1.  DESCRIPTION OF BUSINESS

Diplomat Pharmacy, Inc. and its consolidated subsidiaries (the “Company”) operate a specialty pharmacy business which stocks, dispenses and distributes prescriptions for various biotech and specialty pharmaceuticals. The Company has its corporate headquarters and main distribution facility in Flint, Michigan and maintains eight other pharmacy locations in Michigan, Illinois, Florida, California, Connecticut, Massachusetts and North Carolina. The Company operates as one reportable segment.

Initial Public Offering

In October 2014, the Company completed its initial public offering (“IPO”) in which it issued and sold 11,000,000 shares of common stock and certain existing shareholders sold 4,333,333 shares of common stock at a public offering price of $13.00 per share.  The Company did not receive any proceeds from the sale of common stock by the existing shareholders.  The Company received net proceeds of $130,648 after deducting underwriting discounts and commissions of $9,652, and other offering expenses of $2,700.  The net proceeds were used to repay indebtedness to certain current or former stakeholders and employees, and to fully repay the borrowings under the revolving line of credit (an aggregate of $96,410). The remaining net proceeds of $34,238 will be used for working capital and other general purposes. Immediately prior to the closing of the IPO, each share of the Company’s then-outstanding capital stock converted into one share of its newly-authorized shares of no par value common stock.  The issuance of shares of common stock from the IPO and the conversion of the outstanding capital stock prior to the IPO into shares of common stock will have a significant impact on future computations of net income per share.

2.  BASIS OF PRESENTATION

Interim Unaudited Condensed Consolidated Financial Statements

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“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 interim financial statements include all adjustments of a normal recurring nature necessary for a fair presentation of the results of operations, financial position, changes in shareholders’ deficit and cash flows. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ended December 31, 2014.  These unaudited consolidated condensed financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 31, 2013 included in the Company’s final prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, with the SEC on October 10, 2014.

Stock Split

Immediately prior to the IPO, the Company affected a stock split in the form of a stock dividend of 8,500 shares for each share of capital stock. Accordingly, all share and per share amounts presented in these unaudited condensed consolidated financial statements and notes thereto, were adjusted, where applicable, to reflect the split.

Effect of Conversion from S Corporation to C Corporation

On January 23, 2014, the Company changed its income tax status from an S corporation to a C corporation. Accordingly, on that date, the Company recorded a net deferred income tax liability of $2,861 and reclassified all of its accumulated deficit, inclusive of the net deferred tax liability adjustment, into additional paid-in capital. The pro forma data presented on the unaudited condensed consolidated statements of income give effect to the Company’s election to be a C corporation as if that election was made effective January 1, 2013.

3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The consolidated financial statements include the accounts of Diplomat Pharmacy, Inc. and its wholly-owned subsidiaries and a 51%-owned subsidiary, formed in August 2014, which the Company has the ability to control. Noncontrolling interests in the consolidated balance sheets represent the minority stockholders’ proportionate share of the equity in such subsidiary. The Company also owns a 25% interest in a non-consolidated entity which is accounted for under the equity method of accounting since the Company does not control but has the ability to exercise significant influence over operating and financial policies. All intercompany transactions and accounts have been eliminated in consolidation.

On August 28, 2014, the Company and two unrelated third party entities entered into a contribution agreement to form a new company, Primrose Healthcare, LLC (“Primrose”).  Primrose will function as a management company, managing a network of physicians and medical professionals providing continuum care for patients infected with the Hepatitis C virus. The Company has committed to contributing $5,000 for its 51% interest, of which $2,000 was contributed in August 2014 with the remainder to be contributed in 2014 and 2015. The unrelated third party entities contributed a software licensing agreement valued at $2,647 and intellectual property valued at $2,157. Primrose had no operating activity through September 30, 2014.

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.

Revenue Recognition: The Company recognizes revenue from prescription drug sales 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 payor contracts and does not experience a significant level of returns or reshipments. If the Company administers a drug treatment regimen in a patient’s home, the Company recognizes revenue at the time of administration. Revenues from dispensing specialty prescriptions that are filled at an open door or retail pharmacy location are recorded at prescription adjudication, which approximates fill date. Sales taxes are presented on a net basis (excluded from revenues and costs). Revenues generated from prescription drugs were $591,676 and $395,723 for the three months ended September 30, 2014 and 2013, respectively, and $1,593,114 and $1,095,423 for the nine months ended September 30, 2014 and 2013, respectively.

The Company also recognizes revenue from providing various prescription data to pharmaceutical manufacturers and others and from consulting and other services when these services have been performed and the earnings process is complete. Revenues generated from these services were $3,853 and $2,904 for the three months ended September 30, 2014 and 2013, respectively, and $9,767 and $7,729 for the nine months ended September 30, 2014 and 2013, respectively.

Deferred Offering Costs: The Company has incurred accounting, legal, printing and other expenses in connection with its initial public offering.  Through September 30, 2014, offering costs of $1,604 were deferred and included in other assets in the accompanying condensed consolidated balance sheet.  Such costs will be charged to additional paid-in capital against the gross proceeds of the offering.

New Accounting Pronouncements: In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-8, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This ASU is effective within annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015 with early adoption permitted in certain circumstances. This ASU changes the requirements for reporting discontinued operations. The Company is currently evaluating the impact that the adoption of this guidance will have on its financial position, results of operations, cash flows and/or disclosures.

In May 2014, the FASB issued ASU No. 2014-9, Revenue from Contracts with Customers (Topic 606), which provides a single revenue recognition model intended to improve comparability over a range of industries, companies and geographical boundaries and is intended to enhance disclosures. The standard is effective retrospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2016.  Early adoption is not permitted. The Company is currently assessing the potential impact on its operations and financial statements.

In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Targets Could Be Achieved after the Requisite Service Period. This ASU is effective within annual periods beginning on or after December 15, 2015, including interim periods within that reporting period. This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The Company is currently evaluating the impact that the adoption of this guidance will have on its financial position, results of operations, cash flows and/or disclosures.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (subtopic 205-40). This ASU is effective for annual periods ending after December 15, 2016, and for annual periods and interim periods thereafter, and defines management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. The Company expects the adoption of this guidance will have no impact on the Company’s financial position, results of operations, cash flows and/or disclosures.

4.  BUSINESS ACQUISITIONS

MedPro Rx, Inc.

On June 27, 2014, the Company acquired all of the authorized, issued and outstanding shares of capital stock of MedPro Rx, Inc. (“MedPro”) for a total acquisition price of approximately $68,537, excluding related acquisition costs. Included in the total acquisition price is $52,267 in cash, 716,695 restricted shares of the Company’s Class B Nonvoting Common Stock valued at approximately $12,000, and contingent consideration fair valued at $4,270, with a maximum payout of $11,500 of contingent consideration that is based upon the achievement of certain revenue and gross profit targets in each of the twelve month periods ending June 30, 2015 and 2016. At the closing of the acquisition, approximately $3,503 of the purchase consideration was deposited into an escrow account that will be held for two years after the closing date to satisfy any of the Company’s indemnification claims. The Company incurred related acquisition costs of approximately $825 that were expensed through “Selling, general and administrative expenses” during the nine months ended September 30, 2014.

MedPro is a specialty pharmacy focused on specialty infusion therapies including hemophilia and immune globulin based in Raleigh, North Carolina. The Company acquired MedPro to expand its existing specialty infusion business and to increase its presence in the mid-Atlantic and Southern regions of the country. The Company ascribes significant value to the cost reductions as well as synergies and other benefits that do not meet the recognition criteria of acquired identifiable intangible assets. Accordingly, the value of these components is included within goodwill. The acquisition is treated as a stock purchase for accounting purposes, and the goodwill resulting from this acquisition is deductible for tax purposes. The results of operations for MedPro are included in the Company’s condensed consolidated financial statements from the acquisition date.

The Company did not acquire MedPro’s affiliate from which MedPro leased certain operating and other facilities. Instead, the Company, commensurate with the acquisition, entered into a five-year external lease agreement for the facilities with similar terms. As the Company does not direct the significant activities of the lessor, it is not consolidated into the Company’s financial statements.

The Company accounted for its acquisition of MedPro using the acquisition method as required by FASB Accounting Standards Codification (‘‘ASC’’) Topic 805, Business Combinations (‘‘FASB ASC 805’’). A summary of the fair value determination of the acquired assets and liabilities from the MedPro acquisition is as follows:

Definite-lived intangible assets that were acquired and their respective useful lives are as follows:

The Company determined the estimated fair values of MedPro’s identifiable long-lived assets with assistance from an independent valuation firm. That firm also assisted in the Company’s determination of the fair value of the contingent consideration utilizing historical results, forecasted operating results of MedPro for each of the twelve month periods ending June 30, 2015 and 2016, and the corresponding contractual contingent payouts based on those results discounted at rates commensurate with the uncertainty involved. The related liability is $4,491 as of September 30, 2014, with a charge of $221 to ‘‘Selling, general and administrative expenses’’ for the three and nine month periods ended September 30, 2014.

The Company recorded amortization expense related to its definite-lived intangible assets of $1,564 for the three and nine month periods ended September 30, 2014.

American Homecare Federation, Inc.

On December 16, 2013, the Company acquired all of the authorized, issued and outstanding shares of capital stock of American Homecare Federation, Inc. (“AHF”) for a total acquisition price of approximately $13,449, excluding related acquisition costs. Included in the total acquisition price was approximately $12,100 in cash and contingent consideration fair valued at $1,300, with a maximum payout of $2,000 of contingent consideration that is based on achieving certain revenue and gross profit targets in each of the two years ending December 31, 2014 and 2015. At the closing of the acquisition, approximately $1,353 of the purchase consideration was deposited into an escrow account that will be held for two years after the closing date to satisfy any of the Company’s indemnification claims. The Company incurred related acquisition costs of approximately $552 that were expensed through ‘‘Selling, general and administrative expenses.’’

AHF provides clotting medications, ancillaries and supplies to individuals with bleeding disorders, such as hemophilia. AHF has provided uninterrupted specialty pharmacy services exclusively to the bleeding disorders community since 1989. The acquisition of AHF will allow the Company to participate in AHF’s direct purchase agreements with key hemophilia manufacturers while also providing AHF access to the Company’s proprietary care management modules to better manage clinical care of the AHF patients. The Company ascribes significant value to the cost reductions as well as synergies and other benefits that do not meet the recognition criteria of acquired identifiable intangible assets. Accordingly, the value of these components is included within goodwill. The acquisition is treated as a stock purchase for accounting purposes, and the goodwill resulting from this acquisition is deductible for tax purposes. The results of operations for AHF are included in the Company’s condensed consolidated financial statements from the acquisition date.

The Company did not acquire AHF’s affiliate from which AHF leased its operating facility. Instead, the Company, commensurate with the acquisition, entered into a five-year external lease agreement for the facility with similar terms. As the Company does not direct the significant activities of the lessor, it is not consolidated into the Company’s financial statements.

The Company accounted for its acquisition of AHF using the acquisition method as required by FASB ASC 805. A summary of the fair value determination of the acquired assets and liabilities from the AHF acquisition is as follows:

Definite-lived intangible assets that were acquired and their respective useful lives are as follows:

The Company determined the estimated fair values of AHF’s identifiable long-lived assets with assistance from an independent valuation firm. That firm also assisted in the Company’s determination of the fair value of the contingent consideration utilizing historical results, forecasted operating results of AHF for each of the two years ending December 31, 2014 and 2015, and the corresponding contractual contingent payouts based on those results discounted at rates commensurate with the uncertainty involved. Based on operating results since AHF’s acquisition, the Company increased the estimated contingent payout to $2,000, the maximum amount, during the nine months ended September 30, 2014. The related liability was $1,736 as of September 30, 2014, with charges of $115 and $436 to ‘‘Selling, general and administrative expenses’’ during the three and nine months ended September 30, 2014, respectively.

The Company recorded amortization expense related to the definite-lived intangible assets of $226 and $677 for the three and nine months ended September 30, 2014, respectively.

Pro Forma Operating Results

The following table provides unaudited pro forma results of operations for the three and nine months ended September 30, 2014 and 2013 as if the acquisitions had occurred on January 1, 2013. The unaudited pro forma results reflect certain adjustments related to the acquisitions, such as amortization expense resulting from intangible assets acquired and adjustments to reflect the Company’s borrowings and tax rates.  Accordingly, such pro forma operating results were prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisitions been made as of January 1, 2013 or of results that may occur in the future.

5.  FAIR VALUE MEASUREMENTS

Accounting guidance clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. 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 need to 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).

Assets and liabilities of the Company re-measured and disclosed at fair value on a recurring basis at September 30, 2014 and December 31, 2013 are set forth in the table below:

The following table sets forth a roll forward of the Level 3 measurements:

The fair value of the redeemable common stock was determined by the Company’s Board of Directors, with input from management. The nature of the material assumptions and estimates considered to determine the fair market value of the redeemable common stock are highly complex and subjective. Given the absence of a public trading market of the Company’s common stock prior to the Company’s IPO, and in accordance with the American Institute of Certified Public Accountants Accounting and Valuation Guide: Valuation of Privately-Held-Company Equity Securities issued as Compensation, the Board of Directors exercised reasonable judgment and considered numerous objective and subjective factors to determine the best estimate of the fair value of the redeemable common stock including:

·         recent significant investments by sophisticated, institutional investors for purchases of the Series A Preferred Stock, and the rights, privileges and preferences of such preferred stock to the redeemable common stock;

·         valuations of the Company’s common stock performed by an unrelated third-party valuation specialist;

·         the Company’s historical and projected operating and financial results;

·         the market performance and financial results of comparable publicly-traded companies;

·         industry or company-specific considerations;

·         likelihood of achieving a liquidity event, such as an initial public offering or a sale of the Company;

·         lack of marketability of the Company’s common stock; and

·         the U.S. and global capital market conditions.

For the fair value determination as of September 30, 2014, the Board of Directors considered the Company’s initial public offering price of $13.00 per share.

See Note 4 for more information regarding the valuation of the contingent consideration.

The significant inputs, primarily the LIBOR yield curve, used to determine the fair value of the Company’s interest rate swap contract were considered Level 2 observable market inputs. The Company monitored the credit and nonperformance risk associated with its counterparty and believed them to be insignificant and not warranting a credit adjustment at December 31, 2013.

The Company’s interest rate swap agreement had an original notional amount of $2,160, equal to a mortgage loan with Bank of America. The purpose of the swap agreement was to fix the interest rate on the monthly balance of the mortgage and reduce exposure to interest rate fluctuations. Under the agreement, the Company paid the counterparty interest at a fixed rate of 2.72% and received interest at a variable rate, adjusted quarterly and based on LIBOR. Because this instrument is not classified as a hedging activity, changes in the fair value of this instrument are included in interest expense on the accompanying condensed consolidated statements of income. Fair value of the interest rate swap agreement was recorded in “Other accrued expenses” on the December 31, 2013 condensed consolidated balance sheet. This agreement was terminated in February 2014 at a cost of $9.

The carrying amounts of the Company’s financial instruments, consisting primarily of cash and cash equivalents, accounts receivable, accounts payable and other liabilities, approximate their estimated fair values due to the relative short-term nature of the amounts. The carrying amount of debt approximates fair value due to variable interest rates at customary terms and rates the Company could obtain in current financing.

6.  INVENTORIES

Inventories consist of the following:

7. GOODWILL AND OTHER INTANGIBLE ASSETS

(a)           Acquired Intangible Assets

Definite-lived intangible assets were acquired in the acquisitions of AHF and MedPro, and the formation of Primrose.  The definite-lived intangibles assets are amortized over their estimated useful lives using accelerated method for patient relationships and the straight-line method for the remaining intangible assets.

The software licensing agreement and intellectual property intangibles were contributed on formation of Primrose. No amortization related to these intangibles has been recorded in the three and nine months ended September 30, 2014 as the entity had no significant operations.

Aggregate amortization expense for amortizing intangible assets was $1,790 and $2,241 for the three and nine months ended September 30, 2014, respectively. Estimated amortization expense, including Primrose amortization from the expected start date of its operations, for the remainder of 2014 is: $2,044, $7,985 in 2015, $7,583 in 2016, $7,154 in 2017, and $6,589 in 2018.

(b)           Goodwill

Goodwill represents the excess purchase price paid over the estimated fair value of its acquired net assets recorded from the Company’s acquisitions of MedPro in June 2014 and AHF in December 2013. Goodwill is not amortized but is tested for impairment at least annually or earlier when events and circumstances indicate that it is more likely than not such assets have been impaired. The Company performs its annual impairment testing as of the first day of the fourth quarter of each year. No impairment was identified during the periods presented.

The changes in the carrying amount of goodwill for the nine months ended September 30, 2014 and the year ended December 31, 2013 are as follows:

8.  INVESTMENT IN NON-CONSOLIDATED ENTITY

In October 2011, the Company purchased a 25% minority interest in WorkSmartMD, L.L.C., also known as Ageology, for $5,000 of cash consideration, which was paid in installments during 2011, 2012 and 2013. No further payments or other commitments are required as of September 30, 2014. Because the Company does not direct the activities that most significantly impact the economic performance of Ageology, management has determined that the Company is not its primary beneficiary.

Ageology is an anti-aging physician network dedicated to nutrition, fitness and hormones, and has created a commercial software product for anti-aging physician practices that is in the late stages of development. The Company accounts for Ageology under the equity method, as it has significant influence over its operations. The Company’s portion of Ageology’s net losses were $377 and $319 for the three months ended September 30, 2014 and 2013, respectively, and $1,087 and $629 for the nine months ended September 30, 2014 and 2013, respectively. The Company’s equity investment balance in Ageology at September 30, 2014 and December 31, 2013 was $2,490 and $3,577, respectively.

During January 2014, the Company entered into a $500 8% per annum interest-bearing secured promissory note receivable from Ageology. During November and December 2013, the Company entered into two $1,000 6% per annum interest-bearing promissory notes receivable from Ageology. The notes are secured by all personal property and fixtures owned by Ageology. While due on demand, the Company does not intend to call the notes any time prior to September 30, 2015 and, accordingly, reflects the notes as noncurrent assets within ‘‘Investment in non-consolidated entity’’ on the Condensed Consolidated Balance Sheets.  In addition, in transactions in 2014 unrelated to the Company, an affiliated entity of the Company’s Chief Executive Officer has personally loaned $3.2 million to Ageology as of September 30, 2014.

The following table presents summarized financial information of Ageology:

9.  LINE OF CREDIT

On July 20, 2012, the Company entered into a five-year line of credit with General Electric Capital Corporation (‘‘GE’’). The original facility was comprised of a $60,000 revolving loan commitment, which is secured by security interest in and lien upon substantially all of the Company’s assets, not otherwise encumbered. The Company maintains a depository bank account where money is swept directly to the line of credit. Advances under the revolving credit loan commitment are limited to a borrowing base that consists of approximately 85% of the book value of eligible accounts receivable. In 2013, the facility was amended to increase the aggregate revolving loan commitments under the line of credit from $60,000 to $85,000. On June 26, 2014, the facility was amended to increase the aggregate revolving loan commitments under the line of credit from $85,000 to $120,000. As of September 30, 2014, the Company had $76,562 of borrowings outstanding and had $36,960 of availability under the line of credit. Additionally, the facility allows incremental increases in the line of credit or issuances of term loans up to an aggregate amount of $25,000, subject to specific conditions. As disclosed in Note 1, all outstanding borrowings were repaid from the proceeds received from the Company’s IPO in October 2014.

Interest on borrowings are charged at a rate equal to either: (a) the base rate, which equates to the rate last quoted by The Wall Street Journal as the “Prime Rate” or as further defined in the agreement in the absence of such, plus an applicable margin (the “Base Rate”); or (b) LIBOR, as defined by the agreement, plus an applicable margin. The applicable margin on the Base Rate borrowings is 0.75% and on LIBOR rate borrowings is 1.75%. The effective interest rate for Base Rate borrowings at both September 30, 2014 and December 31, 2013 was 4.00%. The effective rate on LIBOR rate borrowings at September 30, 2014 and December 31, 2013 was 1.90% and 1.92%, respectively. At September 30, 2014, the Company had Base Rate borrowings outstanding in the amount of $51,562 and LIBOR rate borrowings outstanding in the amount of $25,000. Additionally, the Company is charged a monthly unused commitment fee ranging from 0.25% to 0.50% on the average unused daily balance.

In connection with securing this facility, the Company incurred transaction costs totaling $1,538. These costs are being amortized as interest expense over the remaining life of the line of credit.

The revolving credit commitment with GE contains certain financial and non-financial covenants. The Company was in compliance with all covenants as of September 30, 2014.

10.  DEBT

Debt consists of the following:

As disclosed in Note 1, all outstanding borrowings were repaid from the proceeds received from the Company’s IPO in October 2014.

11.  INCOME TAXES

As disclosed in Note 2, on January 23, 2014, the Company changed its income tax status from an S corporation to a C corporation. Accordingly, on that date, the Company recorded a net deferred income tax liability of $2,861 and a corresponding charge to deferred income tax expense.

Prior to January 23, 2014, the Company had elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code. Under these provisions, the Company did not pay federal corporate income taxes on its taxable income. Instead, the shareholders were liable for individual federal income taxes on their respective shares of the Company’s taxable income. Distributions were made periodically to the Company’s shareholders to the extent needed to cover their income tax liability based on the Company’s taxable income.

As a C corporation, the Company accounts for income taxes under the asset and liability approach. Deferred tax assets or liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities and on tax credit carry forwards as measured by the enacted tax rates which will be in effect when these items impact the tax returns. 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.

Significant components of the expense for income taxes for the period from January 23, 2014 to September 30, 2014 are as follows:

The reconciliation of income taxes computed at the United States federal statutory tax rate to income tax expense for the nine months ended September 30, 2014 is:

Significant components of the Company’s deferred tax assets and liabilities at September 30, 2014 are as follows:

The Company prepares and files tax returns based on interpretations of tax laws and regulations. In the normal course of business the Company’s tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities. In determining the Company’s tax provision for financial reporting purposes, the Company establishes a reserve for uncertain income tax positions unless it is determined to be “more likely than not” that such tax positions would be sustained upon examination, based on their technical merits. That is, for financial reporting purposes, the Company only recognizes tax benefits taken on the tax return if it believes it is “more likely than not” that such tax position would be sustained. There is considerable judgment involved in determining whether it is “more likely than not” that such tax positions would be sustained. As of September 30, 2014, the Company has no recorded uncertain tax positions.

The Company adjusts its tax reserve estimates periodically because of ongoing examinations by, and settlements with, varying taxing authorities, as well as changes in tax laws, regulations and interpretations. The consolidated tax provision of any given year includes adjustments to prior year income tax accruals and related estimated interest charges that are considered appropriate. The Company’s policy is to recognize, when applicable, interest and penalties on uncertain income tax positions as part of income tax expense.

12.  CONTINGENCIES

The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. Management believes that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated results of operations, financial position or cash flows of the Company.

13.  CAPITAL STOCK

Pursuant to the Second Amended and Restated Articles of Incorporation dated March 31, 2014, the Company had the following classes of capital stock as of September 30, 2014:

Each class of common stock has equal and identical rights, preferences and limitations, other than for voting rights. The Series A Preferred Stock is entitled to vote as if converted into Class C Voting Common Stock on the voting date.

As disclosed in Note 1, immediately prior to the closing of the IPO, each share of the Company’s then-outstanding capital stock converted into one share of its newly-authorized shares of no par value common stock.

Common Stock

Of the common shares, 552,500 shares of Class A Voting Common Stock and 10,497,500 shares of Class B Nonvoting Common Stock were issued to two shareholders with certain redemption features which provide that upon the death of the shareholder or termination of his employment from the Company, all such outstanding shares owned by such shareholder will immediately be deemed to be offered for sale to the Company at an agreed-upon price meant to represent the then-current fair value of such shares. The Company would then be required to purchase the shares. Pursuant to this provision, the common shares were deemed to be mandatorily redeemable and, as such, are required to be reflected as liabilities at their period end estimated fair value. Changes in their fair value are reflected as “Change in fair value of redeemable common shares” on the Company’s condensed consolidated statements of income. Fair value is determined based on good faith estimates of the Company’s board of directors, in some cases with the assistance of independent third party valuations of the Company. These redemption provisions terminated upon the effectiveness of the Company’s IPO in October 2014.

Pursuant to redemptions that occurred in 2012, as of December 31, 2013, 3,187,500 shares of redeemable Class B Nonvoting Common Stock remained outstanding. In January 2014 and April 2014, 143,339 and 195,545 shares, respectively, were redeemed.  On June 1, 2014, 425,000 shares were transferred into a separate trust, upon which the redemption provisions were terminated for those transferred shares and the related liability was reclassified into additional paid-in capital.

On August 12, 2014, the Company issued 372,486 shares of Class B Nonvoting Common Stock in the aggregate to a relative (and associated trusts) of the Company’s chief executive officer, in connection with the termination of an existing Stock Redemption Agreement. This issuance resulted in a charge of $4,842 to “Termination of existing stock redemption agreement” during both the three and nine month periods ended September 30, 2014. The value of the issued shares was based on the Company’s initial public offering price of $13.00 per share.

Preferred Stock

In January 2014, the Company entered into a Series A Preferred Stock Purchase Agreement with T. Rowe Price under which the Company issued to T. Rowe Price 2,986,228 shares of Series A Preferred Stock at a purchase price of $16.74 per share. The Company used $20,000 of this $50,000 investment for general corporate purposes inclusive of fees associated with this transaction, and the remaining $30,000 was distributed to the currently existing holders of common stock including 143,339 redeemable shares ($26,900) and currently existing holders of options to acquire common stock ($3,100) (Note 14).

In April 2014, the Company entered into a Series A Preferred Stock Purchase Agreement with Janus Capital Group (‘‘Janus’’) under which the Company issued to Janus 3,225,127 shares of Series A Preferred Stock at a purchase price of $16.74 per share. The Company used $25,200 of the $54,000 investment for general corporate purposes inclusive of fees associated with this transaction, and the remaining $28,800 was distributed to the currently existing holders of common stock including 195,545 redeemable shares ($26,500) and currently existing holders of options to acquire common stock ($2,300) (Note 14).

The Series A Preferred Stock has no coupon rate, is convertible into Class C Voting Common Stock at any time at the option of the holder, has optional redemption rights and has liquidation preferences. The conversion rate is on a one-for-one basis, subject to adjustment for stock splits and subdivisions, stock combinations, certain future issuances of common stock or common stock equivalents at effective prices lower than the then-applicable conversion rate, and other circumstances as described in the amended articles of incorporation. The Series A Preferred Stock automatically converts into Class C Voting Common Stock upon either (i) a qualified common stock public offering (as defined), or (ii) an affirmative vote of the majority of the Series A Preferred Stock.

Pursuant to an affirmative vote of the majority of the Series A Preferred Stock, the holders thereof can demand redemption of all outstanding shares of Series A Preferred Stock anytime on or after the earlier of (i) January 23, 2021, (ii) such time as the Company’s aggregate market price (as defined) is equal or greater than $5,000,000, and (iii) such time as certain changes are made to the Company’s board of directors, certain executive officers and/or certain controlling shareholders. The redemption price is payable in cash and will be the greater of the original issuance price plus all declared but unpaid dividends and fair market value (as defined). Because of these redemption features, the Series A Preferred Stock is reflected outside of permanent equity on the Company’s condensed consolidated balance sheet. Upon a liquidation event (as defined) the Series A Preferred Stockholders are entitled to receive the greater of (i) the sum of the original issuance price plus a 15% return compounded annually and (ii) the amount they would receive upon the liquidation had the Series A Preferred Stock converted into Class C Voting Common Stock on the liquidation date.

14.  SHARE-BASED COMPENSATION

The Company’s 2007 Stock Option Plan, as approved by the Company’s Board of Directors and amended March 1, 2009, authorizes the granting of stock options to its key employees at no less than the market price on the date the option is granted. Options generally become exercisable in installments of 25% 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. As of September 30, 2014, all share-based compensation awards for employees were granted under the 2007 Stock Option Plan.  No further awards will be granted under the 2007 Stock Option Plan.  All outstanding awards previously granted under the 2007 Stock Option Plan will continue to be governed by their existing terms.  Equity awards issued on or after the IPO will be granted under the Diplomat Pharmacy, Inc. 2014 Omnibus Incentive Plan (“2014 Plan”).

The Company has reserved 4,000,000 shares of its common stock for issuance to employees, directors or consultants of the Company under the 2014 Plan.  The 2014 Plan provides for the issuance of stock options, stock appreciation rights, restricted stock units and other stock-based awards.  The stock-based awards will be issued at no less than the market price on the date the awards are granted.  On October 10, 2014, the Company issued 1,007,500 stock option awards to key employees and 5,769 restricted shares to a non-employee director. Options generally become exercisable in installments of 25% 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.

Total compensation expense related to employee stock options was $693 and $216 during the three months ended September 30, 2014 and 2013, respectively, and $1,828 and $671 during the nine months ended September 30, 2014 and 2013, respectively. In January 2014, the Company redeemed stock options to buy 148,650 shares of Class A Voting Common Stock and 91,118 shares of Class B Nonvoting Common Stock from certain current and former employees for cash consideration totaling $3,100 (Note 12). In April 2014, the Company redeemed stock options to buy 9,696 shares of Class A Voting Common Stock and 174,297 shares of Class B Nonvoting Common Stock from certain current and former employees for cash consideration totaling $2,300 (Note 13). No incremental compensation expense was recognized as a result of these redemptions.

In May 2014, the Company entered into a Stock Option Redemption Agreement with a former executive whereby the Company redeemed options to acquire 884,000 shares of common stock, comprised of 44,200 shares of Class A Voting Common Stock and 839,800 shares of Class B Nonvoting Common Stock, for the cash purchase price of $4,000. No incremental compensation expense was recognized as a result of this redemption.

15.  INCOME PER COMMON SHARE

The Company computes net income per common share using the two-class method as its preferred shares meet the definition of a participating security and thereby share in the net income or loss of the Company on a ratable basis with the common shareholders. The preferred shares portions of net income for the three and nine months ended September 30, 2014 were 16% and 13%, respectively. Basic net income per common share is computed by dividing net income allocable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share, further includes any common shares available to be issued upon exercise of outstanding stock options if such inclusion would be dilutive.

The following is a reconciliation of the numerators and the denominators of the basic and diluted income per common share:

The effect of certain stock options was excluded from the computation of diluted weighted average common shares outstanding for the three and nine months ended September 30, 2014 as inclusion of such items would be anti-dilutive.  There were approximately 1.3 million stock options in the three and nine months ended September 30, 2014, respectively, that were considered anti-dilutive. All stock options were considered dilutive in the three and nine months period ended September 30, 2013.

Principles of Consolidation: The consolidated financial statements include the accounts of Diplomat Pharmacy, Inc. and its wholly-owned subsidiaries and a 51%-owned subsidiary, formed in August 2014, which the Company has the ability to control. Noncontrolling interests in the consolidated balance sheets represent the minority stockholders’ proportionate share of the equity in such subsidiary. The Company also owns a 25% interest in a non-consolidated entity which is accounted for under the equity method of accounting since the Company does not control but has the ability to exercise significant influence over operating and financial policies. All intercompany transactions and accounts have been eliminated in consolidation.

On August 28, 2014, the Company and two unrelated third party entities entered into a contribution agreement to form a new company, Primrose Healthcare, LLC (“Primrose”).  Primrose will function as a management company, managing a network of physicians and medical professionals providing continuum care for patients infected with the Hepatitis C virus. The Company has committed to contributing $5,000 for its 51% interest, of which $2,000 was contributed in August 2014 with the remainder to be contributed in 2014 and 2015. The unrelated third party entities contributed a software licensing agreement valued at $2,647 and intellectual property valued at $2,157. Primrose had no operating activity through September 30, 2014.

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.

Revenue Recognition: The Company recognizes revenue from prescription drug sales 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 payor contracts and does not experience a significant level of returns or reshipments. If the Company administers a drug treatment regimen in a patient’s home, the Company recognizes revenue at the time of administration. Revenues from dispensing specialty prescriptions that are filled at an open door or retail pharmacy location are recorded at prescription adjudication, which approximates fill date. Sales taxes are presented on a net basis (excluded from revenues and costs). Revenues generated from prescription drugs were $591,676 and $395,723 for the three months ended September 30, 2014 and 2013, respectively, and $1,593,114 and $1,095,423 for the nine months ended September 30, 2014 and 2013, respectively.

The Company also recognizes revenue from providing various prescription data to pharmaceutical manufacturers and others and from consulting and other services when these services have been performed and the earnings process is complete. Revenues generated from these services were $3,853 and $2,904 for the three months ended September 30, 2014 and 2013, respectively, and $9,767 and $7,729 for the nine months ended September 30, 2014 and 2013, respectively.

Deferred Offering Costs: The Company has incurred accounting, legal, printing and other expenses in connection with its initial public offering.  Through September 30, 2014, offering costs of $1,604 were deferred and included in other assets in the accompanying condensed consolidated balance sheet.  Such costs will be charged to additional paid-in capital against the gross proceeds of the offering.

New Accounting Pronouncements: In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-8, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This ASU is effective within annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015 with early adoption permitted in certain circumstances. This ASU changes the requirements for reporting discontinued operations. The Company is currently evaluating the impact that the adoption of this guidance will have on its financial position, results of operations, cash flows and/or disclosures.

In May 2014, the FASB issued ASU No. 2014-9, Revenue from Contracts with Customers (Topic 606), which provides a single revenue recognition model intended to improve comparability over a range of industries, companies and geographical boundaries and is intended to enhance disclosures. The standard is effective retrospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2016.  Early adoption is not permitted. The Company is currently assessing the potential impact on its operations and financial statements.

In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Targets Could Be Achieved after the Requisite Service Period. This ASU is effective within annual periods beginning on or after December 15, 2015, including interim periods within that reporting period. This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The Company is currently evaluating the impact that the adoption of this guidance will have on its financial position, results of operations, cash flows and/or disclosures.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (subtopic 205-40). This ASU is effective for annual periods ending after December 15, 2016, and for annual periods and interim periods thereafter, and defines management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. The Company expects the adoption of this guidance will have no impact on the Company’s financial position, results of operations, cash flows and/or disclosures.