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spk04: Greetings. Welcome to the Pet IQ Inc. Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I will now turn the conference over to your host, Katie Turner. You may begin.
spk02: Good afternoon. Thank you for joining us on PetIQ's third quarter 2021 earnings conference call and webcast. On today's call are Cord Christensen, Chairman and Chief Executive Officer, Susan Schultes, President, and John Newlin, Chief Financial Officer. Michael Smith, Executive Vice President of the Product Division, will also be available for Q&A. Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could differ materially from actual events or those described in these forward-looking statements. Please refer to the company's annual report on Form 10-K and other reports filed from time to time with the Securities and Exchange Commission and the company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note on today's call, management will refer certain non-GAAP financial measures, including adjusted gross profit, adjusted SG&A, adjusted net income, and adjusted EBITDA. While the company believes these non-GAAP financial measures will provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's release for a reconciliation of non-GAAP financial measures the most comparable measures prepared in accordance with GAAP. In addition, PetIQ's posted a supplemental presentation on its website for reference. And with that, I'd like to turn the call over to Cory Christensen.
spk10: Thank you, Katie, and good afternoon, everyone. We appreciate you joining us today to discuss our third quarter financial results. I will begin with an overview of our strategic business and financial highlights, then Susan will provide greater detail on our services segment, and John will review our financial results. Finally, Susan, John, Michael, and I will be available to answer your questions. Our team did a great job executing on our strategic initiatives in the third quarter to ensure we are serving pet parents and their pets where and when they need it to fulfill their pet health and wellness needs. Overall for the third quarter, we believe our financial and operational results demonstrate the strength of our diversified pet products and services offering. In the product segment, we had broad-based growth with share gains in every product category led by flea and tick and health and wellness products. This was the first quarter since COVID started in March of 2020 that we experienced a return to a more normal sales cadence in the product segment, and we expanded segment margin for the third consecutive quarter this year. The services segment returned to positive adjusted EBITDA and had a solid quarter with double-digit growth in pets per clinic and dollars per pet. despite not operating a significant percentage of our clinics due to ongoing labor headwinds. Focusing on the consolidated results, we are pleased to report record third quarter net sales of 210.5 million, an increase of approximately 30% year over year. Adjusted gross margin increased 20 basis points to 22.6%. And we reported adjusted EBITDA of 16.4 million for the quarter, which includes a $2 million R&D milestone accrual for a future over-the-counter pet medication launch. Taking a closer look at our product segment, we generated growth across every product category during the third quarter. Our sales of both distributed and manufactured products benefited from a stronger-than-normal seasonality in the quarter. Product segment net sales of 181.6 million increased 21% compared to the third quarter of last year. For comparative purposes, net sales were up 33%, if you exclude sales from a major animal health manufacturer in the third quarter last year that is no longer included in the third quarter 2021 sales base. Our manufacturer brands accelerated, delivering 16% growth in the flea and tick category and 24% growth in the health and wellness category. The growth in flea and tick in the quarter was led by Capstar oral flea and tick, which was up 68%. We experienced strong growth in the e-commerce channel, which increased 51%, led by an increase of 76% in our manufactured products for the third quarter as compared to the prior year. If you exclude sales from a major animal health manufacturer in the third quarter of last year, that is no longer in the third quarter 2021 sales, then our e-commerce growth would have increased 74% year over year versus the 51% growth we achieved in the third quarter of 2021. In terms of inflation, We have experienced cost inflation headwinds, particularly in labor, freight, raw materials, and packaging. As a result, we finalized a price increase beginning November 1st across our product segment to offset all of these inflationary pressures. From an R&D perspective, we're excited to finalize and ship the first orders of a super premium health and wellness line for a large club store operator. We plan this to ship now and provide benefits in the fourth quarter of this year and a greater benefit in full year 2022. In addition, as I mentioned, we accrued a $2 million R&D milestone payment for a future over-the-counter PrEP medication launch. We have been working with a third-party development company and they reached this exciting milestone that triggered this accrual in the quarter. This gives us great visibility on the item being completed and joining our portfolio in 2023. From a MIPS standpoint, Our business in the quarter consisted of 69% distributed and 31% manufactured sales. This compares favorably to our second quarter mix of 72% distributed and 28% manufactured sales. We believe that our Q3 product sales mix trend is more indicative of our go-forward sales model, which we expect to maintain in Q4 and in 2022. The shift in mix towards our own product portfolio has driven a significant increase in our profitability. product segment adjusted EBITDA margin expanded 100 basis points to 18.5% from the third quarter last year. And year to date, product segment adjusted EBITDA margin has increased 250 basis points to 18.4%. We continue to participate in several of the largest and fastest growing categories within the pet industry, such as flea and tick solutions, along with health and wellness. Our team's emphasis on winning in both brick and mortar retail and e-commerce continues to fuel our growth. Year-to-date, the PetIQ portfolio gained 84 basis points of share within the flea and tick category. This share gain was led by our brand, Pet Armor, which was up 20% compared for the same period last year. As for health and wellness, we also gained 35 basis points of share as the robust growth in the category continues. This segment increased 16%, while our portfolio increased 22% over the first nine months of the year. We believe these share gains will accelerate in the fourth quarter as we start to ship new programs across the market, leveraging our assets in the space. Shifting to our services segment, our services segment delivered net revenues of $29 million compared to $12 million in the third quarter of 2020, or an increase of $17 million. Services also returned to a positive adjusted EBITDA of 3.8 million for the quarter versus an adjusted EBITDA net loss of 0.2 million. All of these improvements were significant, but they were still less than they would have been if it were not for labor-related headwinds that caused us to run fewer clinics. For example, in the third quarter of 2019, we ran nearly 18,473 community clinics versus approximately 13,529 community clinics in the third quarter of this year. While we expect the current labor situation to continue near term, we believe our services segment will make sequential improvements in all key areas impacted by COVID in 2020. This includes improving sales and operating performance in Q4, similar to the improvements we've generated the last four quarters. And the services team has ramped up retention and recruiting efforts, which Susan will provide more detail on. At the same time, we've taken the opportunity to optimize our new wellness center opening plans and reduce the risk of deploying capital and starting operating expenses prior to having a labor in place to operate the clinic. As a result, beginning in the fourth quarter, our team has started to begin construction on new wellness centers once all required in-center labor has been hired. Previously, we would begin build-out and construction, then began our recruiting and staffing. While we have full commitments to open with our retail partners across both conversions and greenfield locations, we believe this enhanced Wellness Center opening plan will also help ensure the best services experience for pet parents, their pets, our retail partners, and our shareholders. Based on using this opening plan for the remainder of the year, we expect to open approximately 100 new Wellness Centers in 2021 compared to our previously stated plan to open 130 to 170. We have confidence in our model and how valuable it is to pet parents across the country. For example, dollars per pet and pets per clinic continue to be the strongest KPIs in the company's history. From a balance sheet and cash perspective, we continue to have ample liquidity and financial flexibility with our cash on hand, cash generation, and existing availability under the new credit facility we entered into mid-April to support our future growth. As we noted in today's earnings release, our outlook remains suspended due to the uncertainty from COVID-19 and Delta variants related impacts to our business. However, we are very pleased with our ability to report record year-over-year net sales and adjusted EBITDA results, and we continue to be optimistic that the services segment will generate significant improvements to its operations in the fourth quarter of 2021. We expect that as the impact to our services segment lessens and becomes more predictable, we will then be in a better position to provide guidance. Also keep in mind, similar to years prior, Q4 represents our smallest net sales in adjusted EBITDA quarter based on the seasonality of the business. We also officially lapped the addition of Capstar in August of this year, which we continue to expect full year 2021 incremental EBITDA contribution of greater than $20 million. We believe that our mission of delivering smarter options for pet parents to help enrich their pet's lives through convenient and affordable access to veterinary products and services is more important than ever, and we expect our differentiated position in the animal health industry will continue to fuel our long-term growth. With that overview, I would like to now turn the call over to Susan.
spk03: Thank you, Cord. Our third quarter results demonstrate another quarter of solid improvement across our services organization. We are very pleased that our pets per clinic, dollars per pet, and dollars per clinic are outperforming pre-COVID and prior year comparisons. demonstrating the strong foundation we have for future growth and the differentiation of our services offering for pet parents and their pets. As you may recall, during the third quarter last year, our team executed on our stated reopening plan with approximately 95% of our business in operation at the end of the 2020 quarter. Focusing on our financial results in more detail, we generated segment net revenues of $29 million compared to $12 million, an increase of 17. Importantly, this result is also an 18.4% increase when compared to the third quarter of 2019 in pre-COVID operating environment. We delivered segment adjusted EBITDA of 3.8 million compared to an adjusted EBITDA loss of 0.2 million. Both the net revenue and adjusted EBITDA increases were generated from the reopening of our wellness centers and mobile clinics as compared to the prior year period and were significant, but they were still less than it would have been if it were not for the labor-related headwinds that caused us to run fewer clinics. In order to help offset this headwind, we initiated the following actions. First, we optimized our clinic schedules in order to reduce labor hours. Second, we temporarily closed clinics where staffing is a consistent issue. Third, We enhanced our retention and recruiting programs, which I will address in greater detail later. And finally, we took a price increase of approximately 6% in our services business beginning September the 1st to help offset the wage-related cost pressure. Our expectation is that we will see a benefit from these initiatives beginning in 2022. We opened 12 new wellness centers in Q3 for a total of 72 new wellness centers opened year to date. Seven of the 12 locations were greenfield centers. One of the highlights of 2021 has been the strong success that we've seen in these greenfield wellness centers as a result of our marketing and specifically our geo-targeting efforts. As I mentioned on our Q2 call, we're excited to open new greenfield centers with one of our retail partners in Texas during the fourth quarter of this year, as Texas is one of the strongest veterinary service markets. Our conversion locations also continue to perform well with all locations coming back in line or exceeding pre-COVID pet count levels. We continue to see new openings in our conversion locations run behind our plans for the year due to retail partners starting construction of the clinics later than expected due to supply chain issues as a result of COVID-19. We expect approximately 22 of these conversion locations to shift into the first half of 2022 due to these build-out delays. For 2021, we continue to expect our build-out schedule to represent 60% greenfield wellness centers and 40% conversion. Importantly, the timing of the build for our greenfield locations is within our control. As Cord discussed, based on our strategy now to begin construction on new wellness centers once all required in-center labor is hired, given the dynamic labor market We are targeting to open approximately 100 wellness centers in 2021 as compared to our prior range of 130 to 170. We will continue to use this approach to new store build out in 2022 to maximize results and reduce risk until these labor headwinds subside. In Q3, our team also continued to connect with pet parents virtually. Call volumes are up over 50% in Q3 compared to Q3 of 2020. and call volumes were in line with Q2 of this year, when we would traditionally expect to see them decline due to seasonality. In addition, our telehealth calls grew again in Q3, up 32% versus prior quarter, with pet parents seeking advice about their pet's health and wellness. Consistent with prior quarters, over 50% of telehealth calls we receive are not current Pet IQ clients, and we are seeing good conversion from our nurture campaign to encourage these pet parents to become clients. You'll recall that we're focused on a couple of initiatives this year, including number one, attracting new pet parents. Again, over 50% of pet parents in the quarter were new to Pet IQ. Our most recent quantitative barriers and drivers research revealed that 55% of our pet parents come to us because we are cost effective. And interestingly, The primary barrier to veterinary care amongst 49% of prospective pet owners is the financial cost. So we are well positioned with prospective clients. The second initiative is leveraging our smart care wellness plans. This is our low monthly subscription plan that helps pet parents more affordably care for their pet's health. We continue to be pleased with the number of pet parents enrolling in this plan. And even as we head into the off season, Over 5% of our pet parents are becoming new prescribers to the plan. Finally, a third initiative worth emphasizing is our ability to be agile and adaptable, a skill set we've honed for the last 19 months. The dynamic labor market in the services industry, and more specifically the veterinary service industry, has the organization's full attention. Every day we are focused on reducing our financial exposure while addressing any and all recruiting retention challenges. We believe our differentiated services business model helps to address key reasons why veterinarians may choose to leave the industry. Research often sites veterinarians are stressed out and burned out from their work. At PetIQ, we offer a low stress work environment focused on wellness, across a national footprint with flexible working hours. For both veterinarians and staff, we offer a compelling benefits package, educational opportunities, competitive wages, and a friendly environment that allows for a work-life balance. We believe this is a winning combination long term. In closing, I want to highlight that from a veterinary industry perspective, in Q3, pet count was flat, and revenue was up approximately 8% versus prior year. On a consolidated basis, PetIQ's pets per clinic, dollars per pet, and dollars per clinic were all up double digit compared to Q3 of 2019. These metrics tell us that when we're operating, the fundamentals of our services business are very strong. And with cost and affordability continuing to be the primary barrier to veterinary care, now and in the future, It is our unique position in the marketplace that will meet the growing demand. With that, I'd like to pass the call over to John.
spk08: Thank you, Susan. We are pleased with our third quarter results. The solid growth from both our products and services segment helped us generate record net sales of 210.5 million, an increase of 29.9%. Third quarter gross profit of 42.1 million represents an increase of 30.4%, resulting in gross margin of 20%, an increase of 10 basis points from the third quarter last year. Adjusted gross profit was $45.9 million, and adjusted gross margin was 22.6% for the third quarter of 2021, representing an improvement of 20 basis points year over year. General and administrative expenses for the third quarter of 2021 were $45.3 million compared to $35.6 million in the prior year quarter, an increase of $9.7 million. The increase was driven by higher amortization of our asset acquisitions that occurred in 2020, the largest being Capstar, an increase in selling and marketing costs for both products and services segments due to growth in sales, and two one-time items including accruals for an R&D milestone payment of $2 million and legal fees of $2.3 million. Adjusted general and administrative expenses were $38.7 million compared to $30.2 million in the prior year period, an increase of $8.5 million. As a percent of net sales, adjusted G&A was 18.4%, a decrease of 20 basis points compared to the prior year period. Our higher mix of sales from manufactured products and their strong gross profit margin, combined with the return of positive contribution from our services segment, fueled our adjusted EBITDA of $16.4 million, an increase of 36.3% compared to Q3 last year. For the third quarter, our consolidated adjusted EBITDA came in significantly better than our plan, considering the one-time R&D expense of $2 million that I mentioned earlier. Adjusted EBITDA margin increased 40 basis points to 7.8% compared to 7.4% in the prior year period. Product adjusted EBITDA increased 28% to $33.7 million, representing an adjusted EBITDA margin increase of 100 basis points to 18.5% compared to the prior year period. Product segment net sales in adjusted EBITDA benefited from an increased sales mix of manufactured products and overall better year-over-year growth as compared to the prior year, partially offset by higher prescription drug product sales. Services segment adjusted EBITDA improved to $3.8 million compared to an adjusted EBITDA loss of $0.2 million in the third quarter of 2020. Turning to our balance sheet and liquidity, As of September 30th, 2021, the company had cash and cash equivalents of 63.2 million. Our long-term debt balance, which is largely comprised of its term loan and convertible debt facilities, was 438.4 million as of September 30th, 2021. The company has 125 million of availability on its revolving credit facility, representing total liquidity of 188.2 million as of September 30, 2021. Working capital increased to $197.7 million as of September 30, 2021, primarily as a result of earnings providing cash from operations and normal working capital decreases in accounts receivable and inventory. We continue to believe our available liquidity, consistent contribution from the product segment, and improvement in the services segment positions the company to drive free cash flow and build cash in the quarters ahead, as well as opportunistically pay down our debt. With that overview, Cord, Susan, Michael, and I are available for your questions. Operator?
spk04: And at this time, we will be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your hand tip before pressing the star keys. One moment please while we poll for questions. And our first question is from David Westenberg with Guggenheim Securities. Please proceed with your question.
spk01: Thanks for taking the question, and thank you for all the color on the services side. Hopefully, I can get this out clearly here. Do you have kind of an equilibrium wage that you're looking at? And what I mean by that is that, you know, in one hand, you can increase wages and get those stores open and increase the growth. On the other, I mean, maybe you take such a hit that it's not valuable for you to kind of increase those wages. So can you kind of walk us through how you're thinking about just how much money you can throw at these services and kind of how much growth that you want or kind of what your willingness is? I get that that's a really ambiguous question here, but I'm just kind of trying to think about the dynamic between operating margins and growth as we go forward?
spk10: Yeah, David, thank you for the question. I'll take a piece of it. I'll let Susan fill in. And I think we understand the question well. The first thing you have to realize is sometimes no matter what the wage is, the availability of veterinarians is still a bigger issue even more than just the wage rates and moving people around. So I think in general, we found the industry has stabilized at a wage rate that is balanced not just to be trading back and forth across the streets. And the price increases that we've taken have allowed us to balance our operating model in a way that we believe we can still generate the same operating margins when we're running at full capacity. So any dilution today to our overall margins that we had pre-COVID is driven by running less clinics and not having the leverage flow through that we would if we could run all of the clinics. And so we feel like we've got the right balance with that and obviously today we talked about the fact that our old model was to build a store and we could always use our temp labor and very quickly get a permanent w-2 veterinarian to work and we're finding that that process is taking longer some zip codes are going to be even longer than that and so we're going to take a more conservative approach to our build schedule and put more zip codes out there being recruited have opportunities to catch more veterinarians for our pool and but we'll put them in a training program for 60 days while we build the store to make sure day one when we open, we have a operating business that we've invested capital against a unit that's gonna open and start generating returns for the company and just have a better risk approach to it. Susan, anything that I missed you'd like to add?
spk03: Yeah, no, thank you for the question, David. A couple of items that I would add to that. First of all, just in the wellness centers, so those of course are our W-2 veterinarians. We are competitive with salary, but a lot of that also has to do with the benefits package that we offer that a traditional veterinary clinic does not offer. For example, a 401 plan, really great health benefits. But also I think even more importantly in this environment, and I think you're probably hearing the same things that we are, especially this last quarter, having that work-life balance is really meaningful. When you talk with the veterinarians that are coming into our WW2 or when they're becoming employees, they're coming to us for that work-life balance so that they can basically close the door at 6 o'clock and go home every night. So I think that our offering is incredibly competitive for our WW2 veterinarians, and it isn't just about salary. The second piece that I would add to that is in our community clinic model. So if you remember our community clinic model, veterinarians come in and they basically bid on routes. And so that actually helps us to be more competitive or actually to bring our costs down as they come in and bid on those routes. So it's a little bit of a different model than a traditional veterinary clinic model because of that bidding process. So I think that that what we need to continue to focus on, and we are focusing on, is getting veterinarians into that pool, into that bidding pool. Right now, we are pulling, on average, the last three months, we've been pulling in 50 new veterinarians into that recruiting pool every single month. So I think the more that we bring into that pool, the more that we're going to be able to move that labor and to be able to cover clinics more appropriately.
spk01: Got it. All very helpful. I don't know if you're prepared to answer this today or maybe this is for a future period, but you've had these number goals of number of clinic openings in the future. How should we think about the way we adjust these either for this year or future periods and you know, is there a future period in which you think those numbers maybe still exist?
spk10: Yeah, I think, David, I think what we're doing now is it's been long enough through the pandemic that we have to start operating the businesses as if this is a new norm and then progress with the new norm as it becomes better. And it'll be our job to do a good job at communicating to you the progress we're making on recruiting and construction starts to help build the model. We've We know that there's demand from a pet perspective and we know there's more of demand than even a retail partner perspective to get to a thousand clinics. But we are going to make sure that we are deploying capital and building stores at a rate that is responsible. We believe if we get enough zip codes recruiting, we could potentially get back to be on the same schedule. But right now it's going to be a small step change as we get that figured out. And we'll need to give you more clarity as we get this model up and running and we are running it now. We're using it in fourth quarter. We're having good progress. As Susan said, we've had three months in a row of some of the best recruiting we've done. I think it's part of us. We're learning how to recruit in this environment, which is something we had to relearn because it's just different. So long term, we absolutely see a thousand stores. The rate that we can get there, we need to be communicating with you as we go through this because it's a different norm right now in the pandemic and the number of stores that we can build is going to be driven based on the employee base, not more so than the real estate location. Got it.
spk01: Thank you very much for your answers.
spk04: Thanks, David. Our next question comes from the line of Bill Chappell with Truist. Please proceed with your question.
spk11: Thanks. Good afternoon. I guess sticking on the services, you know, I guess trying to understand what's changed in the past, I guess, three months. It seems like the labor market And your labor have had issues for some time. I know labor has been tight for at least six months. You had absenteeism before that. And so I'm just trying to, you know, but three months ago, you were fairly confident that you could do 130 to 150 or 170. And then, you know, now there's change. So just what gives you confidence that you could even do, you know, these 100 this year and that you can continue at that pace going forward and, you know, What should we be looking for in terms of labor not tightening? And I just want to make sure you're talking mainly about vets, not the techs in the thing, which I imagine is also hard to fill in this market.
spk10: Yeah, I think, Bill, this should not be perceived as something negative. I think what we've done is we've constantly communicated that we were being patient to see how fast the pandemic would subside and that the market would return to normal. And as it's extended and we've seen the labor issues continue quarter after quarter. We've hit a point as a company and we targeted to make that decision around September on potentially doing something different because of that. And this is purely responsible about cash preservation because we're at a point now we are generating great cash from our products business and we want to make sure we deploy that cash. It is immediately going to be a position to provide a return. And we're talking about a very short period of time that we have a, a, a, person hired before they're active in a fixed location and we can use that labor in our temp you know community clinics so we get there so it's still a more efficient a model for this environment um we don't know if we can build 200 stores yet a year but what we do know is we don't want to build 100 stores that we can't put people in and and use cash irresponsibly as we come out of the pandemic so we are set up to have a fantastic year this year versus last year we're set up to have an even better year and have the growth we've been talking about next year, this is just going to be something that we're going to have to do as we work out of this on this segment of our business. But it's going to be something that doesn't change over the long term, our ability still to deliver our goals of growing the business as we've talked about. We just got to be smart about how we deploy cash in this time.
spk11: Okay. And then just as I look at next year on the product side, I mean, do you consider this past year a – exceptionally good flea and tick season, or is it normal flea and tick season? How do you look at that from a top line comp? And on the services, I understand that the wellness centers don't really kick in for six quarters in terms of the P&L, but I would expect that the pause and kind of the growth would make it much more profitable, much faster in terms of your P&L. So as I'm looking, any kind of thoughts you can give us on 22, just from both those perspectives?
spk10: I think I'll let Michael answer that. He can talk more to the flea and tick piece. Go ahead, Michael.
spk00: Yeah, it's been an interesting year. If you look at the first three, four months of the season, we would have classified it as a concern, a soft season, but no season in flea and tick really occurs the same year over year due to anomalies in the weather and other elements that drive the infestation rate. We've been pleasantly surprised with a very strong late season. Generally, the season will start to taper back end of July into August, and we actually saw August and then well into September, even some significant positive trends in the category and some of the mixed shifts in the category related to forms was also favorable for us as Oral really grew share in the back half of the season. We disproportionately have a high share in that form. was a double positive for us. The category got healthier, and then the forms that we tend to be stronger in within the category were even stronger in performance. So good year, slow starts, a lot of recovery made in the last 10, 12 weeks of the season in late July through summer. In terms of looking into next year, Go ahead. Was there a follow-up on that?
spk11: No, no, no. Go ahead.
spk00: Yeah, so just a little bit of color of next year. You know, I wish I had a crystal ball to predict what the category is going to do next year. You know, it is definitely a caveat with seasonality and weather trends that will vary not only year to year, but region to region across the country, and clearly Weather has a much stronger impact in states like Florida and Georgia where you have a high pest rate. Great weather ingredients in the state of Utah doesn't necessarily have the same impact on the category, so it's very difficult to call in advance. But if you look at the things that we can control, our business plans with customers and the initiatives that we're working on to prepare our portfolio, to win within the category. We do feel very good about how we're positioned in 2022 as we're just now wrapping up our business plans with key customers for next year. And hopefully, again, a nice tailwind in terms of category health would help, but we feel confident with the plans we've built with our customers that we'll be positioned well for next year.
spk10: I think I'd only add also, Bill, if you look at the brands, our best brand, the Pet Armor brand is up significantly year over year for us, outpacing the category. And the Capstar acquisition that we acquired this past quarter was up 68% versus last year, which was a year that we actually were running the brand. So it just goes to show you our execution with items that are extremely problem for the company. And we expect to continue to let those plans be executed and let us outpace and outperform against the market. So We expect our great year, as Michael said, is a slow start and a strong finish. That happens sometimes. In the perfect situation, you get an early start and a late finish, but we didn't have the early start. But it's let us have a great quarter this quarter, and we're very happy with how the product business is delivering and our visibility into next year.
spk11: Okay. Thanks so much.
spk04: Thanks, Bill. Our next question comes from the line of John Anderson with William Blair. Please proceed with your question.
spk10: Good afternoon, everybody. Hi, John.
spk07: Hi. On the start on the product side of business, the manufactured items were up, I think you said 76% year on year. Very strong. Could you talk about that? Was that more on the the OTC side of your business? Was it more on the health and wellness side? You know, it kind of characterized what's driving that growth and how sustainable you see it at this point in time. I know you have some new initiatives in club, you know, but there were probably some puts and takes as well in terms of fill versus sell through. So, again, what's driving the manufactured growth and how sustainable is that as you look ahead?
spk10: I think, John, I appreciate the question. Good to hear your voice. First and foremost, the 76% number that you referenced was what we were up with our manufactured brands online. We were up 51% in total online in the e-commerce category, but 76% was our business. Flea and tick, we were up 16%. Health and wellness, we were up 24%. All very positive numbers relative to the category and exceeding kind of category year over year growth. And I think it speaks to Our brand, I think it speaks to our marketing execution. I think it speaks to how we're retaining and connecting with our customers and retaining them to make the base stay in place. But I also remind you, we're very active right now developing new items. Our R&D pipeline has never been more active. Obviously, we talked about the success fee that we paid this quarter for an item we've had in development that we will launch sometime in 2023. We talked about another one last quarter that we're making payments again. That's a significant item. So I would say you should plan to see us continue to accelerate what we're doing in our manufactured goods, delivering higher margins. We just delivered the best mix we've had in the history of the company with 31% of our sales in manufactured up from 28 last quarter. And from our visibility in the fourth quarter and what we expect in the next year, we expect to have that be the new floor for the business and going from there. So the product business is, hitting on all cylinders and honestly doesn't get talked about enough based on what it's doing and how it's growing and the numbers it's delivering and the earnings growth year over year that we're delivering in total as a company that right now we're carrying definitely more water with the product business as the service organization recovers. But we feel great about the growth.
spk07: Yeah, and that's kind of why I asked because I tend to agree with you on that, the lack of credit for that. So Again, to kind of peel the onion, the manufactured side of the products business, 31%, it sounds like you see as a floor. It's probably likely to get better from here given, I think, some of the innovation that you have in programs on the health and wellness side of the business and some of the new item success as reflected in this milestone payment. Is that fair?
spk10: Very fair. That's exactly how we see the next couple of years. And as we continue to develop, it'll be extended beyond that. But you've definitely captured it right. It's definitely a part that we want to have people look at and understand the stability that was provided in the top line. But more importantly, the margin expansion, the EBITDA expansion that's being driven through the business. So, yeah, we're very excited about our R&D projects and what they will deliver. We're very excited about how the team is delivering just with our base core items. outpacing the market growth, outpacing the execution, the key categories that we're in. So again, very, very pleased.
spk07: And just so I understand, the $2 million R&D milestone payment, that wasn't reconciled out of the $16.4 million in EBITDA. So should we be thinking about kind of the underlying EBITDA on the quarter of closer to $18.5 million?
spk10: That's exactly what it was. And if you look at the slide deck we published We actually show that visibly on the slide. We had $18.5 million of adjusted EBITDA, and we made that payment for that product that will benefit us in 2023. So it was a fantastic quarter from an EBITDA perspective when you look at it through that lens that the sales were a significant improvement over where we thought we'd be, and then obviously the 18th floor was a couple million dollars better than what we thought we were going to deliver for the quarter and was still able to come in line with a great delivery even with that payment.
spk07: Okay. and then just i don't want to beat it to death but on the labor issues headwinds in in the services business because that is sounds like the primary issue um i know susan you mentioned some of the actions you're taking i mean how i mean how confident you know are you that you know that this can start to show material improvement, you know, beginning, I think you said, at the start of 2022, because it did really affect, with the numbers you provided, the number of clinics you could run, you know, in the quarter this year versus last year. So, I mean, are you seeing anything really kind of tangible through these actions that you outlined that suggests, you know, we could be back on a more of kind of a normal plane early in 2022? Yeah.
spk03: Yeah, John, thank you for the question. So a couple of things. First of all, I would just start out by saying that when we talk about the labor-related headwinds that we have, it is not just veterinarians. As you see in all services businesses across the United States, and especially in the veterinary services industry, it is staffing as well, too. So we really have had to take a two-pronged approach. We are confident in our approach with our clinic staffing. And we're already starting to see fruits of our labor in regards to being able to recruit staff members. So we basically focused on areas where we've got issues, where we have problems, and ramped up our efforts to get that staffing level back up. So that piece, I am confident that we will start to see a turn in fourth quarter in regards to just the clinic staff. In regard to veterinarians, we've already seen a vast improvement in Q3 when we basically rolled out all of the plans that we talked about rolling out or that I talked about. in the call, we rolled those out really at the beginning of Q3 when we started to see the headwinds. We started to see them like right around the middle of the second quarter, maybe getting to the end of the second quarter. We weren't seeing them at all in first quarter. So when we started to see those, we literally started to put all the plans together in order for us to be able to refocus our efforts on veterinarians. And we started in Q3, our recruiting efforts more than doubled what we saw in Q1. So I'm confident in the approach that we're taking. I do think that it's going to take some time. But I think that we'll start to see the corner. We'll start to see ourselves turn a corner here in Q4. Great.
spk07: Thanks so much. Good luck.
spk04: Thanks, John. Our next question comes from the line of Stephanie Wissing from Jefferies. Please proceed with your question.
spk09: Hi, this is Corey Grady on First Staff. So first, on your contract with your largest distribution customer, has it been officially renewed, meaning fully signed, sealed, delivered, on terms consistent with prior years? And how long is that contract for, if it has?
spk10: Yeah, the contract's through 2024. All things are finished with the contract. And we are still operating the same thing. There's no change in our pricing model, no dilution to the margin. So we just continue with the same terms.
spk09: Got it. And then I wanted to follow up on, so on the 2 million R&D milestone payment for the future health and wellness product, is there any additional color you can add on that program?
spk10: yeah we don't disclose new items obviously because we view those as competitive uh advantages we have and going to market with things that only we have other people won't have so we won't tell you what the items are but we have two significant items that we are um planning to be launched sometime in 2023 both are consistent with our margin structure we have in our manufactured goods so they're not diluted to the business and we believe the size of the prize for those items is a 25 to 60 million dollar item opportunity that we think will take us probably 18 to 24 months to get to those run rates. But it's definitely great items that will create great margin expansion for the product category.
spk09: That's really helpful. And then on the club program launching this quarter, can you remind us how much EBITDA you expect that program to generate this year?
spk10: This year is going to be just what we generate off of really filling up the stores. We've now shipped the first order, the first orders shipped. And so the fill order is out. Obviously our retail partners where this is item is only going to one partner. Don't like us to disclose what their orders are. So we won't give you the specific numbers for just the fill order that's going out or what the contribution is, but it has similar margin contribution to the company as our other manufactured items. We view it as being a significant opportunity with an item performance for full year 2022 in the $15-plus million sales range. But, again, it's an item that we see as being able to deliver somewhere between $6 and $11 million, even based on where sales come in.
spk09: Got it. Yeah, sorry. I meant to say for 2022. Okay. And then just last one, maybe you can quantify the scope of the distribution business just in terms of percent of sales and percent of profits. That might be helpful just as a reminder of the distribution business's contribution to the profit base of the company.
spk10: Yeah, so we're 31% of sales is manufactured. 69% is what we distribute from a EBITDA perspective, if you look at the business at $100 million of EBITDA, which is kind of how we measure where we are today, if it wasn't for some of the absenteeism, you would have roughly just under $20 million from the distribution business and a little over $70 million from the manufactured business of that EBITDA. And then at full capacity, we would run at about $15 million in our service organization and growing with our store expansion.
spk09: Got it, thank you very much.
spk04: Our next question comes from the line of Elliot Wilbo with Raymond James. Please proceed with your question.
spk05: Thanks, good afternoon. Couple questions on the services business. I guess with respect to the change in near-term strategy in terms of onboarding labor before you actually open the clinics, I think, Cord, you mentioned, you know, something like having labor established 60 days before advancing or opening the clinic, but just curious, you know, how that new approach may impact your prior assumptions in terms of the ramp to profitability.
spk10: Yeah, good question, Elliot. I mean, I think what you have to appreciate is When we're running a cancellation rate as high as we are, which includes the new stores, this model actually reduces the current performance against those models. The stores that are staffed are absolutely running on pace with our current projections and will deliver that. So if you add the extra 60 days where literally it's only labor, they get trained and working in our community clinic business, so they are contributing to revenue during that time period. It's an improvement from where we are because we take those cancellation rates on those stores that we're building and take them out of that pool. So it's an improvement on use of cash from a capital expense standpoint. But it's just in general, if you take a store and say now we added 60 days of labor, well, we can run through that and say maybe it's an incremental $20,000. But that $20,000, we believe we can get a lot of it returned back from customers through our community clinics because they'll be actively working at other stores. The net effect isn't 100% understood yet, but it is not a significant impact to the overall plans. And more importantly, it is a significant improvement from opening stores and having to, you know, not run 25% of them because you don't have the labor.
spk05: Okay. And I think recently you talked about implementing a price increase, roughly 6%. And that side of the model, given some of the inflationary impacts that you've seen in terms of the labor pool, just wondering what the actual experience has been against that 6% increase, whether or not that is sufficient to cover the inflationary pressures that you're seeing or whether that gets kind of the recent trends here in terms of labor force. may actually have inflation running slightly above that rate.
spk10: Susan, do you want to take that?
spk03: Yeah, no, it's a good question. Actually, when we raised our prices in September, which is very much off cycle for us, we traditionally raise prices in January at the very beginning of the year. But we implemented an off cycle in order to be able to cover the incremental labor expenses. that we're currently incurring today, we would fully expect to be taking another pricing action at the beginning of 2022. But in regards to demand, in regards to just the sheer number of pets that we're seeing, interestingly enough, last month we hit our million pet mark And so, if you think about first quarter of this year and what was happening still with COVID, we've really been blowing and going in these clinics with our pet count. So, we have not seen our pet count slow down at all, and it hasn't slowed down as with our pricing action either.
spk05: Okay. Then maybe just a couple of questions on the product side as well. I mean, Cordy referred to the strong growth rates in the e-commerce business, both for the combined business and for the manufactured products base. Can you give us a sense of what that bucket represents in terms of the overall product revenue base?
spk10: Total sales to that channel? Correct. I don't have that number in front of me. I don't want to misspeak to that. So I think it's something we need to follow up with you offline, Elliot, to get you that answer. I'd be close, but not, I don't want to get the wrong answer.
spk05: Okay, got it. And then with respect to the new health and wellness offering, may have missed your prepared commentary, but update there in terms of whether that was
spk10: launched this quarter or is is on expect to be launched in the near term yeah we're very excited we've already shipped the first fill order orders out the remainder of those orders will ship next week and so all fill orders will be out it'll start hitting in club very very soon obviously health and wellness becomes a hot topic for humans but with the humanization of pet it becomes a very hot topic so you'll see significant promotional activity around the launch of it after the new year with people emphasizing the health of themselves and the health of their pets. As I said earlier on the call, we estimate for full year 2022 it to be a revenue opportunity greater than $15 million, and based on how much greater, it should be an EBITDA contribution of somewhere between $6 and $11 million to the company.
spk05: Okay. And does this product compete in what you term the super premium portion of the market?
spk10: It does. It does. It would be in line with the highest portion or formulations that are available in the market. I mean, Michael, probably better to describe the item to you if you want to take it, Michael.
spk00: Yeah. In terms of the quality of the product, you won't find a better product on the market. I mean, this has been designed to be the best offering, not only that we've put in to market in the health and wellness category, but what you'd find in the category, period. If you look at the price point, Clearly Costco has a strategy that's heavily weighted towards member value. So this is a product, I would say the raw price point would be competitive with the high end of the market today, but give their member a product that is significantly superior to equally priced alternatives in the market found under other brands.
spk05: Okay. And then last question for you, Cord. I guess given the current dynamics in the services segment with slightly slower than previously anticipated build-out of wellness centers and maybe a little bit longer timeline to profitability, the company obviously still has a fair amount of financial flexibility on the balance sheet, but how do you think about potentially pursuing larger manufactured product opportunities, just given the strong growth that you continue to see that portfolio, you know, the very high return on invested capital, very quick payback periods versus what you're seeing in the services business.
spk10: Yeah, I mean, do I answer this question every time? We have the gas pushed down all the way on the product business. We're generating enough capital to more than invest in that side aggressively and and deliver the type of growth we have. If you remember, that's a division that was $260 million in sales, making less than $18 million of EBITDA, that now is over $800 million on a run rate basis, making close to $100 million on its own. We're going to continue to aggressively push there. We have the capital to do it. We have the people, the R&D machine running, and we're going to do everything that's available in that category, irrespective of what happens in the service organization. The service organization It's complimentary to that business. It helps it grow. Sometimes people can't visibly see the benefit that organization brings to the total. And so sometimes it gets also not some of the credit it deserves and how it helps to contribute to the other side of the business as well as you look at the overall retail partnerships we have, how that affects promotional and placement of our products, and then sell through. So we're going to push on both sides right now. And coming out of this pandemic, it's the right decision to let the labor be the guarding force on when we start construction. And if we do our jobs well enough, we should be able to build enough stores to stay on track with our schedule. But we need to be smart about it, as we've learned a lot. And as Susan said, we're getting better traction than we ever have on monthly recruiting. And so this doesn't mean that we're going to not hit the number. This means we have to be clear that this is the smarter choice for deploying of capital and taking risk. this current environment and is this this opportunity or this labor issue subsides we easily can go back and push the gas and make the construction the first domino not the labor but right now that's the right decision for use of cash we're very balanced in what our cash generation is versus what we're using this service organization so nothing's changed there and we feel great about our cash flow generation for this year and what we end up using on a net basis and what we generated in leftover or excess cash to pay down debt or have it ready to invest in things like additional product offerings. So the company's never been stronger, never been executing better.
spk05: All right, thank you.
spk04: And our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question.
spk06: All right, this is Andrew Chasnoff on for Brian. I just have two quick questions for you. The first one, I guess just on the demand side of the product business, you've kind of discussed how it's been recovering pretty well throughout the quarter. Have you noticed any lumpiness or have sales now began to smooth out over the last three months?
spk10: No, and I think just to be clear, the product business actually has done extremely well on a total trailing basis compared to the years over year. We had lumpiness with COVID with peaks and valleys in some of the consumption. What we saw in third quarter is the consumption normalized where inventory was being purchased at rate of consumption. So we were able to see actual kind of performance of the overall category. It obviously saw a very strong result where we saw, you know, 22% year over year growth, but 33% if you exclude a piece of business that's not in the base any longer. So we can't ask for any better execution or numbers. Some of that's driven off the flea and tick season, extending longer than normal and being better. but it's also just broad-based execution for the company doing better across all the channels and continuing to be very focused on the animal health category and what we do in it. So we feel great about how the business has reacted historically and how it reacted this quarter especially, but more importantly, we feel great about where it's going in the future.
spk06: Thank you. And the last question is, I don't hate the labor pressures, but you know, understanding that you've taken some proactive measures to mitigate those pressures, you know, namely raising prices that you think will kind of come into gear in the next year. Can you kind of quantify how much the labor shortages may have weighed on sales, particularly in the last quarter?
spk10: Yeah, I mean, we are, I don't know if that's easy to quantify specifically. I mean, we had roughly 25% of our clinics not operate last quarter that were expected to operate. Some of those were new, some of those were mature, so on a blended basis, it's probably not far from our average clinic performance. But again, it's something that the clinics that we're operating, the 75% that ran had the best KPIs on pets and dollars per pet and delivered well within our line of what we'd expect from a margin and a delivery for contribution to the company because the price increase has covered the inflation part of it. We're taking efforts to reduce that number. We think we've made the right decisions on how to do that as we've staffed up our recruiting teams and looked at our build schedule differently. But, again, it's a business that, you know, if it was running at full tilt in 2021, it should have delivered over $160 million for the full year. And we're not going to deliver that with these cancellations. All right.
spk06: I appreciate it. Thank you. Yep.
spk04: And we have reached the end of the question and answer session. I'll now turn the call over to management for closing remarks.
spk10: Thank you, everybody, for attending the call today. Obviously, we're very excited with the signs that we're seeing in the market, how our brands are performing, how the company is growing top line and bottom line, and how we're seeing more normalized sales to consumption. It was incredibly great to see a $17 million year-over-year improvement in our service organization's revenue with a positive adjusted EBITDA contribution versus a loss last year. All great signs that we're running the business properly. We're heading in the right direction as a company. We're super grateful for our team, our team members, our veterinarians, our staff members out there on the front lines and the works that they're doing to deliver these results. And we're excited to finish the year strongly and come back and have a call with you again after the new year and show you how we finished in a very positive way and position the company to continue to have the growth and the execution next year. So Thank you, everyone, for your time today, and we appreciate and look forward to talking to you all soon.
spk04: And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.
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