescription drug inventory from AmerisourceBergen, a prescription drug wholesaler. These purchases accounted for approximately 41 percent, 49 percent and 50 percent of cost of products sold for the years ended December 31, 2017, 2016 and 2015, respectively. The Company has alternative vendors available if necessary. See Note 13 for discussion of the Company’s minimum purchase obligation with AmerisourceBergen.

The Company purchases certain prescription drugs from Celgene Corporation (“Celgene”) and Pharmacyclics, Inc. (“Pharmacyclics”), drug manufacturers. Purchases from Celgene and Pharmacyclics accounted for approximately 17 percent and 14 percent, 13 percent and 10 percent, and 12 percent and 9 percent of cost of products sold for the years ended December 31, 2017, 2016 and 2015, respectively, with no minimum purchase obligation. The specialty drugs that the Company purchases from Celgene and Pharmacyclics are not available from any other source.

Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less from the date of purchase to be cash equivalents.

Accounts Receivable, net

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

The Company maintains an allowance for doubtful accounts that reduces receivables to amounts that are expected to be collected. In estimating the allowance, management considers factors such as current overall economic conditions, historical and anticipated customer performance, historical experience with write-offs and the level of past due accounts. The Company’s general policy for uncollectible accounts, if not reserved through specific examination procedures, is to reserve based upon the aging categories of accounts receivable. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Activity in the allowance for doubtful accounts was as follows:

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

Property and Equipment, net

Property and equipment are stated at cost less accumulated depreciation. Depreciation is generally computed on a straight-line basis over the estimated useful lives of the assets. The costs of leasehold improvements are depreciated either over the life of the improvement or the lease term, whichever is shorter. For income tax purposes, accelerated methods of depreciation are generally used. Significant improvements are capitalized, and disposed or replaced property is written off. Maintenance and repairs are charged to expense in the period they are incurred. When items of property or equipment are sold or retired, the related cost and accumulated depreciation are removed from the accounts, and any gain or loss is included in earnings.

Capitalized Software for Internal Use, net

The Company capitalizes certain development costs primarily related to a custom-developed, proprietary, scalable patient care system. The Company expenses the costs incurred during the preliminary project stage, and capitalizes the direct development costs, including the associated payroll and related costs for employees and outside contractors working on development, during the application development stage. The Company monitors development on an ongoing basis and capitalizes the costs of any major improvements or that result in significant additional functionality.

Capitalized internal use software costs are amortized on a straight-line basis over the estimated useful lives of the assets, generally three years. For income tax purposes, accelerated methods of amortization are generally used. Management evaluates the useful lives of these assets on an annual basis.

Definite-Lived Intangible Assets, net

Definite-lived intangible assets consist of assets related to acquisitions and are amortized over their estimated useful lives using an accelerated method for the majority of customer, patient and physician relationships, and the straight-line method for the remaining intangible assets.

Long-Lived Assets

Long-lived assets, such as property and equipment, capitalized software for internal use and definite-lived intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group to be tested for possible impairment, the Company compares the undiscounted cash flows expected to be generated by that asset or asset group to its carrying amount. If the carrying amount of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment charge is recognized to the extent that the carrying amount exceeds fair value. Fair values of long-lived assets are determined through various techniques, such as applying probability weighted, expected present value calculations to the estimated future cash flows using assumptions a market participant would utilize, or through the use of a third-party independent appraiser or valuation specialist.

Goodwill

Goodwill represents the excess acquisition cost of an acquired entity over the estimated fair values of the net tangible assets and the identifiable intangible assets acquired. Goodwill is not amortized, but rather is reviewed for impairment annually during the fourth quarter, or more frequently if facts or circumstances indicate that the carrying value may not be recoverable.

An entity has the option to perform a qualitative assessment to determine whether it is more-likely-than-not that the fair value of the reporting unit is less than its carrying amount prior to performing a quantitative impairment test. The qualitative assessment evaluates various events and circumstances, such as macro-economic conditions, industry and market conditions, cost factors, relevant events and financial trends that may impact a reporting unit’s fair value. If it is determined that the estimated fair value of the reporting unit is more-likely-than-not less than its carrying amount, including goodwill, a quantitative assessment is required. Otherwise, no further analysis is necessary.

If a quantitative assessment is performed, a reporting unit’s fair value is compared to its carrying value. A reporting unit’s fair value is determined based upon consideration of various valuation methodologies, including the income approach, which utilizes projected future cash flows discounted at rates commensurate with the risks involved, and multiples of current and future earnings. If the fair value of a reporting unit is less than its carrying amount, an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized cannot exceed the total amount of goodwill allocated to that reporting unit.

Debt Issuance Costs

Costs incurred related to the issuance of the Company’s credit facility were deferred and are being amortized to interest expense using the effective interest method over the term of the agreement.

Revenue Recognition

The Company recognizes revenue from dispensing prescription drugs for home delivery at the time the drugs are shipped. At the time of shipment, the Company has performed substantially all of its obligations under its payer contracts and does not experience a significant level of returns or reshipments. Revenues from dispensing prescription drugs that are picked up by patients at an open-door or retail pharmacy location are recorded at prescription adjudication, which approximates the fill date. Revenue generated from dispensing prescription drugs was $4,444,486, $4,386,643 and $3,346,652 for the years ended December 31, 2017, 2016 and 2015, respectively.

The Company accrues an estimate of fees, including direct and indirect remuneration fees (“DIR fees”), which are assessed or expected to be assessed by payers at some point after adjudication of a claim, as a reduction at the time revenue is recognized. Changes in the Company’s estimate of such fees are recorded when the change becomes known.

The Company recognizes revenue from the sale of prescription drugs by its retail pharmacy network when the claim is adjudicated. When the Company acts as principal in the arrangement, exercises pricing latitude and independently has a contractual obligation to pay its network pharmacy providers for benefits provided to its clients’ members, the Company includes the total prescription price (ingredient cost plus dispensing fee) it has contracted with these clients as revenue, including member co-payments to pharmacies. Revenue generated from the sale of prescription drugs by retail pharmacies was $6,531 for the year ended December 31, 2017. When the Company merely administers a client’s network pharmacy contracts and does not assume credit risk, the Company earns an administrative fee for collecting payments from the client and remits the corresponding amount to the pharmacies in the client’s network, drug ingredient cost is not included in the Company’s revenues or cost of products sold. Administrative fee revenue was $1,724 for the year ended December 31, 2017.

The Company recognizes revenue from service, data and consulting services when the services have been performed and the earnings process is therefore complete. Revenues generated from service, data and consulting services were $32,489, $23,745 and $19,979 for the years ended December 31, 2017, 2016 and 2015, respectively.

Sales taxes are presented on a net basis (excluded from revenues and costs).

The Company derived its revenue from the following therapeutic classes:

Shipping and Handling Costs

Shipping and handling costs are not billed to patients; therefore, there are no shipping and handling revenues. The Company recognizes shipping and handling costs as incurred as a component of “Selling, general and administrative expenses” and were $15,689, $15,144 and $13,899 for the years ended December 31, 2017, 2016 and 2015, respectively.

Advertising and Marketing Costs

Advertising and marketing costs are expensed as incurred as a component of “Selling, general and administrative expenses” and were $2,251, $3,868 and $3,553 for the years ended December 31, 2017, 2016 and 2015, respectively.

Defined Contribution Savings Plans

The Company maintains certain defined contribution savings plans for eligible employees. The total expenses attributable to the Company’s defined contribution savings plans are recognized as a component of “Selling, general and administrative expenses” and were $2,908, $2,665 and $1,877 for the years ended December 31, 2017, 2016 and 2015, respectively.

Share-Based Compensation

The Company grants stock options to key employees, which are accounted for as equity awards. The exercise price of a granted stock option is equal to the closing market stock price of the underlying common share on the date the option is granted. The grant date fair value of these awards is measured using the Black-Scholes-Merton option pricing model. Stock options generally become exercisable in installments of 25 percent per year, beginning on the first anniversary of the grant date and each of the three anniversaries thereafter, and have a maximum term of ten years. Certain stock option grants have performance-based conditions, which require the satisfaction of certain revenue and/or Adjusted EBITDA targets prior to vesting. The Company expenses the grant date fair value of its stock options over their respective vesting periods on a straight-line basis.

The Company also grants restricted stock units (“RSU” or “RSUs”) to key employees, which are accounted for as equity awards. Some granted RSUs cliff vest after three years, whereas others vest one-third per year. The grant date fair value of a RSU is determined by the closing market price of our common stock as of the date of grant. The Company expenses the grant date fair value of the RSU over the three-year vesting period on a straight-line basis.

The Company grants restricted stock awards (“RSA” or “RSAs”) to non-employee directors, which are accounted for as equity awards. Generally, such RSAs fully vest on the first anniversary of the grant date. The grant date fair value of a RSA is determined by the closing market price of the Company’s common stock as of the date of grant. The grant date fair value of the RSU is expensed over the vesting period on a straight-line basis.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company provides a valuation allowance against net deferred tax assets unless, based upon the available evidence, it is more likely than not that the deferred tax assets will be realized.

The Company records interest and penalties related to tax uncertainties as income tax expense. Based on management’s evaluation, the Company concluded there were no significant uncertain tax positions requiring recognition in its consolidated financial statements.

Segment Information

The Company’s chief operating decision maker reviews the financial results of the Company in total when evaluating financial performance and for purposes of allocating resources. The Company has thus determined that it operates in a single reportable segment — specialty pharmacy services.

Accounting Standards Update (“ASU”) Adoption — Balance Sheet Classification of Deferred Taxes

In April 2015, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”), eliminating the requirement for companies to present deferred tax assets and liabilities as current and noncurrent. Instead, companies are required to classify all deferred tax assets and liabilities as noncurrent.

Effective January 1, 2017, the Company retrospectively adopted the accounting guidance contained within ASU 2015-17. The following December 31, 2016 consolidated balance sheet line items were adjusted due to this adoption:

ASU Adoption — Simplifying the Test for Goodwill Impairment

In January 2017, the FASB issued ASU No. 2017-04, Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), eliminating Step 2 from the quantitative goodwill impairment test. Instead, an entity will perform its annual, or interim, quantitative goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount (Step 1). An entity will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized cannot exceed the total amount of goodwill allocated to that reporting unit. This ASU is effective for an entity’s annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019, though early adoption is permitted.

Effective January 1, 2017, the Company adopted the accounting guidance contained within ASU 2017-04. This adoption had no impact on the Company’s consolidated financial statements.

New Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which will supersede the existing revenue recognition guidance under U.S. GAAP. The new standard focuses on creating a single source of revenue guidance for revenue arising from contracts with customers for all industries. The objective of the new standard is for companies to recognize revenue when it transfers the promised goods or services to its customers at an amount that represents what the company expects to be entitled to in exchange for those goods or services. In July 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606) Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 by one year to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, for public entities, though early adoption was permitted. Topic 606 permits two methods of adoption: retrospective approach reflecting the application of the standard in each prior reporting period presented (full retrospective method), or retrospective approach with the cumulative effect of initially applying the guidance recognized at the date of initial application (cumulative catch-up transition method). The new standard also includes a cohesive set of disclosure requirements intended to provide users of financial statements with comprehensive information about the nature, amount, timing and uncertainty of revenue and cash flows arising from a company’s contracts with customers. The Company is finalizing the impact of Topic 606 on the disclosures for its consolidated financial statement footnotes and expects the disclosures to be enhanced.

On January 1, 2018, the Company adopted Topic 606 using the cumulative catch-up transition method and will record an immaterial after-tax adjustment to reduce retained earnings. This cumulative adjustment relates to a shift in the recognition of dispensing prescription drugs for home delivery from the date the drugs are shipped under the Company’s existing accounting policy to the date the drugs are physically delivered (when control transfers) under the new standard. The effect of this change will not be significant as there is a very short timeframe from shipment to physical delivery of the prescription medication.

For the Company’s PBM businesses acquired late in the fourth quarter of 2017, the Company has gathered most of its data from customer contracts, is finalizing its evaluation of the potential impact of the new standard and is in the process of completing its applicable accounting policy memorandums. A portion of the Company’s PBM businesses includes dispensing prescription drugs for home delivery, the impact of which will be included in the cumulative adjustment previously discussed. For the remainder of its PBM businesses, the Company is finalizing the evaluation of reporting revenues on a gross or net basis under its payer contracts, however, based on the preliminary analysis to date, it is not expected that other aspects of the new standard will have a significant impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842),  requiring lessees to recognize a right-of-use asset and a lease liability for all leases (with the exception of short-term leases) at lease commencement date. This ASU is effective for annual periods beginning on or after December 15, 2018, including interim periods within those annual periods, though early adoption is permitted. The Company is in the early stages of evaluating the impact that the adoption of this guidance will have on its consolidated financial statements and/or notes thereto.

In May 2017, the FASB issued ASU No. 2017-09, Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting, providing guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This ASU is effective for annual periods beginning on or after December 15, 2017, including interim periods within those annual periods. This ASU is to be applied prospectively to an award modified on or after the adoption date. The adoption of this guidance is not expected to have any immediate impact on the Company’s consolidated financial statements.