PetIQ, Inc.

Good afternoon. Thank you for joining us on PetIQ's third quarter 2023 earnings conference call and webcast. For today's prepared remarks, we will hear from Cord Christensen, Chairman and Chief Executive Officer, and Zvi Glassman, Chief Financial Officer. 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 to certain non-GAAP financial measures. 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 reconciliation of non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. In addition, PetIQ posted a supplemental presentation on its website for reference. And with that, I'd like to turn the call over to Cord Christensen.

Thank you, Katie, and good afternoon, everyone. We appreciate you joining us today to discuss our record third quarter financial results. I'll begin with an overview of key highlights, then review our financial results for the quarter and outlook. Finally, V, Michael, John, and I will be available to answer your questions. For the third quarter, our financial results exceeded our expectations yet again. Our products and services team have been diligent and strategic in their execution of our initiatives to fuel top line growth, invest in areas of our business where we are seeing favorable returns, and make decisions to improve our operations. I'd like to thank everyone for their hard work and dedication in helping us to achieve record net sales and adjusted EBITDA. And as a result of our better than expected Q3, In year-to-date results, we are pleased to be able to raise our full year 2023 outlook. A few key highlights from the third quarter include we reported net sales of $277 million, an increase of approximately 32%. The net sales result was above our third quarter outlook of $220 million to $240 million. We had strong broad-based growth across our business with a 200 basis points of gross margin expansion and improved leverage of our SG&A expenses, even with the significant increase in investments in advertising and promotional spend to support the growth of our manufactured product portfolio. This helped us achieve a record Q3 adjusted EBITDA of $29.3 million, an 80 percent increase from Q3 last year, and ahead of our guidance for Q3 of adjusted EBITDA of $18 to $20 million. Our higher earnings and improved working capital helped us achieve third quarter record cash from operations, and we reduced the company's net leverage to 2.8 times as of September 30th, 2023. Going into our product segment in more detail, the product segment contributed net sales of $239.7 million, an increase of 36% compared to the prior year period. The growth in Q3 of this year was broad-based across product categories, Net sales for products and brands outperformed our growth expectations for the third quarter of 2023 as compared to the prior year period with an increase of 41.7%, including the acquisition of Rockland Roxy, or an increase of 27% on an organic basis. Much of this growth is fueled by a continued exceptional season in the over-the-counter flea and tick category. When you look at all sales channels combined, We had one of the strongest seasons in the last 10 years for the over-the-counter flea and tick category. Pet parents are increasingly providing protection for their pets, and favorable weather also helped fuel the category this year. In the third quarter of 2023, the flea and tick category grew 7.1%, and Pet IQ's brand increased 15.2%. In Q3 of this year, nearly 50% of the over-the-counter flea and tick category sales were generated online. At retail, PetIQ's flea and fake brands outperformed across seven of the top eight retailers driven by Pet Armor and Capstar brands. PetIQ's portfolio of brands continue to capture a disproportionate amount of this online growth and dramatically outperformed the broader category as evidenced by our market share results. For the 12-week sentence, September 30th, 2023, PetIQ manufactured brands captured 17.7% of the category dollars, which is an increase of 124 basis points versus the prior year period. On a unit basis, we gained an even greater amount of the share, up 192 basis points for the quarter. The pet supplement category also maintained its growth trajectory in the quarter, gaining 16.5% over the prior year period. This fast-growing category has now more than doubled over the last four years and has surpassed the OTC flea and tick business as the largest category we compete in within our manufactured portfolio. Our pet supplement products continue to see accelerated consumption growth in the third quarter of 2023. Our product portfolio grew 22.1% compared to the prior year period. Strong household penetration trends along with expanded need states in the pet supplement category give us confidence that these double digit growth rates should continue for many years to come and Pet IQ is positioned very well to continue to gain share in this important category. In addition, Our pet dental and treat offerings outperformed in Q3. The Minty's and Pure Love brands both threw at two times the category, leading to meaningful share gains. The Minty's brand grew 36% and gained 54 basis points of share. The Pure Love treat brand posted strong category growth of 136%. The newest brand in our product portfolio, Rock on Roxy, grew 10.1% for the third quarter of 2023, ahead of our projections. Remember, We exited several non-core Rocco and Roxy offerings in the first half of 2023 that we determined were not a strategic fit for us. And yet our team has executed well, and we are very pleased to have grown the base business better than expected for Q3 and year to date. Our core Rocco and Roxy products are focused on the premium pet stain and odor category, and pet parents continue to look to Rocco and Roxy for their stain and odor needs in Q3. We believe the Rocco and Roxy brand can extend its growth in other premium pet categories like supplements and treats. We are very encouraged with the brand's initial success in these product categories and are excited about the potential for Rocco and Roxy to increase distribution of both its core and new premium pet offerings as we increase advertising and promotional investments to build brand awareness and consumption over the next several years. Across our pedigree brands, we continue to see a great return on our enhanced advertising and promotional efforts in the third quarter of 2023 as evidenced by our growth. We will get more detail around our incremental spend in Q3 and expectations for Q4 as we continue to lean into prioritizing investments and initiatives that we expect to support the long-term success of our brands. We look forward to driving outpaced growth from these efforts into 2024 and beyond. Now focusing on the services segment, our services segment reported third quarter 2023 net revenue of $37.4 million, an increase of approximately 12% as compared to the prior year period, with segment gross profit, dollars, and margins showing solid improvement from our operational initiatives. We are continuing to test and learn from the six wellness centers that we converted to focus on hygiene. Our initial taker needs positive. We are generating incremental pet traffic and enabling improved cost controls by matching veteran labor We are also excited to have collaborated with Walmart and existing partners on a new pilot wellness center that offers a variety of pet services, including veterinary care, grooming, and hygiene care. Both Pet IQ and Walmart are committed to offering affordable and accessible pet products and services. With the opening of this location in late September, we are pleased to offer pet parents more ways to save money on their evolving pet health and wellness needs. We will continue to test and learn together and are pleased with the initial response thus far from pet parents. We are optimistic about the opportunity and the additional locations. As we announced in today's earnings release, late in the third quarter, we initiated a services segment optimization to close 149 wellness centers in an effort to improve future profitability. We expect to generate a cost of 6.3 in net cost savings over the next 12 months, all of which we anticipate reinvesting into our future growth, focusing primarily on the growth of our mobile community clinics and sales and marketing initiatives for our manufacturer brands. Our team came to the strategic decision after the financial and operational assessment of wellness centers since reopening after the pandemic, as well as the assessment of the veterinarian labor market in each geographic market. We also evaluated our ability to potentially convert these locations to a more hygiene-focused offering and determined that we would not be able to convert these locations in the future based on available square footage. In Q3, we closed 45 centers and expect to close the remaining Q4 to end the year with 133 wellness centers. We believe this is the right decision for our total business and look forward to better align our future expenditures with the areas of our business where we experience the highest returns. In closing, We appreciate the hard work and dedication of our employees in our manufacturing and distribution facilities, as well as our corporate office, for their commitment to our mission and core values in helping us to achieve record results to date in 2023. We believe we have an incredible team that continues to execute at a high level to help us end the year strong and position us well for continued success in 2024 and well into the future. With that overview, I'd like to turn the call over to Zee.

Thank you, Cord. Our teams across all areas of our business has executed extremely well to fuel our growth in net sales, expand gross margins, and leverage both our fixed and variable expenses to achieve better than expected profit results for the third quarter. These results have driven our ability to raise our 23 outlook. At the same time, we've made important strategic decisions to help us to increase operating efficiencies, and focus our spending on the areas of our business where we are seeing favorable returns. We believe these efforts will position us well for continued success, increased profitability, and cash generation for 2024 and beyond. Now, shifting to our quarterly financials in more detail and our outlook for the year ending December 31st, 2023. We reported record Q3 next sales of $277 million, an increase of approximately 32% compared to Q3 last year, driven by an increase in sales from both the products and services segment, as well as the addition of Rocco and Roxy. As Cord mentioned, we had strong, broad-based growth across sales channels and product categories. Third quarter 2023 gross profit dollars increased 43%, to $72.6 million, while our gross margin expanded 200 basis points to 26.2% from Q3 of last year. We benefited from operating leverage on the higher net sales, increased manufacturing efficiencies, as well as a favorable shift in product mix as compared to the prior year period. Our services segment also had a solid gross profit improvement from higher sales and increased operating efficiencies as compared to the third quarter of 2022. SG&A expenses for the third quarter of 23 were $55 million compared to $46 million in the prior year period. SG&A as a percentage of net sales decreased 210 basis points to 19.9%. Q3 adjusted SG&A was $51.9 million compared to $42.5 million in Q3 last year. As a percentage of net sales, adjusted SG&A was 18.7 percent, a decrease of 150 basis points compared to the prior year period. The leverage in SG&A and adjusted SG&A was primarily due to continued leverage of costs and increased business expense efficiencies relative to growth in net sales. It's worth noting that we continue to leverage SG&A in the quarter while also growing our A&P investments to support the long-term health of our manufactured brand portfolio. We recorded restructuring and related expenses of $8.5 million for the third quarter of 2023 related to the services segment optimization. We expect additional restructuring and related expenses of $6.1 million in the fourth quarter of 2023, resulting in a total of $14.6 million for the full year of 2023. Importantly, $11.3 million of the total projected restructuring charges are non-cash in nature related to depreciation and amortization of $11 million and inventory reserves of $.3 million. Accordingly, Total cash restructuring costs recorded in the P&L are expected to be $3.3 million, and we expect to incur cash costs of $3 million to settle lease obligations, which will not result in an additional charge to our P&L as the liabilities are currently reflected in the company's balance sheet, bringing total projected cash expenditures related to the optimization to $6.3 million, most of which we expect to pay in the fourth quarter. We expect to recoup our approximate $6.3 million of cash costs related to the optimization in approximately 12 months, as the expected EBITDA losses from the centers we are closing are projected to be approximately $6 million for 2024. From a profits perspective, we've reported Q3 net income of $.5 million, or EPS of two cents, inclusive of the restructuring of related charges I mentioned. Adjusted net income for the third quarter of 23 was $12.6 million, an increase of $11.8 million from Q3 of last year, and adjusted EPS was 42 cents for the third quarter of 2023. Q3 EBITDA was $24.7 million, an increase of 93.2% compared to $12.8 million in the prior year period. We reported record third quarter adjusted EBITDA of $29.3 million, an increase of 80% compared to $16.3 million in Q3 last year, representing an adjusted EBITDA margin of 10.6%, an increase of 280 basis points compared to Q3 of 2022. Turning to our balance sheet and liquidity for the third quarter, and in September 30th, 2023, the company had total cash and cash equivalents of $124.6 million. The company generated $50.1 million of cash from operations for the third quarter of 2023. This was driven by increased cash earnings as well as $30.2 million from working capital benefits. And on a year-to-date basis, we generated the highest cash from operations in the company history of $64.5 million. We expect to generate annual free cash flow at or above the top end of our $30 to $40 million range for 2023. Despite the approximate $6.3 million of cash expenditures, we expect to incur related to our services segment optimization. The company's total debt. which is comprised of its term loan, ABL, convertible debt, and capital leases was $447.9 million as of September 30th, 2023. In addition to our cash on hand, the company's $125 million ABL is undrawn. Total liquidity, which we define as cash on hand plus debt availability, was $249.6 million as of September 30th, 2023. While we have no intention of making additional borrowings, we would note that our liquidity is ample and our credit facilities are flexible. Our net leverage is calculated under terms of our credit facilities at the end of the third quarter of 2023 was 2.8, down from 4.3 in the prior year period, driven by higher earnings and improved working capital. Keep in mind, our net leverage will tick up a bit in Q4 of 2023 due to some expected changes in working capital, primarily potential timing of increased inventory to position us well to start 2024. Now, turning to our guidance. For the year ending December 31st, 2023, we are raising our outlook inclusive of the services segment optimization that we announced today and that Cord discussed earlier in our remarks. Note, I will reference the midpoint of the guidance ranges when discussing percentages increases in net sales and adjusted EBITDA as compared to the prior year. This is consistent with what is presented in today's press release and earnings presentation. We now expect net sales of $1.6 billion to $1.8 billion, an increase of approximately 16% as compared to 2022. For adjusted EBITDA, we increased the range to $99 million to $103 million, representing an increase of approximately 30% as compared to 2022. We've had an excellent year so far with record results, and we expect to end the year positioned extremely well for a great 2024. Obviously, when you do the math on the implied net sales and adjusted EBITDA for Q4 of 23, it looks flat compared to Q4 of last year, and it reflects a few straightforward items. First, consistent with prior year periods, The fourth quarter of 2023 will be the lowest contribution net sales in the adjusted EBITDA quarter of the full year. Second, as you think about our higher outlook for 2023 relative to the outperformance we had in Q3, there was approximately $15 million of sales and $3 million of EBITDA that we expected to occur in Q4 of this year, but we actually recognized in Q3 based on the timing of orders. And finally, as we mentioned last quarter, Based on the success of our marketing initiatives, we are continuing to make strategic investments in A&P. We now expect to spend a total of $4 million in incremental A&P. This is an increase from the $2 million we stated on our Q2 call, of which $1 million was spent during the third quarter of 2023, with the remaining $3 million to be spent in the fourth quarter of 2023 to support the continued growth and development of our brands and positioned us well for the start of 2024. Our growth would be up approximately 10% for both net sales and adjusted EBITDA were it not for these items. In closing, we reported strong record results for the third quarter and first nine months of 2023. And our team remains optimistic about our opportunities for growth in 2024. At PetIQ, our team will continue to execute our strategic initiatives to deliver value for all stakeholders as we deliver on our mission of smarter, convenient, and affordable pet health and wellness for pet parents. That concludes my financial review. Cord, Michael, John, and I are now available for your questions. Operator?