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Diplomat Pharmacy Inc  (NYSE:DPLO)
Q3 2018 Earnings Conference Call
Nov. 06, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello and welcome to Diplomat's Third Quarter 2018 Earnings Conference Call. At this time I would like to inform all participants that their lines will be in a listen-only mode. After the speakers remarks there will be a question and answer period.

I'd like to turn the call over to Terri Anne Powers, Vice President of Investor Relations.

Terri Anne Powers -- Vice President Investor Relations

Good afternoon everyone. Please note after the market closed today, Diplomat issued its third quarter 2018 earnings press release. Before we begin today as you know I need to 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, objective, expectations or intentions. 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 company's annual 10-K report and subsequent filings with the Securities and Exchange Commission. These statements speak only as of the date hereof of 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 statements.

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 gap 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, Diplomat's Chairman and CEO. Brian. Please go ahead.

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Thank you, Terri Anne, and good afternoon everybody. We appreciate you're joining us on a busy earnings day as we review Diplomat's third quarter and year-to-date 2018 performance. I'm joined today by Joel Saban, our president and Atul Kavthekar, our CFO.

First, I'll provide some high level comments on the quarter and then I'll provide some commentary on recent industry developments, before concluding with an update on recent company activities that support our growth strategy. I'll then turn the call over to Atul to provide more detail on our third quarter performance and year-end outlook. This afternoon, we reported a 22% increase in revenue to $1.4 billion for the third quarter of 2018, while adjusted EBITDA increased 81% to $42 million. Our results continue to be driven by the addition of the CastiaRx business and its strong performance against expected synergies, as well as solid growth within our Specialty and Infusion businesses. This quarter, we added two additional limited distribution drugs to our already extensive limited distribution drug portfolio of more than 120 LDD products.

We continue to be pleased with the CastiaRx performance. Integration activities are expected to be complete by year-end. Synergies remained at a run rate similar to 2Q '18 for a year-to-date total of $7 million, tracking in line with our guidance of $8 million to $10 million in synergies in 2018. Synergies continue to be driven by client contract improvements, PBM services, manufacturer discounts, and improved cost of goods.

We've completed the transition of CastiaRx's exclusive Specialty clients LDD volume from competitor pharmacies to Diplomat Specialty Pharmacy. We remain focused on converting CastiaRx's open network clients to Diplomat. We continue to see strong interest in CastiaRx's solutions since we launched the brand on April 30th, observing significantly higher RFP activity compared to last year. We believe that our value proposition is resonating in the market, as we've been awarded new client contracts in the third quarter, split roughly one half commercial and one half Medicare Part D.

Before touching on further details of the quarter, I'd like to take a moment to briefly address a few key topics associated with the evolving healthcare landscape. From a policy standpoint, the Trump Administration continues to move forward with proposals detailed in its blueprint in order to make drugs more affordable and improve patient access. Currently, we have no new information regarding HHS's proposed rule to remove and replace the Safe Harbor protection for rebates. At this point, it is still unclear whether the administration will implement a model, which applies the value of rebates at the point of sale or via a net price model.

In the conversations we've been having with perspective and renewing PBM clients, we aren't seeing changes in demand to move away from the traditional rebate model. Having said that, we have the ability today to offer point of sale rebates to our clients that may have an interest in that model. As we previously indicated, CastiaRx offers a full menu of services and flexible contract structures, as we tailor our offerings to what our clients who are demanding. If the industry profit model does indeed shift away from rebates, we expect to be able to shift profit levers to maintain profitability. As you know the administration has methodically pursued efforts to drive down drug list prices and prices paid by consumers at the point of sale. We are encouraged by the recent signing into law of Know the Lowest Price and The Patient Right to Know Drug Prices acts. Both acts banned the use of so-called pharmacy gag clauses, something CastiaRx has not used, which is a win for patients who may be paying too much for their prescriptions.

In addition, The Patient's Right to Know Drug Prices Act will allow the FDC to scrutinize settlements between biologics manufacturers and biosimilars developers. Any involvement by the FDC that could result in increased competition in the US biosimilars market should be good for our clients and for Diplomat as we believe we are well positioned to help improve the uptake of biosimilars once more products are launched.

As a reminder, as biosimilars penetrate the market, we would expect Diplomat's revenue to be negatively impacted, while gross profit and margin would be higher relative to the branded products. Furthermore, on the topic of drug prices, I know all of you are keenly focused on drug price inflation trends. For Diplomat third quarter brand price inflation was in line with expectations, with a moderation in the trend observed in the first half of the year. We continue to expect full-year brand price inflation to be at the low end of the 5% to 7 % range initially communicated for 2018.

Turning back to our business results, Diplomat continues to execute on its strategy to get closer to the payer. We are making ongoing investments in our Specialty and PBM sales teams, provider and patient-focused solutions and internal systems and processes to drive improved patient engagement, clinical outcomes, customer service and operational efficiency. New developments in the quarter that support our growth strategy include the recent opening of our new state-of-the-art Chandler, Arizona distribution and patient call center. We expect to eventually support all therapeutic areas via the new facility, which creates added scale and redundancy to provide uninterrupted service to our patients and partners nationwide.

In conjunction with the Chandler opening, we are in the process of implementing a new end-to-end Specialty pharmacy platform called ScriptMed, which should improve our operational efficiency, and drive better data and analytics reporting. The initial rollout is planned for Chandler, which is expected to go live by the end of the month with full migration at both the Chandler and Flint facilities expected by the end of the second quarter of 2019. You'll recall, earlier in the year we announced a partnership with Fitbit in the design of an application for oncology patients to seamlessly integrate Diplomat's care management platform with Fitbit Ionic and Versa. Once ScriptMed is live, patients who have a Fitbit will be able to utilize it for medication reminders, personalized to their treatment regimen, refill and shipping notifications and real time connectivity with Diplomat's clinical support team, creating seamless integration in the patient's life and facilitating improved medication adherence.

During the quarter we started to roll out a new patient mobile app for our Specialty pharmacy patients, which will provide another means for patients to easily refill their prescriptions and obtain clinical support. The patient's mobile app will also be rolled out to Specialty Infusion patients as we progress toward common systems and applications across all of our business units. We expect to complete the rollout nationwide by the end of the year.

Finally, we are moving forward with additional efforts around the development and eventual monetization of data and analytics. But its early days yet, some more details on this should be expected in 2019. Overall, I'm pleased with this quarter's performance. Every day, our 2,400 employees put our patients first, demonstrating the Diplomat difference. We are progressing in the development of innovative solutions and data and analytics that will drive long term growth. We believe our efforts today will drive solutions for tomorrow's challenges, positioning the company to impact total healthcare costs.

With that I'll turn the call over to Atul for a review of our financial performance in the quarter and details of our revised outlook. Atul?

Atul Kavthekar -- Chief Financial Officer, Treasurer

Thank you, Brian, and good afternoon everyone. Our third quarter results highlight the company's progress around our operational improvement and our growth initiatives. In the third quarter, our Specialty segment generated revenue of $1.2 billion or about an 8% increase from the prior year. Oncology and Infusion continued to be strong drivers in the quarter with revenue growth of 8% and 13% respectively.

Gross margins in Specialty segment were 5.5% and generated $287 per script. On the same basis of measurement, this would've compared to 5.8% and $289 per script in the prior year period. CastiaRx, our PBM segment generated revenues of $170 million and gross profit of $26 million in the quarter. As discussed on prior calls, we did see a sequential decrease in PBM revenues in the quarter, related to the termination of client contracts, while maintaining overall profitability.

We remain pleased with CastiaRx's performance through the closing of the integration process and continue to expect a total of $8 million to $10 million of overall synergies in 2018. Taken together and combined with a sequential improvement in overall operating efficiencies, our consolidated adjusted EBITDA for the quarter was $42 million, an increase from the prior year of over 81%. Net income in the quarter was breakeven and was negatively impacted by an incremental $4 million of stock-based compensation compared to the prior year.

We ended the quarter with leverage of roughly 3.8x our trailing pro forma adjusted EBITDA. This slight sequential uptick was driven by an offsetting reduction in our accounts payable obligation. This reduction was in connection with revised vendor terms, which in effect trades short-term cash flow for meaningful multi-year savings. Although this had the effect of increasing our net working capital in the quarter, we are actively pursuing several strategies to drive our net working capital back to more normalized levels in 2019.

Furthermore, we remain committed to our leverage target of between 2x and 3x trailing adjusted EBITDA in 2019. As for 2018 full year guidance, we are making a few adjustments to reflect our updated views on the business. We are expecting revenues of between $5.5 billion to $5.7 billion based on current business trends, including reimbursement rates, launches and uptake of generic drugs and known PBM revenue losses to name a few.

Given our strong performance on PBM synergies and overall profitability, partially offset by start-up costs related to our new distribution facility and other investments in our broader operations and processes, we remain confident and are reiterating our 2018 adjusted EBITDA guidance between $164 million and $170 million.

We are slightly increasing our GAAP net income expectations for the full year to a loss of $8 million to income of $3 million and expect between a loss of $0.10 cents a share to a gain of $0.03 cents a share in EPS. This is related to a reduced expectation around stock-based comp for the year. As mentioned earlier, we have initiatives in flight to bring our overall net working capital back to normalized levels. However, we expect this will not be completed until 2019 and thus, we expect our 2018 cash flow from operations to be within a range of $50 million to $70 million.

As we look ahead to 2019, we do see numerous headwinds and tailwinds in each of our segments that we are taking into consideration and are worth pointing out. In our Specialty segment, the market and its growth prospects remain attractive. For example, the introduction of Specialty Generics and Biosimilars are expected to negatively impact revenue, but drive incremental gross profit. New indications for existing products, new product launches particularly in oncology, where Diplomat is an industry leader and increased access to limited distribution drugs are also expected to contribute to both revenue and profit growth. We also expect strong growth in Infusion to continue as payers continue to focus on site of care strategies to drive Infusion into the home. In addition we also expect to see the benefits of this year's investments in sales and data analytics to drive incremental volumes from providers as well as health plans and hospital systems. However, the evolving healthcare environment makes it difficult to predict what level of brand price inflation we will observe next year. In addition reimbursement pressure from payers continues to increase, putting further pressure on our margins.

In 2018, CastiaRx has been focused on integration of the acquired PBM businesses, rebranding effort and driving new sales. As Brian indicated, we are seeing strong interest in CastiaRx solutions and we are seeing some early new client wins. At the same time, we are also renewing clients at current market rates. In addition you'll recall that we previously indicated that rebates associated with government business were expected to be negligible in the future. This is in part because we will lose some high revenue, but relatively low margin Medicare Part D contracts, as of 1/1/2019, some of which were lost due to M&A in our client base.

We expect the loss of this business to negatively impact Diplomat's 2019 revenue by approximately 4%. Our objective is to offset this revenue loss with new relatively higher margin business, some of which we've already booked. We are still in the midst of the 2019 PBM selling season and so a full view into the 2019 outlook is not currently available, but will be incorporated in our 2019 guidance.

Finally, enterprise level investments to drive growth, which have contributed to higher near term SG&A costs are expected to deliver benefits later in 2019. These benefits in combination with other operational efficiency efforts are expected to help mitigate some of these previously mentioned headwinds. We will continue to observe the evolving healthcare environment, as well as, preliminary Q4 results while forming our 2019 guidance, which we expect to provide early next year.

Thank you again for your time and for your interest in understanding the Diplomat story. And, I'll now turn the call back over to Brian. Brian?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Thanks, Atul. As we continue to execute on our strategy, our first priority remains our patients. As the healthcare environment in the United States continues to evolve, Diplomat will successfully evolve with it. But be assured our focus every day is on our patients. We are investing in the business to provide value added solutions to all of our clients and Diplomat is well positioned to drive long-term sustainable growth.

Finally, I want to thank each of our associates for their commitment to Diplomat and to the patients we serve. Thank you for your time and we look forward to your questions.

Terri Anne Powers -- Vice President Investor Relations

Thanks, Brian. We'll now move to Q&A. I'd ask everyone to please limit your questions to one and a follow up so that all participants may be able to ask a question. Operator, can you please provide the instructions?

Questions and Answers:

Operator

Certainly. (Operator Instructions). Your first question comes from the line of Lisa Gill of JPMorgan. Your line is open.

Lisa Gill -- JPMorgan -- Analyst

Good afternoon. How are you? Thanks for taking my question. I just want to start first, Atul, thank you for the comments on the way to think about headwinds and tailwinds for 2019. A good amount of detail there, but if I'm thinking about this correctly, there seems to be more tailwinds for Specialty in 2019 than headwinds? And the headwinds, it seems like are things that -- we've known about it for some time right. You know reimbursement pressure is continuing, is one -- is that the right way to think about it when we think about that the Specialty side of the business. Two, when we think about some of the proposed changes coming out of D.C. on Part D, will that have any -- I know it probably won't happen in 2019, but how do we think about the potential impact to your relationship with oncologists as we think about Specialty? And then lastly on the PBM side, it seems almost more balanced. Will we see growth in the PBM for 2019?

And then lastly on the PBM side, it seems almost more balanced. Will we see growth in the PBM for 2019?

Atul Kavthekar -- Chief Financial Officer, Treasurer

Hey, Lisa. This is Atul. Thanks again for the question. Let me try and address your first one and then your last one and then for the one in the middle maybe I'll ask Brian and Joel to comment. But with regards to your commentary around Specialty pharmacy, I think you have it exactly right. I think that, it's fair to say we've not really seen anything particularly new jumping out in terms of headwind and we still have the strength in the tailwinds that we've talked about. I think there are a lot of positive things that are happening in the business, a lot of investment that's taken -- that's taking place and that will take root, that's going to be a long-term driver of the business. You didn't ask the question, but I'll volunteer the answer around DIR. In addition, we've not seen any structural changes in DIR going forward, either. So, I think we're feeling pretty good that we have a close read on the headwinds and tailwinds in the Specialty pharmacy. Maybe I'll ask some of the other gentlemen to -- I didn't quite hear, you broken up a little bit in your second question, Lisa. Would you mind repeating that?

Lisa Gill -- JPMorgan -- Analyst

Yes, sure. So the second part of the question was just on the PBM side. So again, when you gave that -- it did seem that the headwinds, tailwinds were a little more balanced on the PBM side, right, so renewing some contracts at the current market rate, talked about some lost business, but being able to offset that hopefully with business wins, with new business that potentially would have a higher margin, should we think that that PBM will have the ability to grow in 2019 or do you view 2019 as kind of a more of a rebuilding year for the PBM? And then just the last question was -- Brian if you want to answer, how do we think about that the impact of proposed changes on Medicare Part B?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Lisa, thanks for the question. Yes, so let me -- I'll start obviously with the PBM question. Yes, two-point, I think at some level, it's a rebuilding, you're right. We just launched the brand. And as you know, we launched that back in the back-end of April. As we've referenced I think on the Q2 call, we're saying a lot more RFP activity, certainly relative to last year. So we're expecting that we'll be in the hunt so to speak on a significant amount of new name business in '19.

And as you know relative to the small group market that we're focused on, the commercial market, the effective dates are really spread a little bit more evenly across the year. So the opportunity in other words will continue throughout the year on that. But I think that we're getting a nice uptick and interest in the brand. But clearly, we're new out into the market with that brand. As I've said, I think in the Q2, I'm really happy about the investments that we've made in the field organization there. So we've got some seasoned executives both in the sales organization and in the account management organization that are now leading that and each of whom have been over 25 years of experience. So we've got some really seasoned experienced folks out there representing the Company. So I feel good about our position. I know that it's resonating in the market. So, certainly we're tasking them with growing in 2019 and beyond.

Relative to the Part B question, as you know we've got limited exposure overall to Med Part B, most of our Medicare Part B exposure relates to our Infusion business and it represents a single digit percentage of our Infusion business. So it really is not a material impact to our business. Now, to the degree that we get better insight into the rule making on this is to the degree that the rules would apply to hospitals and physicians office administration of the Part B drugs and therefore wouldn't apply to Diplomat Part B business meaning our home Infusion business. There may be an opportunity for pharmacies like us to provide those drugs to the physicians offices and to the hospital system. So there may be an opportunity in it. So in short, limited exposure today in Part B, but the potential for opportunity into the future.

Terri Anne Powers -- Vice President Investor Relations

Thank you. Go ahead. Any clarifying questions.

Operator

Your next question comes from the line of Steven Valiquette of Barclays. Your line is open.

Steven Valiquette -- Barclays -- Analyst

Thanks. Good afternoon, Brian and Atul. Thanks for taking the question. I think there's a few more moving parts in the -- here at the PBM results for 2018 on the revenue line, but what also jumps out to me is the improvement in the PBM gross margin you're now up to 15.5% in the quarter, which obviously is a pretty phenomenal number. Just curious to hear more about maybe the sustainability of PBM gross margins in that range as we think about the forward period with all the puts and takes on the PBM side? Thanks.

Atul Kavthekar -- Chief Financial Officer, Treasurer

Hey, Steve, thanks for the question. So the quarter was really sort of the demonstration of some of the points we were making earlier. We've signaled earlier in the year, we had some contracts that were lower in margin, that were going to be leaving. Our signal was that, there really wasn't going to be a big impact to profitability. And so the margin is really just an artifact of the lower revenue with a consistent -- relatively consistent profitability level for the PBM segment. So I think that -- that's really what you're seeing. You're just seeing revenue going away without really impacting the gross margin line. Going forward, I think that we take a little bit more conservative view on margins. We have business that is going to be renewed and we're renewing that business at market rates. And we are expecting to see some -- perhaps some pullback in terms of the margins going forward. So I don't think that you should expect this level of gross margin percentage for the going forward period.

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Yes, Steve I would just add, this is Brian. I would just add to Atul's comments that as you know the operating platform that we now have in the CastiaRx platform really can manage large scale accounts. So to the degree that we're more successful on the higher end of our account mix, then obviously that will put pressure on the -- on the gross margin percentage.

Steven Valiquette -- Barclays -- Analyst

Okay, that's helpful. Thanks.

Terri Anne Powers -- Vice President Investor Relations

Next question, please.

Operator

Your next question comes from the line of David Larsen of Leerink Partners. Your line is open.

Leerink Partners -- -- Analyst

Hi, this is Johnson on for Dave. I was just wondering if you could give a little bit more color on your new business wins. You've been talking about a strong RFP pipeline. Just wondering sort of how you're progressing?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

So, I'll start it and then if Joe would like to add to it, you can add to it. So, in terms of the selling season, as I mentioned in response to Lisa's question, we are seeing really nice momentum there. We're still in the middle of the 2019 selling season, right, so as you think about our small group focus here -- we're going to continue to see activity and hopefully some new wins in the November and December timeframe for 1/1/19 business. And then the other point I wanted to make is that, obviously for us as a small group focused player -- our new name business is going to be more spread out across 2019. So, we haven't -- we haven't pointed obviously to a net number here. As I mentioned in my introductory comments, though the wins that we -- that we have booked to-date is -- to-date is a solid mix of 50% commercial and 50% Medicare Part D. So the point being that -- as we position ourselves with the new brand as I referenced in my comments in response to Lisa's question, it is an opportunity for us to grow the PBM. So, it's a growth here for us. And we'll be able to do that with our new cost of goods and compete effectively and win in both the commercial and the Medicare Part D market.

Leerink Partners -- -- Analyst

That's great. Thank you. And if I could just follow-up on -- with the see sort of the brand new vertical mergers that come in closer to reality, have you seen any sort of shifts in the market at all? Is there anything that you'd call out there?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Yes. Great question. We haven't seen any incremental RFP activity that was specifically due to the impending vertical mergers. That's not to say that, once the deals close, that we would see increased volumes in RFPs, but at least at this point we don't see it connected specifically to those integrations.

Terri Anne Powers -- Vice President Investor Relations

Thanks Johnson.

Leerink Partners -- -- Analyst

Thanks very much.

Terri Anne Powers -- Vice President Investor Relations

David, next question please.

Operator

Your next question comes from the line of Brooks O'Neil from Lake Street Capital. Your line is open.

Brooks O'Neil -- Lake Street Capital -- Analyst

Good Afternoon. Atul, I was hoping you might be able to sort of help us understand what you mean when you say we're redoing our business at -- current market rates. I mean is that no increase, is that a decrease, is that a little bit up and help us to understand?

Atul Kavthekar -- Chief Financial Officer, Treasurer

Brooks, thanks for the question. So simply what I mean by that is as we renew contracts in exchange and the quid pro quo for perhaps extending some of the contracts that we have in place, perhaps adding services to them and extending them in general, we may take market rates being a bit of a customer acquisition. So we may take a reduced rate, a reduced margin on the overall business for the benefit of either an enhanced revenue or an enhanced overall dollar profitability standpoint. That's all I meant by that.

Brooks O'Neil -- Lake Street Capital -- Analyst

Okay that's helpful. And then I wanted to follow up with the last question. So we're seeing really what I think of it as one of the biggest changes in your market place that we've ever seen. So the big three PBMs will be integrated with three of the biggest international health plans.

Are you telling us that you have not seen any response in the marketplace yet in terms of the 500 other health plans that are not named United, Aetna or Cigna and/or the middle market players that you're targeting?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Brooks, this is Brian. Thanks for the question. And great to hear your voice. In terms of -- I'd answer it in a couple of different ways. Relative to opportunities that might be created by the vertical integrations, really my point in response to the last question was we've seen an overall increase in PBM activity -- our RFP activity, but we can't tie it directly to the vertical integration. So in other words we don't have brokers and consultants saying hey listen we're issuing this set of RFPs based on the vertical integrations.

We do -- candidly, I expect to see more volume, once the mergers are closed. And I would expect that the increase in volume associated with that, ultimately we'd see into the 2020 selling season. Now, the vertical integrations have an impact on -- at some level on one of our other key strategies, which is our focus in developing relationships with health plans. So to the degree that with respect to Specialty and Infusion, and there we're seeing significant level of activity with mid to large tier health plans. They're looking for us to enhance their management of the Specialty benefit. They are also asking us to look at the medical side of the Specialty benefit, where we have an existing relationship and that represents an expansion opportunity for us. So, I'd say specifically in terms of new opportunities that could be created as a result of those vertical integrations, that whole new strategy that we're focused on -- focusing on the mid to large health plan client base and basically working with them to carve out a Specialty, there we can -- we can leverage, as I referenced in my initial comments, the very strong limited distribution portfolio, particularly around oncology as well as our clinical programs and ultimately help them to drive down their overall cost. So, I think that that's really the more immediate bigger opportunity connected to potential impacts of the vertical integrations.

Brooks O'Neil -- Lake Street Capital -- Analyst

Perfect. Thank you very much.

Terri Anne Powers -- Vice President Investor Relations

Thanks, Brooks. David, next question please.

Operator

Your next question comes from the line of John Kreger from William Blair. Your line is open.

John Kreger -- William Blair -- Analyst

Hi, thanks very much. Atul, I think you're -- the gross margin in the Specialty pharmacy business has gone down in the last two or three quarters. Can you just talk a little bit more about that? I assume that's being driven by the reimbursement compression that you mentioned. How broad based is that and should we assume that that sort of downward trajectory continues or do you think there's an opportunity to stabilize or even improve that metric in the coming quarters?

Atul Kavthekar -- Chief Financial Officer, Treasurer

Yes. Hey, John. Thanks for the question. So, yes, I think you got it right. I think there's a combination of things that drive the margin for Specialty pharmacy. You've got obviously the price inflation, you've got the reimbursement pushing down on it, but you also have and we've talked a little bit about this over the year, improved cost of goods. We've been spending some energy and we've got a team build out that's really been doing a great job of helping sort of leverage the buying power and the volume of the business. And so all of those springs are sort of working in concert. And so, you know I think of it more of a bit of a fluctuation and sort of consistent with the patterns that we've seen on a -- on a sequential basiscompared to last year. So, going forward I think that you again will continue to see those same three forces at work. I think one of the new elements that is going to be driving margins as well is going to be the introduction of generic drugs. We have been talking about it, but I think that there's a couple in the market that are -- that are imminent. And you know as they come into the mix of drugs that we dispense. I think you will see an upward element going forward and so, we think the net of all of that on at least on a medium term basis is relatively to -- to relatively stabilize that gross margin on the Specialty side. Thanks for the question.

John Kreger -- William Blair -- Analyst

Okay, thanks. And then on CastiaRx business, Joe or Brian, historically, what sort of churn have you had in that business? And then for this year, do you have a sense about what your client retention rates will be?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

So, obviously Atul referred to the Medicare component of it. I don't have at this sense a year-over-year comparison against client retention rates. Candidly, I'm not sure exactly what kind of data we've got from the legacy businesses to be able to do that. Joel, do you have any additional commentary?

Joel Saban -- President

The other thing I would add is that, some of our clients are not necessarily leaving us, but some of their base tend to fluctuate such as TPAs or Medicare Part D sponsors, as they win regions or lose regions. So, we feel very confident that we -- that our retention rate is typical if not a little bit better than -- than most PBMs. But you know this client base does have some fluctuation based on membership within the client themselves.

John Kreger -- William Blair -- Analyst

Okay.

Brian Griffin -- Chairman of the Board, Chief Executive Officer

I'll just -- I'll just going to add on that. We'll get better at this in terms of you know now that we have -- we've integrated the legacy PBMs into CastiaRx platform. We'll be in a position moving forward to give you know a much better visibility into overall client retention rates. As I mentioned in response to Lisa's earlier question, from my vantage point, with respect to the CastiaRx launch in April, this is really early days relative to our pure PBM performance. It is a rebuilding year for us. However, we have been very successful in the integration as you've seen in the Q2 earnings call, we pointed to the acceleration of synergies there. So I feel really good about how the PBM is positioned for growth into the future and I think the early indication on the new name wins, again in both commercial and med D that we can compete and win. So, I'm happy with our position, but it is -- it's clearly a rebuilding year for us.

John Kreger -- William Blair -- Analyst

Great. Thank you.

Terri Anne Powers -- Vice President Investor Relations

Thanks, John. Next question, please.

Operator

Your next question comes from the line of Eric Coldwell from Baird. Your line is open.

Eric Coldwell -- Baird -- Analyst

Thank you very much. Good evening. First question and I apologize just to do a quick clarification here. You talked about some higher revenue, lower margin Med D contracts starting to perhaps wane and it sounds like maybe some of your clients are losing some of their clients, not necessarily that you're losing the account outright, but you said 4% impact to revenue. I wasn't unclear, are you talking about 4% to the PBM or 4% to the enterprise in total?

Atul Kavthekar -- Chief Financial Officer, Treasurer

Yes, Hey, Eric. Thanks for the question and I'm glad you asked to clarify. Yes. So, that is 4% of the total enterprise. So, call it in the neighborhood of $200 million.

Eric Coldwell -- Baird -- Analyst

Okay. And if that is -- Atul, you said that was low margin revenue, correct?

Atul Kavthekar -- Chief Financial Officer, Treasurer

Relatively low margin, yes.

Eric Coldwell -- Baird -- Analyst

Okay. So I guess when I'm -- I think what I'm going to -- I'm probably struggling with this a bit as we're absorbing a lot of numbers busy day here, but I think one of the pushbacks you're obviously hearing from some folks on the call is whether this $14 a script in Castia is really a sustainable number, but it sounds like another couple of hundred million of low margin works going away. So by default what's remaining is clearly much higher than $14 a script. So I just -- I'd love it if you guys could maybe help us think about this market that you're in and -- I think your challenges that you're comparing -- your being compared against three very big PBMs. The report numbers that are a fraction of where you are in terms of profit per script. So, I think one of the things we need to all figure out is how sustainable is it and how dissimilar are your profits from perhaps a similar client mix within those three large PBMs? I know it's a long question, but I'll wrap it there.

Atul Kavthekar -- Chief Financial Officer, Treasurer

Yes. No, Eric, thanks for the question. Let me let me start and then I'll invite Brian and Joel to chime in as well. But I think you know the way that we have positioned CastiaRx has been a pure middle market and we've defined that as 500 to 5,000 members, a pure middle market PBM. And as such -- as it's generally consistent with that part of the market, they tend to be higher margin, higher profit clients. We do more services for them effectively. And so, yes you're seeing a little bit of a shift. But I would also -- I would also point out that of the business that we've signed to date at the PBM level, half of that is actually Medicare Part D. But I think -- I'd make two points about it -- I'd make, number one, I think we are still competitive with our price of goods in the Medicare Part D market. And also that going forward, it's going to be a blend of both of those businesses. So you're not going to see a complete shift from one to the other, from Medicare to pure commercial. So, I think you'll see more of a balance. But I think as I mentioned in an earlier call, I think we are also realistically expecting that the overall margins for the PBM are going to be potentially gravitating toward a lower number. I think we're enjoying that -- about the margins that we see today. But I think -- you know going forward as we grow, as we acquire new customers and invest in that acquisition through -- potentially through margin and as we grow and as we inevitably go for larger and larger clients where the margins may not be as robust, I think you will see some sort of a mitigation in the overall margins for the PBM business. I hope that's helpful, but if you have a follow up that's fine.

Eric Coldwell -- Baird -- Analyst

Yes. It very much. So, thank you very much.

Terri Anne Powers -- Vice President Investor Relations

Thanks, Eric. Next question please.

Operator

Your next question comes from the line of Erin Wright from Credit Suisse. Your line is open.

Erin Wright -- Credit Suisse -- Analyst

Great. Thanks. I have a broader and more philosophical question here. How are you sort of envisioning, Brian, Diplomat in three years to five years? Will it be a broader healthcare services company with other ties to Specialty-related services, a bigger PBM unit with a Specialty focus or are there other arms that you are interested in building out, tying into your Infusion business or manufacturer services or even data analytics as well? Thanks.

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Erin, thanks very much for the question. Yes, I think you've covered some of the key areas that we're focused on as a team in the context of our long-term growth plan. So kind of going through the business segments, I'd say relative to the PBM business, I think continued focus is solid middle market player, certainly to the degree that there are changes in the competitive marketplace relative to financial models. Be assured that we're going to be well positioned to offer new product offerings. You can imagine us, for example, moving forward with financial models that emphasize our clinical performance as one example.

In terms of additional opportunities in new name businesses, I would say as you know we do have our Envoy Health Pharma Services division, which -- we candidly we don't talk about very much in these calls, because it's currently not material. But, I do envision a much broader set of services that we can offer to pharma and specifically we've made investments in data and analytics that I believe that will create new markets for us with pharma. So, I anticipate within that long-term time frame that we'll have a bigger pharma services business overall.

In terms of the Specialty and Infusion segments of the business, you could certainly imagine us creating new coordinated care models with our health plan partners. So, for example, in oncology where we've got such a strong franchise and such a broad portfolio of limited distribution products, you can envision us creating a coordinated care model with key health plan partners and hospital system partners and that's just one example of where -- how I think that we'll continue to evolve in those two segments of the business.

Erin Wright -- Credit Suisse -- Analyst

Okay, great. That's helpful. And then can you speak to the incremental investments needed for like the ScriptMed initiatives and other initiatives from an IT perspective at your Chandler and Flint facilities? Should we anticipate any sort of another meaningful step up in investments as we head into 2019? Thanks.

Atul Kavthekar -- Chief Financial Officer, Treasurer

Well, Erin -- Hey, this is Atul. And so, let me let me just make reference. I mean I think we are seeing most of that Chandler and ScriptMed and there are other -- others by the way. You're seeing the bulk of that running through the CapEx line. There is some in the OpEx as we've called out in the past, but I would characterize it as more sort of smaller single-digit type of million dollars of SG&A related to those contracts. Now going forward, I think the way we're thinking about it is that, and as Brian outlined, I think there's a lot of opportunity for the business. There's a lot of opportunity to invest in some really foundational, growth-oriented assets and that probably will involve building on top of some of the foundational things that we did this year. So, for example, around data analytics, I think that can be a very rich opportunity for investment and we haven't quite defined that and that's something that we will elaborate more on when we provide guidance. But I don't think that you should think of our ideas around investment as sort of -- kind of one and done. I think this is something that, I think every well-run business needs to be doing on a continuous basis as reinvesting in the product. And that's really what we're trying to get to.

Joel Saban -- President

Yes. I guess I would just add one piece. My response to your question was really focused on new markets new growth opportunities. I think it is important just to add to that, that as we think about just better data and analytics, there's an operational dimension to that as well -- for example the investment that we've made in ScriptMed -- we can -- as a result of the improved data and analytics that we get with that implementation, we'll be able to analyze our workflows to drive efficiencies. We're confident that we can improve our overall labor expenditures connected to the fulfillment process as another example. And then I guess lastly, incorporating more external data to drive improved patient engagement. So, as you know we're very focused on our patients and the level of engagement that we -- that we drive with them, we think that, that is a Diplomat advantage. And so, the the data and analytics focus also has an operational dimension that we think will add value to the enterprise as well.

Erin Wright -- Credit Suisse -- Analyst

Thank you.

Unidentified Participant -- -- Analyst

Thanks, Erin. David, next question please.

Operator

Your next question comes from the line of Charles Rhyee from Cowen. Your line is open. Your next question comes from the line of Ricky Goldwasser from Morgan Stanley. Your line is open.

Ricky Goldwasser -- Morgan Stanley -- Analyst

Yes, thank you. Hi, good evening. Given the scale of the lost contract that you talked about, it seems to be about a quarter of the PBM business. Can you just give us a little bit more color on the relationship and why did you lose the contract and do you think this is a one off or there's some kind of structural issue behind that?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Hey, good afternoon Ricky. It's Brian. So, let me tackle that one and then I'll ask Joel if he wants to add any additional color to it. But see these -- by the way it was multiple Med D contract. So, it wasn't just one. And -- these were contracts that were bid by the legacy companies prior to Diplomat's acquisition of those businesses. So, as you know in terms of the Med D bidding cycle, you're really -- you're bidding 15 months to 18 months in advance of the Medicare contract effective date. So, in these -- the two clients that were referring to earlier were bid out in advance of Diplomat's ownership, and importantly in advance of being able to leverage Diplomat's cost of goods and our pricing position. So, I do think that it's a one off. Obviously, we're disappointed that we lost that business. However, you know on a move forward basis, again we believe that based on our new cost of goods position that we've been able to negotiate with pharma as well as network contracting et cetera, I think as evidenced by the Castia performance in 2018 here, that we're -- very well positioned to win -- again both in commercial and Med D into the future. So, I would look at them as a one-off.

Joel Saban -- President

And, this is Joel. I would add one more thing, Ricky. One of the clients actually was a consolidated M&A activity, meaning that this client was bought out by a larger health plan and that movement is due to that consolidation.

Ricky Goldwasser -- Morgan Stanley -- Analyst

Okay. That's a helpful color. Thank you. And then just when we think about the payer relationship being really a key part of the strategy for the enterprise. Do you think that this is going to play out in kind of like 2019 or that potentially it will have some of these health plans just kind of like sitting on the sideline waiting to see how some of these new models are developing before making a decision.

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Yes. Ricky, I would say that we're in discussions with a number of health plans today and there is significant interest around this new carved out strategy that really Joel and the team started to deploy earlier this year, again focused on both hospitals and health plans. So, this -- very active discussions and we're seeing significant interest in the model. There's a lot that we can do for health plans. As I referenced earlier, our clinical programs -- I think you know we're recognized in the industry for our patient care model as a differentiated advantage for the company. And when we start to work with mid-to-large scale health plans, that is a really important differentiated advantage for us. They can also leverage our limited distribution portfolio that many of the health plans just don't have the access to that broader portfolio -- they're not able to access that level of expertise in oncology. So that clinical (inaudible) to what we provide to those health plans I think is resonating right now and you know in active discussions with them.

Operator

Your next question comes from the line of Charles Rhyee from Cowen. Your line is open.

Cowen and Company -- -- Analyst

Hi, it's Jean for Charles. I know it's early in the selling season for you guys and some of the larger PBMs, but can you tell us what percentage of your client renewals you have completed so far and any indications on what the retention rate looks like on those? And also how much of the RFPs that you've bid on so far, have you been able to convert into new ones?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

So as we referenced earlier, we really don't have full visibility into client retention level at this point, right. We're still -- again in mid process into the 01/01/2019 selling season. And certainly we're well ahead of the remainder of the 2019 selling season. So, it's pretty difficult for us to be able to point to a win rate against RFP activity at this point, because there's just so much still outstanding for both 01/01/19 and beyond that into the balance of the 2019 selling season.

Cowen and Company -- -- Analyst

Okay. Can you talk more about your digital health initiative? I think last quarter it was noted that you have guys have a partnership with Pear. Maybe give us an update on how that's progressing and what's some of the other partnerships you have in the pipeline and what the feedback has been from customers and prospective clients?

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Yes. So, we -- thank you for the question. I -- we've made a number of key investments in digital and as I referenced earlier, obviously with a key focus of driving patient engagement more broadly in terms of the Pear Therapeutics arrangement. We see us being able to play a supporting role to organizations like Pear with -- by providing associated support with applications that we can wrap around the overall services that they're providing. The other really exciting one that we referenced as well was the relationship with Fitbit, and this basically provides real time connectivity with the patient and Diplomat's clinical support team. So, in short without getting into the detail -- all of the details of that relationship, once a patient connects with us, they have their Fitbit account and they can leverage our digital platform. And that basically means that we can do medication refill reminders, other adherence messaging, general communications related to their therapy and also it would provide them the ability to ask for assistance from the Diplomat clinical support team. So, you know all of the processes across our mobile apps, our web portals and wearables are very consistent. They are standard across each one of those channels. So, we're looking at this as really the first step in terms of wearables. We expect that in the future that, that strategy around patient connectivity will extend beyond just the -- the initial relationship with Fitbit. We anticipate that really -- that strategy becoming a much larger patient engagement strategy with more partners. So, both in terms of pharma relationships as well as focus on the patient and driving adherence, there's a lot that we've accomplished in the quarter and we're expecting a solid impact as a result.

Cowen and Company -- -- Analyst

Okay, thank you.

Terri Anne Powers -- Vice President Investor Relations

Thanks, James. Next question?

Operator

There are no further questions at this time. I will turn the call back over to Brian Griffin for concluding remarks.

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Thank you very much everybody for joining today. We know, again it was a very busy earnings day for all of you and we appreciate your hanging in with us here at the end of this evening and we look forward to our next call with you in the beginning of the new year. And we'll be in a position to provide more detail around the 2018 results. Thank you very much and have a great evening.

Operator

This concludes today's conference call. You may now disconnect.

Duration: 59 minutes

Call participants:

Terri Anne Powers -- Vice President Investor Relations

Brian Griffin -- Chairman of the Board, Chief Executive Officer

Atul Kavthekar -- Chief Financial Officer, Treasurer

Lisa Gill -- JPMorgan -- Analyst

Steven Valiquette -- Barclays -- Analyst

Leerink Partners -- -- Analyst

Brooks O'Neil -- Lake Street Capital -- Analyst

John Kreger -- William Blair -- Analyst

Joel Saban -- President

Eric Coldwell -- Baird -- Analyst

Erin Wright -- Credit Suisse -- Analyst

Unidentified Participant -- -- Analyst

Ricky Goldwasser -- Morgan Stanley -- Analyst

Cowen and Company -- -- Analyst

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