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Edited Transcript of DPLO earnings conference call or presentation 7-May-19 12:30pm GMT

Q1 2019 Diplomat Pharmacy Inc Earnings Call

Flint May 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Diplomat Pharmacy Inc earnings conference call or presentation Tuesday, May 7, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Thomas Griffin

Diplomat Pharmacy, Inc. - CEO & Chairman of the Board

* Daniel Paul Davison

Diplomat Pharmacy, Inc. - CFO & Treasurer

* Terri Anne Powers

Diplomat Pharmacy, Inc. - VP of IR

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Conference Call Participants

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* Albert J. William Rice

Crédit Suisse AG, Research Division - Research Analyst

* Charles Rhyee

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* David M. Larsen

SVB Leerink LLC, Research Division - MD of Healthcare Information Technology & Distribution and Senior Research Analyst

* Eric White Coldwell

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* John Wilson Ransom

Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research

* Jonathan Marley Kaufman

William Blair & Company L.L.C., Research Division - Associate

* Lisa Christine Gill

JP Morgan Chase & Co, Research Division - Senior Publishing Analyst

* Rivka Regina Goldwasser

Morgan Stanley, Research Division - MD

* Steven James Valiquette

Barclays Bank PLC, Research Division - Research Analyst

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Presentation

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Operator [1]

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Hello, and welcome to Diplomat's First Quarter 2019 Conference Call. (Operator Instructions) I'd like to turn the call over to Terri Anne Powers, Vice President of Investor Relations.

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Terri Anne Powers, Diplomat Pharmacy, Inc. - VP of IR [2]

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Good morning, everyone. As you are aware, Diplomat issued first quarter 2019 financial results before market opened today. Before I turn it over to our Chairman and CEO, Brian Griffin, for his remarks, I will read the following safe harbor statement. Some of the company's statements made on this conference call will be forward-looking statements, which may include financial projections or other statements of the company's plans, objectives, expectations or intention. These matters involve certain risks and uncertainties. The company's actual results may differ significantly from those projected or suggested in any forward-looking statement due to a variety of risks and uncertainties, which are discussed in detail in the earnings release just issued in the company's annual 10-K report and subsequent filings with the Securities and Exchange Commission.

These statements speak only as of the date hereof or the date specified on the call. And except as required by law, the company does not undertake any obligation to update or otherwise release publicly any revisions to its forward-looking statement.

During this call, the company will also discuss non-GAAP financial measures. Please refer to the tables included in the company's earnings press release just issued for a reconciliation of these non-GAAP measures to the comparable GAAP measures and a related discussion thereof. A replay of the call and associated slide presentation is accessible through a link on the Investor Relations page of the company's website and it will be available for 90 days.

I will now turn the call over to Brian Griffin. Brian, please go ahead.

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [3]

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Thank you, Terri Anne, and good morning, everyone. This morning we'll discuss our first quarter results and then provide an update on our strategy, execution and outlook. But first I'd like to welcome Dan Davison, Diplomat's new CFO to the team. As of today, he's been on board almost a month and I and the rest of the Diplomat team are looking forward to working with him to execute on the company's strategy.

In addition, as you've seen in our press release, we've appointed Dave Loschinskey as Chief Operating Officer, effective May 2. Dave was most recently Diplomat's Chief Information Officer. In addition to his CIO duties, Dave was responsible for service reliability across all of Diplomat's operations and leading our change management processes. Dave is a seasoned operations executive with 27 years of experience in a variety of operations and IT roles, including more than 15 years in the specialty pharmacy industry. Dave's longtime focus on service reliability and operational excellence, along with a laser focus on patient care, have differentiated him and made him more than a technologist.

This morning we reported $1.3 billion in revenue for the first quarter, down 6% year-over-year. First quarter revenue was driven by 1% Specialty segment revenue growth while, as expected, PBM sales were down almost 50%. Adjusted EBITDA in the first quarter was $23 million compared to $40 million in the prior year. Adjusted EBITDA results were impacted by top line performance as well as a one-time charge of $3 million for prior years to establish estate sales and gross receipt tax liability.

Excluding this charge, adjusted EBITDA would have been $26 million.

In the first quarter, we added 6 limited distribution drugs, bringing our total portfolio to more than 130. LDDs added were in oncology, multiple sclerosis and other rare diseases. We continue to invest in incremental sales and account management talent across all of our businesses in order to drive incremental volumes to Diplomat and position the company for future growth.

We have a robust pipeline of prospects for 2019 and 2020 across the entire company. For health plans, we continue to have a strong pipeline and are in advanced discussions to expand existing partnerships or be awarded new business in core specialty pharmacy and infusion.

We continue to see strong interest from midsize health plans and large employers, in particular, given our access to oncology, limited distribution drugs and our associated clinical care model. Aggressive management in this area is top of mind for these payers because it represents significant cost driver within their benefit. Within our infusion therapeutic area, Diplomat continues to be successful in partnering with major health plans as a specialty infusion partner and in 2019 is on track to sign more participating provider agreements than in 2018. We continue to observe strong performance in this area and remain positive for 2019.

In addition, we are seeing strong activity from hospital systems and are encouraged by recent contract awards. Contracts awarded were with new clients and expanded business with existing clients to provide wraparound LDD access and clinical services and to our 340(b) services. These awards underscore that our value proposition to the hospital system market is winning. These opportunities are a direct result of the investment in 2018 in our health plan and hospital systems focused sales team and the relationships that we're building in the market. We are encouraged that our value proposition is resonating in the market, and we continue to expect additional awards in the coming months.

We don't discuss our pharma services business unit EnvoyHealth very much but we have recently been awarded new agreements with several pharmaceutical manufacturers to provide hub and medical information services. We're also seeing growth in EnvoyHealth's digital therapeutic service line.

For our PBM business, we continue to receive frequent new RFP requests for both 2019 and 2020. This year we're seeing requests from larger clients versus our historical focus of 500 to 5,000 members. The consultant community is recognizing our improved operating performance in specialty pharmacy clinical value proposition and are including us in larger client RFPs.

In addition, CastiaRx is making a concerted effort to develop opportunities with larger clients. We've seen RFPs from some larger corporations, which, if awarded, would be a substantial opportunity relative to the size of the business today. We still expect to be awarded new business in 2019.

In addition, our 2020 pipeline is extremely encouraging. It is substantially higher today than it was at the same time last year. We remain confident in our PBM strategy, but as we previously indicated 2019 is a rebuilding year. We've significantly improved our operational performance and our service levels remain in line with industry standards. We remain focused on providing the best customer service, retaining clients and building new product offerings to position the company for growth in 2020 and beyond.

Moving to the regulatory environment, since we last communicated with the market, CMS has provided further clarity surrounding the 2020 bidding process for Medicare Part D prescription drug plans to help reduce risk for participating entities, given the uncertainty regarding the implementation of the HHS proposed rebate rule. While it is not certain that the government will implement the rule as of 1/1/2020 we continue to believe that implementation of the rule, as it is written, will not be material to our PBM business.

CastiaRx has limited government business today and associated rebates are expected to be immaterial in 2019. To the extent that rebates are eliminated at some point in the commercial market, whether due to client demand or to congressional action, we still expect to shift profit levers to make up for the lost rebate profits.

We've previously indicated that 2019 is a rebuilding year. We're focused on stabilizing the PBM business and have added incremental sales and account management resources to generate new business while maintaining industry-standard levels of customer service.

In Specialty, we've also committed incremental sales resources to combat competitive pressures to create new strategic partnerships with health plans and hospital systems and drive more volumes to Diplomat. We're also implementing operational efficiency initiatives to adjust our cost structure to reflect market conditions.

While we remain concerned about increased competitive pressure in a tougher reimbursement environment, we remain encouraged by our pipeline of opportunity across all of Diplomat's businesses, and we are continuing to take measures to improve operational efficiency. Our Board and management team are singularly focused on rebuilding shareholder value, and we remain open to all means of achieving that goal.

I'll now turn the call over to Dan for a review of our financial performance in the quarter. Dan?

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [4]

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Thank you, Brian, and good morning, everyone. It's a pleasure to be on board. As many of you know, I previously worked with and for Brian during the roughly 25 years we both worked at Medco. I'm happy to once again be working with Brian and am excited about working with the entire Diplomat team.

I decided to join Diplomat because I saw an opportunity to join a great company with a long-standing reputation for strong clinical expertise and high-touch patient care and apply my specialty pharmacy and PBM knowledge and experience to help support the company's strategy. And frankly, I'm also here because I believe in the leadership, integrity and vision of Brian Griffin.

I've been on board about a month, so it's still early days. I'm currently in the process of evaluating the organization, its systems and processes and anticipate having better insights by the next quarterly report.

In the near term, my priorities are, first, to complete my deep dive business assessment and develop a plan of action focused on organizational efficiency with an eye on bottom line opportunities as well as ways to support our broader growth strategies through better data analytics and reporting.

Second, to establish relationships with all of you and the broader analyst and investor community. Third, to improve working capital management and support of debt pay down. And finally, to support all opportunities for the enhancement of shareholder value.

Moving on to first quarter results. As Brian noted, total company revenue was approximately $1.3 billion, down $86 million compared to the prior year. Looking at revenue at the segment level in the first quarter, our Specialty segment generated revenue of $1.2 billion, up 1% from the prior year. Segment revenue growth benefited from brand price inflation but was almost fully offset by payer reimbursement compression and volume declines in certain therapeutic areas.

Infusion sales grew 8% year-over-year, driven by higher volumes. Oncology sales were flat year-over-year as the benefit of brand inflation was offset by higher generic utilization, reimbursement compression and prescription volume declines.

As we noted during our last report, 2019 Specialty performance is being negatively impacted by increased competition, including narrowing of specialty pharmacy networks and member channel management, reducing our volumes in certain therapies. CastiaRx recorded $98 million in revenue, down $94 million from the prior year as we realized the impact of previously disclosed lost business.

Taking a look at gross profit and margin, total company gross profit was $79 million, down 12% year-over-year, and gross margin was 6.3%, down 40 basis points compared to the prior year. Gross profit in the Specialty segment was $68 million, down 7% year-over-year, and gross margin in the segment was down 50 basis points year-over-year to 5.8%. Both the gross profit and margin decline were the direct result of lower reimbursement and lower volumes within higher profit therapies.

Specialty prescription volumes increased 1% year-over-year to $225,000, driven by growth in infusion volumes while other therapeutic area volumes were down year-over-year. Gross profit per script in the first quarter of 2019 was $298 per script compared to $318 per script in the prior year period.

CastiaRx recorded gross profit of $12 million in the quarter, down $6 million and generated a gross margin of 11.9% versus 9.2% in the prior year. Gross margin improved year-over-year due to the loss of previously disclosed lower-margin business and the timing of rebate recognition in 2018, which suppressed our margins in the first quarter of the year.

Total company SG&A increased $1 million compared to the prior year to $83 million primarily driven by investments in the company's sales and account management and executive teams in support of our growth strategy offset by a decrease in amortization due to the impairment of intangibles in the fourth quarter of 2018 and lower acquisition-related expense.

Activities to support operating efficiency remain on track, and we continue to expect to generate more than $10 million in efficiencies this year. Taken together, our consolidated adjusted EBITDA for the first quarter was $23 million, down 42% from the prior year period due to factors previously discussed. As Brian mentioned, our adjusted EBITDA was negatively impacted by a one-time charge for prior years of $3 million related to the establishment of a sales and use and gross receipts tax liability for certain states in which we do business. During our ongoing review of state nexus rules, we determined we have a probable liability in certain states. Our 2019 guidance factors in the future impact of this review.

Net loss in the quarter was $14 million or $0.19 per share compared to a loss of $500,000 and $0.01 per share in the first quarter of 2018. Turning to the balance sheet. This quarter we implemented a new lease accounting standard. This standard requires companies to recognize a lease liability representing our obligation for all future lease payments measured on a discounted basis and a right of use asset on its balance sheet.

For Diplomat, this primarily relates to real estate operating leases. The adoption of this accounting rule resulted in the recording of a right of use asset of $28 million and a lease liability of $29 million on Diplomat's balance sheet as of January 1, 2019.

Our working capital improved by $8 million compared to December 31, 2018, driven primarily by the reduction of inventory, offset in part by the related reduction in accounts payable. We will continue to look at ways to improve our working capital position.

We reported $622 million in net debt, including contingent consideration as of March 31, 2019, and our leverage ratio was 4.0x. We paid down debt by a total of $16 million compared to the end of last year, mainly on our revolving credit facility.

We have significant availability under our credit facility, and during 2019 we will continue to utilize excess cash flow to reduce debt. We expect our debt at the end of this year to be lower than at the end of 2018.

Even at the low end of our 2019 adjusted EBITDA guidance range, we expect to remain in compliance with our debt covenants throughout this year. In addition, we see potential improvement over the course of the year as we improve operational efficiency and working capital.

Looking to 2019 full year guidance, we are reiterating the guidance previously provided for revenue and adjusted EBITDA. However, we are adjusting GAAP net loss guidance due to an adjustment to our expected income tax provision, which I will more fully explain in a minute.

We reiterate consolidated revenues between $4.7 billion and $5 billion. This includes Specialty segment revenue between $4.4 billion and $4.6 billion and PBM segment revenue between $300 million and $400 million.

Our adjusted EBITDA is still expected to be in a range of $110 million to $116 million. We expect second quarter adjusted EBITDA to be essentially flat compared to the first quarter, and we also expect second half adjusted EBITDA to be stronger than the first half. Consistent with past results, the second half will benefit from seasonal volume increases as well as the impact of greater operational efficiencies.

Please note, our expectation for interest expense is now $37 million to $40 million versus the prior $40 million to $43 million due to lower expected average debt balances throughout the year. As it relates to the income tax item, we now expect to record income tax expense in the year primarily related to state taxes versus the previously expected tax benefit. The company will not be able to record a federal tax benefit for 2019 losses as we are required to record a valuation allowance against any such benefit due to being in a cumulative loss position.

GAAP net loss expectations for the full year are now between negative $49 million and negative $33 million, which translates into a GAAP EPS loss range of negative $0.65 to negative $0.44. We expect income tax expense to be approximately $2 million. CapEx is still expected to be approximately $20 million to $22 million for the year primarily related to investments expected to improve unit cost efficiencies as well as enhanced analytic capabilities to support the creation of new solutions for our manufacturer and payer clients.

Thank you again for your time, and I look forward to working with all of you. I'll now turn the call back over to Brian.

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [5]

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Thank you, Dan. As previously indicated, 2019 is a rebuilding year, and we're focused on driving new business awards across all of our businesses and executing on company-wide efficiency initiatives.

I remain confident that Diplomat is making the right investments and executing the right strategy to leverage our competitive strengths and position Diplomat for future growth and profitability. I remain convinced that there's a significant opportunity for an independent, specialty-focused health care services provider to succeed in the market.

The Board, myself and the rest of the Diplomat management team are committed to enhancing shareholder value while maintaining focus on rebuilding our PBM business and expanding business with health plans, hospital systems and manufacturer partners. As we continue to execute on our strategy, our first priority remains our patients and providing high-quality patient care.

And as always, I'd like to thank our team members for their continued commitment to our patients, partners and Diplomat. Thank you for your time, and we look forward to your questions.

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Questions and Answers

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Terri Anne Powers, Diplomat Pharmacy, Inc. - VP of IR [1]

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(Operator Instructions) Operator, can you please provide the instructions?

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Operator [2]

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(Operator Instructions) And your first question comes from Lisa Gill with JPMorgan.

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Lisa Christine Gill, JP Morgan Chase & Co, Research Division - Senior Publishing Analyst [3]

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Welcome, Dan, to Diplomat. I look forward to working with you. So Brian, just going back to your comments about the 2020 pipeline, is there any way you can potentially size that for us? I know you said it's bigger than what it was last year but just to kind of put a dollar value on that. And then secondly, you talked about new product offerings, I'm just curious to what kind of product offerings are potential clients looking for in the marketplace today?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [4]

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Lisa, thanks for the question. Yes. I think that cuts across a pretty big range. So in terms of the pipeline, I don't have a dollar figure that we're prepared to share, but the pipeline -- as you think about the PBM business, it's significantly higher than it was last year. So obviously we've introduced a whole new sales organization into the PBM and they're starting to get some nice traction, so I think -- the great news is I think the operating issues -- the operational issues that we had mid-'18 into the back half of the year, we've stabilized, and we're now in great shape from an operating perspective across all of our key operating metrics. And I think that's being recognized by the broker and consultant community. And now that we've got a seasoned sales force in place within the PBM, they're really driving significant level of new RFP activity. Again, both for '19 as well as I think even more impressive in 2020.

On the Specialty side of the business that also, as you know, is a new sales strategy. The idea that we're focused on building strategic partnerships with health plans and hospital systems is new for the company and that team is also new but very seasoned. So these are folks that are former colleagues of ours from Medco and Walgreens and other organizations that have been focused on building relationships with health plans and hospitals so that -- while it's a new team, it's a seasoned team and I've been really impressed with what they've been able to develop thus far and I'm expecting that we'll see some activity here in '19 and a significant level of new opportunity into the new year.

In terms of -- and I should note also that we're having really nice success in the hospital systems part of that sales process and that is also new for us in terms of an area of focus. As I think about the -- your question around new product offerings, it cuts across, on the PBM side we'll be introducing some new clinical programs into the future. So we've had a team working on expanding out the clinical programs within the PBM. And as I think about how the PBM value proposition will likely evolve moving forward, I think having really strong clinical programs with performance guarantees as an example is going to be a differentiated advantage for our PBM value proposition.

As we turn over to the Specialty business, we've been making significant investments in '18 that now position us in '19 to deliver on a much broader set of analytics to our health plan and hospital system partners and that includes offering predictive analytics that integrates medical pharmacy, specialty infusion data and identifies gaps in care to basically position the health plan to manage the specialty benefit across both the pharmacy and medical benefits. So I think those are a couple of the key investments that now have really enhanced our product offerings and put us in the position to offer new products.

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Operator [5]

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Your next question comes from Steven Valiquette with Barclays.

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Steven James Valiquette, Barclays Bank PLC, Research Division - Research Analyst [6]

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I guess for us what really stood out to me as kind of a positive data point was the Specialty prescription number. You guys talked about losing some volume to competitors, but you actually grew that number year-over-year in the first quarter. So I'm just curious to hear more about maybe the sustainability of those scripts for all of calendar '19 maybe showing modest growth instead of the probably most sorts of modeling some sort of decline in the specialty scripts for calendar '19?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [7]

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Steve, this is Brian. I'll -- let me take a crack at it and then I'll ask Dan to add some color to it. But obviously, to your point, we're able to grow volume and I think we've introduced a number of measures -- we pointed to in our last earnings call kind of the -- what we've seen is the increasing use of what we've referred to as patient channel management techniques to drive script volumes into the big 3 and larger health plans. And so we've introduced a set of countermeasures there and I think we're being successful there, particularly in the Medicare part of our business.

And then the other key factor was just the growth within our infusion business. We saw some really strong growth in infusion. Our projection is we'll see continued growth in that portion of the Specialty segment.

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [8]

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And I would just add that, that's one of the reasons we expect second half EBITDA -- adjusted EBITDA to be stronger than the first half as the strength we're seeing in volumes and infusion volumes in particular.

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [9]

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And Steve, just note, last comment, we are seeing expansion within certain of our health plan and hospital system relationships where they're introducing, for example, new therapeutic categories into the relationship, so we're seeing that expansion have an impact as well.

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Operator [10]

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Your next question comes from A.J. Rice with Crédit Suisse.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [11]

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First, just to ask about a little more on the current selling season and the PBM side. Obviously there's some competitive changes going on as -- and so that's probably impacting landscape, and obviously, your focus on both the larger but the middle market as well means that you're selling all year for next year launches. Can you just give us a little bit more flavor as to what you've seen and how much do you think you see in the spring versus how much continues to be bid in the business you're going after as the year progresses?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [12]

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Thanks, A.J. Yes. We are seeing nice activity here in 2019, which reflects effective dates here toward the back half. So I'm happy with the level of activity that we're seeing here in '19. And as I referenced in my introductory comments here, we're seeing a much higher level of RFP activity for 1/1/20 and beyond. And to your point, while we've historically been focused on the middle market, we are seeing incremental RFP activity really driving toward larger corporate accounts, so that's new for us. And again I think that, that's reflective of the fact that we've stabilized the PBM and that we're demonstrating superior overall operating performance. And that's -- again, it's being recognized by the brokers and consultants that are driving this market. And the idea that we potentially move upstream into the large group market is happening a little quicker than I expected. So we're seeing those RFPs coming in from the consultant community. And then in addition to that, we've got our sales team focused on driving up market. So obviously, I lost some revenue in the beginning of the year and obviously, we've talked quite a bit about that. So this is a great opportunity for me to go into the upstream market and capture higher levels of revenue. So right now I'm feeling good about the level of activity in '19, but I feel like we've got -- we're positioned well for 2020 as well.

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Albert J. William Rice, Crédit Suisse AG, Research Division - Research Analyst [13]

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Okay. And if I could just slip in a follow-up. I appreciate the comments on the covenants. You feel pretty comfortable about those but I wondered if we could -- I know a lot of times numbers get adjusted in the covenant calculation versus what you report. I guess is there any way to give a flavor for how close you think you will be? How much cushion you have as you get into the latter part of the year and which quarter do you think will actually be the tough -- the closest quarter you get? Maybe just a little more flavor on what your comfort level around those numbers?

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [14]

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Sure, A.J. This is Dan. Thanks for the question. We basically have 2 covenants. We have a leverage covenant and an interest coverage covenant. We're at 4x on the leverage and the threshold is 5.75x and changes to 5.5 at the end of September. We expect to remain in the high 3s, maybe creep above 4, so we're comfortably within that covenant.

In terms of interest coverage, we plan to be in compliance throughout the year. We're going to bring down our debt through the year and bring down our interest expense, and with the combination of that with the operational efficiencies and growth in EBITDA -- adjusted EBITDA in the back part of the year, we're going to be comfortably within the limit on the interest coverage ratio as well.

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Operator [15]

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Your next question comes from John Kreger with William Blair.

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Jonathan Marley Kaufman, William Blair & Company L.L.C., Research Division - Associate [16]

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This is Jon Kaufman on for Kreger. On the infusion business, that seems to be quite a bright spot right now. Can you remind us why is infusion more immune from some of the pressures that you've been discussing on the Specialty pharmacy side? And I guess specifically, what prevents an integrated PBM from directing patients to their own infusion offerings, much as they have in the rest of the Specialty pharmacy portfolio?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [17]

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Jon, this is Brian. And just in terms of infusion obviously you know that I come from a health plan background and this is still across -- the health plans across the country still are fairly fragmented, meaning that the health plans haven't -- that are obviously the key drivers of volume, haven't really narrowed their networks dramatically. Our infusion leadership team and sales team has been just tremendously successful in building these relationships with health plans, which obviously drive volume. So they're doing a great job for us and we're -- as you think about the potential for narrowing networks for health plans, I think we're actually pretty well positioned because we're delivering on a superior clinical performance here, and our nurses that are out in the field have tremendous experience in home infusion. You know that our business is home infusion, and I think our reputation in terms of our clinical performance is resonating really well within the health plan universe.

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Jonathan Marley Kaufman, William Blair & Company L.L.C., Research Division - Associate [18]

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Okay. Great. And then just one quick follow up. Have your assumptions for branded price inflation this year changed?

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [19]

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We're still expecting 4% to 6% brand price inflation for the year.

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Operator [20]

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Your next question comes from David Larsen with Leerink.

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David M. Larsen, SVB Leerink LLC, Research Division - MD of Healthcare Information Technology & Distribution and Senior Research Analyst [21]

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Can you talk about limited distribution product deals that you may have gotten on year-to-date or you expect to get on this year and how does that compare to previous years?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [22]

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Dave, in terms of the limited distribution portfolio, the team has done a great job there. We've introduced 6 new limited distribution partnerships since the beginning of the year and since our last report out. So we've got an industry relations team that I think is -- leverages our clinical reputation to capture share in the LDD market and so we're excited about that. We think that there's more opportunity for us, particularly in the oncology area to capture more LDDs here moving forward. But this is just the team executing day in and day out and our very strong relationships with our pharma partners.

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David M. Larsen, SVB Leerink LLC, Research Division - MD of Healthcare Information Technology & Distribution and Senior Research Analyst [23]

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Okay. Great. And then can you just remind me with regards to rebates, I'm sorry if you covered this earlier, but assuming rebates evaporate and like, let's say, this final rule comes out, how are you thinking about your overall portfolio? What mitigating steps can you take to keep yourself whole? And do you expect this to impact both the commercial Medicare and Medicaid sides of the business or do you think it'll be limited more to Medicare?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [24]

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Yes. I think it'll be limited more to the government business. And as we've indicated, we -- at this point, that business is really immaterial to the overall business. As you think about our market, the commercial middle market, we are not seeing at this point an increase in demand from the broker and consultant community or even from -- directly from our direct relationships with accounts, a different model versus the traditional model. I should note by the way that we do offer our clients a structure where we're pushing rebates through to the point-of-sale at the consumer level, and we're really not seeing much uptake on that and so we're -- we continue to compete more on a traditional basis. Now that being said, we have been working on developing alternative models, and I referenced this I think in my response to Lisa's initial question.

We are focused on delivering on an improved clinical value proposition in terms of our kind of move forward go-to-market strategy. So to the degree that the commercial market ultimately, either by an act of Congress or through just a shift in the commercial market, starts to focus on rebate value being pushed through at the point-of-sale, I think we'll be very well positioned to recapture that -- the rebate margin in the form of other -- of our financial levers, including that clinical value proposition.

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Operator [25]

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Your next question comes from Eric Coldwell with Baird.

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Eric White Coldwell, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [26]

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I guess first question, how many new client facing account executives have you been talking about, and I'm really talking about on a net basis for the upgraded sales team? And then can you give some status on the sizing of your health system initiatives? And I have maybe a follow-up or two after that.

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Terri Anne Powers, Diplomat Pharmacy, Inc. - VP of IR [27]

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[18%] on the providers, but that's all we can disclose.

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [28]

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So Eric, yes, in terms of the PBM team, I think we've referenced in some of our one-on-one discussions, the legacy PBMs really did not have large sales and account management. So this literally is an all-new team from -- starting from last year. And we've just added 2 to 3 additional sales resources just here over the last quarter. Some -- then again, they're really seasoned folks, some of whom worked with Dan and I at Medco as an example and have some great new sales talent that we've added, and we have very high expectations of that talent, I should note. And on the other side of the business, meaning this -- the focus on the health plan and hospital system business, we've added a dozen plus new folks across -- from a sales perspective across that book of business, and we've also added additional account management staff to manage those relationships.

So as we build a relationship with a hospital system, for example, we need account managers to -- obviously to manage that relationship and to expand that relationship, so we've added staff there as well.

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Eric White Coldwell, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [29]

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I guess my -- that's helpful. My follow up is obviously I'm sure you saw the headlines that Premier is exiting their health system focus, specialty pharmacy business and frankly kind of a giveaway looking at the price tag. I'm curious if that wasn't something that was perhaps interesting to you, given your initiatives to grow that business. You could have touched $0.5 billion of revenue pretty quickly there, so I'm just curious on your thoughts on if there was a look and if not, why not?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [30]

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Yes. So obviously I can't comment on whether there was a look or not, but I think what we've been focused on there is growing that organically. We've got a very strong sales team on that and what we've also been focused on as I alluded to in my introductory comments here is a different level of analytics that we're providing in support of those relationships. And as a result of that, I think we're seeing expansion of the relationship, both in terms of therapeutic categories that are covered under the relationship, the expansion of our LDD platform in the hospital system relationship. So we're growing pretty nicely just based on that focused effort with a new value proposition.

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Eric White Coldwell, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

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Last one for me. Just a quick one here, Chandler distribution facility, I'm just curious if you have an update on how that's progressing and whether it might or how it might impact your inventory levels and therefore cash flow as the year progresses?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [32]

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So yes, it's going very well. So Chandler is officially up and running. Our call center is staffed and the -- from an operational perspective obviously we have now the redundancy that we were looking for with the addition of Chandler. Obviously, as I've referenced in previous calls, that positions us very nicely with respect to regional and national health plans who look for a platform that provides that level of redundancy. Our ScriptMed platform, which is, as you know, our Specialty operating platform is running in Chandler. We've got our Oncology Center of Excellence up and running in the facility and then during the remainder of the year, in terms of the implementation, the plan is kind of a balanced approach to our back and dispensing across all of our products and looking to do that before June 1. So it's going well.

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [33]

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And in terms -- this is Dan, Eric. In terms of the inventory, we would expect a bit of a bump in our inventory as we launch that site but we will quickly bring that back down in the back part of the year.

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Operator [34]

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Your next question comes from Ricky Goldwasser with Morgan Stanley.

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Rivka Regina Goldwasser, Morgan Stanley, Research Division - MD [35]

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So you're assuming some pretty nice acceleration in EBITDA in the second half of the year. I know you mentioned the ramp in infusion volume, but can you just give us a little bit more color on what's kind of like driving the second half pickup?

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [36]

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Sure, Ricky. This is Dan. Besides the infusion volume, we see a pickup in our existing generics and the launch of some new generics in the back part of the year that's going to drive EBITDA. In terms of the PBM, we see higher gross margins in the back part of the year due to seasonality and the timing of rebate recognition. We're looking at some improvement in our cost of goods and our cost of sales. And then we do anticipate a significant contribution from our operational efficiency initiatives across the entire business. So that's all back half weighted driving that EBITDA growth.

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Rivka Regina Goldwasser, Morgan Stanley, Research Division - MD [37]

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Okay. And one follow-up question. I know, Brian, you talked about the HHS rebate rule as it refers to the PBM business. But when we think about the Specialty pharmacy business, they are also some suggestions in the rule regarding kind of like pharmacy reimbursement and treatment of DIR fees. Do you have any early thoughts of what if the rule is implemented, is proposed, what it would mean to the Specialty business?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [38]

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Yes. Ricky, first of all, we don't anticipate the rule having a significant impact on our Specialty business. And maybe the second part of the question is around the potential changes in Part B, which is related to that, and we don't expect that to impact our infusion business either.

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Operator [39]

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Your next question comes from Charles Rhyee with Cowen.

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Charles Rhyee, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [40]

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Brian, you talked early about sort of the uptick in sort of RFP activity. Can you discuss now with the new organization that you kind of -- sales organization put in place and your expectations around -- or how should we think about the conversion of RFPs? Because if I recall last year, we did see good activity at the beginning, it was something we weren't quite able to close as much on by the end of the year. Can you kind of talk about sort of what you're seeing so far in conversions?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [41]

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Yes. So in terms of -- I don't have a specific number or win rate to share with you. We have won some clients for 2019. And I think last year as you think about how we've reported out on that, we went into a fair amount of detail in Q1 and really what we were saying is that our new name didn't offset some of the losses that we sustained in the beginning of the year, which again I think were largely tied to some of the service issues that we had in '18 tied to the integration of the 2 legacy PBM businesses.

But -- so on the PBM side, we're seeing again very strong RFP activity, significantly increased over last year and we are winning. But the other side of the business, meaning on the Specialty organization and that level of RFP activity, we're seeing some really nice trends, and by that I'm referring to obviously just an increase in overall activity, but then very specifically we're seeing more of a trend toward carve out of Specialty and maybe more specifically a focus on the management of the specialty benefit across both medical and pharmacy. And I think -- I'm excited about that because I think that's an area that -- where we excel, where we have excelled historically and then in addition to it, when you include the incremental set of analytics that I outlined earlier, I think that, that really positions us well to manage across both the medical and pharmacy benefit pretty well. So that -- Mike, the point of that was to say that I think that we'll be in a position to close more because of that new value proposition that we're going to market with in the specialty carve out business.

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Charles Rhyee, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [42]

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Great. That's helpful. And just a follow up on the specialty pharmacy side. Following maybe Eric's question around -- Premier, when they talked about getting out of the specialty pharmacy business, they highlighted the sort of continued DIR fees, sort of a slowing kind of market environment. But they also kind of point towards PBM consolidation and challenges as larger -- integrated sort of PBMs kind of push volumes to the specialty pharmacy. Obviously, something you guys have pointed out a little bit in the past as well. Anything that you're seeing sort of in the market environment that you think can start to change maybe for the better as we think about the rest of this year, maybe into next year.

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [43]

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Yes. To your point, obviously we pointed to in our last earnings call, we talked about the continuation of reimbursement pressure, I think that's been a constant. We also referred to what we've seen more recently as an increased narrowing of networks as well as this member channel management, which I think we referred to for the first time in our last call. So we understand the pressures that they may have referenced. I didn't see the specific references but certainly, from an industry perspective, we see that.

In terms of what might mitigate against that I think it's really the whole new strategy that we've introduced as of last year to build relationships with health plans. And I referenced it in my prepared comments that we're absolutely seeing a near-term opportunity and a longer-term opportunity tied to being an independent specialty focused provider. I think that, that is really what's resonating in the market. So with -- in the face of the vertical integrations and to some degree that -- the vertical integrations are contributing toward the pressures that I just outlined. On the other side of that, there are major health plans, blue systems that are looking for an independent player to be their strategic partner. And I think that, that puts us in a position to capture big chunks of volume through those -- through building those relationships.

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Operator [44]

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Your next question comes from John Ransom with Raymond James.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [45]

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On your specialty pharmacy, what is the mix today of limited distribution drugs versus nonlimited distribution? And do you see a margin difference in those 2 categories?

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [46]

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This is Dan, John. About 75% of the drugs are limited distribution -- I'm sorry, 50%, I got that number wrong. And the profile is not that different between limited distribution and our regular drugs.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [47]

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So I mean would the conclusion flow from that, that those are no more immune from margin pressure, reimbursement pressure than the more widely available drugs or is it -- are they just bigger drugs that structurally have lower margins?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [48]

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Yes. I was just going to add. I think that we're seeing pricing pressure across the whole mix. My hope is and the focus that I've had in driving a new analytics set of capabilities for the company is to be able to leverage that to improve our margin profile on limited distribution drugs. I think -- I believe that there's a broader set of opportunities with pharma around data analytics beyond what we're doing today even in support of our limited distribution partnerships. And so my hope is that we'll be able to improve the margin profile as it relates to the LDDs.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [49]

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Okay. And just kind of flipping to the PBM for a minute, when you talk to real-world clients in the commercial marketplace, how much excitement really is there for point-of-sale rebates? And if that's not a trend, if the government is just trying to force something that's not there, what are companies doing to address the real problem of affordability? The intersection of affordability and list prices and high copay plans if they're not going to do the point-of-sale rebates, what other strategies are you seeing with some of your more forward-looking RFPs or clients?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [50]

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Yes. Great question. And again, we're not seeing an increase in demand there at all for point-of-sale rebates. As we've discussed, the rebates have been kind of the underpinning, supporting, not only the pharmacy benefit but the overall health benefit. So this -- the rebates retained at a planned sponsor level are offsetting overall costs and ultimately to the degree that they are passed through at the point-of-sale. Obviously, for an insured client, there'd be an increase in premium. For a self-insured client, there'd likely be an increase in cost-sharing levels, et cetera. So there are real impacts.

And from an employer perspective, there -- at least with respect to our middle market, they continue to be focused on the traditional model that has the PBM rebate as part of that financial equation. So what are they focused on to try to lower costs, I think there really are the traditional PBM levers, really, the clinical programs that we bring to bear to reduce overall program costs, our formulary management, prior authorization to ensure appropriate clinical utilization of the products. And those, as you know, are the traditional methods for bending the cost curve from an employer perspective.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [51]

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So I mean why wouldn't you though -- I mean, I saw what Express Scripts did with insulin. Why wouldn't we think about these high copay? And if we're talking about medical and pharma, does it really make sense to have high copay if the net effect is a patient lands in the ER with insulin shock. Are we seeing more sophistication of the tiering of some of these copays or you think it's still just a big blunt tool and there's really not any move to try to fix this issue?

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [52]

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Yes. Great question. And I've seen this evolve over time, and I'm really referring to the last several years here, with smarter cost share levels, and that's tied to drug selection, meaning formulary and -- as well as the clinical edits that are deployed by the PBMs. But I'd say that from my perspective, planned design is getting smarter, it's not just a blunt instrument to your point. And I think you can be pretty effective with the right kind of plan designed to drive appropriate utilization and behavior. So I think while there's more opportunity there, I think the industry has been pretty effective at moving towards smart design.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [53]

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Great. And then last one for me, the $3 million add back, is that added back to your adjusted EBITDA guide? In other words, should we use $26 million as the base for the year or should we use $23 million as the base for the year?

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [54]

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You can use $26 million. That was a one-time prior period item.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [55]

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Is there a reason you didn't break that out in your press release, I think there's a little bit of confusion this morning about the performance? Wouldn't it be better to put that in the release and provide just a little color as to what adjusted EBITDA was?

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [56]

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I'm sorry, repeat the question.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [57]

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I'm just curious, why that add back wasn't spiked out in the press release.

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Daniel Paul Davison, Diplomat Pharmacy, Inc. - CFO & Treasurer [58]

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Well, I think the intent was to cover it during the call.

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John Wilson Ransom, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Healthcare Research [59]

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I guess with my unsolicited opinion that it might have been helpful to put in there but I'm glad you broke it out.

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [60]

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Okay.

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Operator [61]

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I am showing no further questions at this time. I will turn the call back over now to Brian Griffin for any closing remarks.

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Brian Thomas Griffin, Diplomat Pharmacy, Inc. - CEO & Chairman of the Board [62]

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Thanks very much, everybody, for your time today. We're -- obviously, we're going to be available after the call if any of you have any further questions. And we're also looking forward to seeing many of you at the Bank of America Health Care Conference next week. So we look forward to seeing you then. Thanks very much for joining us today.

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Operator [63]

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And ladies and gentlemen, this concludes today's conference call. You may now disconnect.