Q3 2021 PetIQ Inc Earnings Call
[music].
Greetings and 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.
Now I'll turn the conference over to your host Katie Turner you may begin.
Good afternoon. Thank you for joining us on <unk> third quarter 2021 earnings conference call and webcast on today's call are cord, Christensen, Chairman and Chief Executive Officer.
Susan Sholtis, President and John Newland, Chief Financial Officer, Michael Smith, Executive Vice President of the products Division will also be available for Q&A.
Before I 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 or or a certain non-GAAP financial measures, including adjusted gross profit adjusted SG&A adjusted net income and adjusted EBIDTA. 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. It's been most comparable measures prepared in accordance with GAAP. In addition, Pat Keyes 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 third quarter financial results.
I will begin with an overview of our strategic business and financial highlights from 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.
It seem did a great job to execute on our strategic initiatives in the third quarter to ensure we are serving both parents and their pets, where and when they need it to fulfill their plant health.
Health and wellness needs.
Overall for the third quarter, we believe our financial and operational results demonstrate the strength of our diversified products and services offered.
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 of 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.
Fight 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 dollar RMB milestone accrual for future over the counter medication launch.
Taking a closer look at our products 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.
<unk> segment net sales of $181 6 million increased 21% compared to the third quarter of last year for.
For comparative purposes, net sales were up 33% if you exclude sales from our major animal health manufacturer in the third quarter of last year that is no longer included in the third quarter 2021 sales base.
Our manufactured brands accelerated delivering 16% growth in our flea and tick category and 24% growth in the health and wellness category.
Growth in <unk> in the quarter was led by caps are oral flea and tick which was up 68%.
We experienced strong growth in the ecommerce channel, which increased 51% led by an increase of 76% and our manufactured products for the third quarter as compared to the prior year.
If you exclude sales from major animal health manufacturers in the third quarter of last year that is no longer in the third quarter 2021 sales.
Our ecommerce 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 one across our products segment to offset all of these inflationary pressures.
From an R&D perspective, we're excited to finalize and shipped our first orders of a superpremium premium health and wellness line for a large club store operator.
Plans are 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 future over the counter medication launch we have been working with a third party development company and they reach 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 mixed 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 cells. 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 it.
<unk> increased our profitability.
Products 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 William quick 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 portfolio gained 84 basis points of share within the <unk> category. This share gain was led by our brand at armour, 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 <unk> 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 18473 community clinics.
Approximately 13529 community clinics in the third quarter of this year.
While we expect the current labor situations 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 to 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 and 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, $1 per pet and pets per clinic continues to be the strongest kpis in the Companys 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 variance related impacts to our business.
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 impacts of our services segment lessons 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 and adjusted EBITDA quarter based on the seasonality of the business.
We also officially lap. The addition of Capstone 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 pets' lives through convenient and affordable access to veterinarian 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 Sue.
Awesome.
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-19 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 and 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.
This result is also in the 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 <unk> 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've 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.
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% and our services business beginning September 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, we opened 12, new wellness centers in Q3 for a total of 72, new wellness centers opened year to date seven.
Seven of the 12 locations were Greenfield centers.
One of the highlights of 2021 has been a 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-19 pet count levels.
We continued 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 just shifts into the first half of 2022 due to these build out delays.
For 2021, we continue to expect our buildout schedule to represent 60% Greenfield wellness centers and 40% conversion in.
<unk> looked at the timing of the build for a 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 hired <unk>.
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 risks 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 costs grew again in Q3 up 32% versus prior quarter with pet parents seeking advice about their pet 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 a low monthly subscription plan that helps pet parents more affordably care for their pets health.
We continue to be pleased with the number of pet parents enrolling in its 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 our skill set we've shown 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 office sites veterinarians are stressed out and burned out from their work.
Pat IQ, 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.
On a consolidated basis pad iqs pets per clinic dollars per pet and dollars per clinic.
All up double digits compared to Q3 of 2019.
These metrics tell us that when we're operating the fundamentals of our services business are very strong and.
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.
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, representing an increase of 34%, resulting in gross margin at 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.
Yeah.
The increase was driven by higher amortization of our asset acquisitions that occurred in 2020, the largest being cap store and increase in selling and marketing costs for both products and services segment due to growth in sales and two one time items, including accruals for the R&D milestone payment of $2 million in legal fees of two.
$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.
Yes.
A 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.
During the one time R&D expense of $2 million that I mentioned earlier.
Adjusted EBITDA margin increased 40 basis points to seven 8% compared to seven 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 and 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 $2 million in the third quarter of 2020.
Turning to our balance sheet and liquidity.
September 32021, 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 30th 2021.
Working capital increased $197 7 million as of September 32021, primarily as a result of earnings providing cash from operations and normal working capital decreases.
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.
Okay.
And at this time, we will be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad.
<unk> 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 handset before pressing the star keys.
One moment, please while we poll for questions.
Yes.
And our first question is from David Western brand with Guggenheim Securities. Please proceed with your question.
Hi, 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 youre looking at and what I mean by that is is that.
In one hand, you can increase wages and get those stores open an increase there.
It is.
Is driven by running last clinics.
And not having to leverage flow through that we would if we could run all of the clinics and so we we felt like we 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 can always use our temp labor and barely quickly get a permanent W. Two veterinarian to work and we're finding that that process is taking longer.
Some zip codes are gonna be even longer than that.
So we're gonna 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, but we'll put them in a training program for 60 days, while we build the store to make sure a day one when we open we have a operating business that we've invested capital against a a unit that's gonna open and star.
Generating you know returns for the company and just have a better risk approach to it Susan anything that I Miss you'd like to add.
Yeah No I. Thank you for the question David a couple a couple of the items that I would add to that first of all I'm just in the in the Wellness Center said those of course are <unk> veterinarians are and we we are competitive with salary, but a lot of that also has to do with with the benefits package that we offer that a.
<unk> Veterinary clinic does not offer for example, a 401k plan really great health benefits, but also I think even more importantly in this environment and I think you'll probably hearing the same things that we are especially this last quarter, having that work life balance is really meaningful when you talk with a veterinarians that are coming in.
T O R. R. W. W two or when they're becoming employees, they're coming to ask for that work life balance so that they can basically close the door at six o'clock and go home every night. So uhm I think that are offering is incredibly competitive for our W. Two veterinarians and it isn't just about it isn't just about salary and the second piece that I would add to that is.
In our community clinic model. So if you remember our community clinic model and veterinarians come in and they basically bid on route and so that that actually helps us to be more competitive are actually to bring our costs down, whereas they come in and get on those route. So it's a little bit of a different model than a traditional a veterinary.
Make model because of that bidding process. So I think that that that what we need to continue to focus on and we are focusing on is getting veterinarians into that I'm into that pool into that bidding pool right. Now we're pulling them on average the last three months, we didn't and pulling and 50, new veterinarians into that recruit.
<unk> pool every single month, so I think that was more than we bring into that pool. The more that we're gonna be able to to move that labor and to be able to cover clinics more appropriately.
Got it all very helpful and if.
I don't know if you're prepared to answer this today or maybe just for a future period, but you know you you've had these these number goals of number of clinic openings in the future.
How should we think about the way we adjust do you use either you know for this your future periods and.
You know is there a future period in which you think those numbers maybe still exist.
Yeah, I think David I think the what we're doing now is it's been long enough through the pandemic.
We have to start operating the businesses is if this is the new norm and then progressed with the new norm as it becomes better.
And it'll be our job to do a a good job of communicating to the progress we're making on recruiting in construction starts to help build the model. We we know that there's demand for a pet perspective, and we know there's more of a demand and 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 are right that is responsible we believe we get enough zip codes recruiting we could potentially get back to be on the same schedule, but right now it's gonna be a small step changes, we get that figured out and won't need to give you more clarity as we get this model up and running that we are running and now we're using fourthquarter, we're having good prog.
This is 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 cause it's just different so longterm, we absolutely see a thousand stores the rate that we can get there we need to be communicate with you as we go through this because it's a different norm right now in the pandemic and the number stores that we can build is gonna be driven based on the employee base not more so than the real estate location.
Got it thank you very much for your answers.
Thanks, David.
Our next question comes from the line of Bill travel, which Lewis. Please proceed with your question.
Thanks, Good afternoon, I guess sticking on the services.
Yeah, I guess trying to understand.
What's changed in the past.
Three months.
Yeah, It seems like the labor market and your labor and it had issues for for some time in the labor is some.
Type or at least six months.
S and T as in before that and so.
I'm just trying to you know, but the three months ago, you're fairly confident that do you do 130 to 150 or 170, and and then you know now the scene. So just.
What gives you confidence that you could even do you know these hundred this year and 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 and I just want to make sure you're talking mainly about <unk> not the text and the and the thing was that <unk>.
And it's also hard to fill in this market.
Yeah, I think <unk> 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 if how fast the pandemic would subside and that the market will 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.
<unk> <unk>.
Because of that and and this is purely responsible about cash preservation because we're at a point now where generate great cash from our products business, we want to make sure we deploy that catch it is immediately could it be a position that would 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 and I fixed location and we can use that labour in our <unk> you know.
Community College, so we get there so it's still a more efficient Ah model for this environment. We don't know if we can build 200 stores you out of the year.
We do know is we don't want to build a hunter stores that we can't put people in and and use cash irresponsibly as we come out of the pandemic. So we're set up to have a fantastic year. This year versus last year were set up to have.
And even better you're in and have the growth we've been talking about next year.
This is just gonna be something that we're gonna have to do is we work out of this on this segment of our business, but it's going to be something that doesn't change over the longterm our ability still to deliver our goals of growing the business as we talked about we just gotta be smart about how we deploy cash list at this time.
Okay, and and then just as I look at next year on the product side I mean.
Do you consider this past year a.
It's definitely good fleeing six season I, just don't you know or is it normal. Please season, how do you look at that from a a topline calm and on the services I understand that the the wellness centers don't really kick in for for for six quarters into the terms of the piano, but I would expect the the pause and kind of the growth would make it much more.
Profitable much faster in terms of your P&L. So you know as I'm looking any any kind of thoughts you can give us on 22 just from from both of those perspectives.
Yeah, I think I'll, let Michael answered that he can talk more to definitely and check. These go ahead Michael.
Okay.
Yeah, it's been an interesting year. If you look at the first three or four months of the season, we would've classified it as a concern us off season, but no season, and flea and tick really occurs the same year over year due to anomalies in the weather and other you know elements that that drive the infestation right. So we've been.
And pleasantly surprised with a very strong late season generally the season will start with paper backing of July and August and we actually saw August and then well into September even some significant positive trends in the category and some of the myths shifts in the category related to form was also favorable for us.
Oral.
Really.
Grew share in the back half of the season, we disproportionately have a high share in that forum. So was a double positive for us to category got healthier than the forms that we tend to be stronger in within the category, we're even stronger and performance. So good year slow.
Start a lotta recovery made in the last 10 12 weeks of of the season in late July through September.
And in terms, okay looking into <unk>.
Sure.
Go ahead with a follow up on that no no no no I was close.
But.
Yeah, So just a little bit of color of next year I.
I wish I had a crystal ball to predict what the categories Gonna do next year you know it is a definitely a caveat with seasonality and weather trends that will vary not only year to year the region to region across the country and clearly whether has a much stronger impact in states like Florida, and Georgia, where you have a high.
Past right.
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. The wind within the category. We do feel very good about how we are positioned in 2022 is we're just now wrapping up our business plans with key customers for next year and hopefully.
Hopefully the the again a nice tailwind in terms of category helps would would help but we feel confident with the plans we built with our customers that will be positioned well for for next year.
And I think I had only I'd also bill if you look at the the brands are best brand Pet armour brand is up significantly year over year for us outpacing the category.
And the caps or acquisition that we acquired this past quarter was up 68% versus last year, which was a year that we actually were running the brands. 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 it'd be executed lettuce outpacing outperform against the market. So.
We expect a a great years, Michael set of the slow start in a strong finish.
Uhm that happens sometimes in the perfect situation, you'll get a early start in a late finish but uhm. We didn't have the early start but it's it's let us have a great cord of this quarter and we're very happy that the product businesses delivering in our visibility into next year.
Okay. Thanks, so much.
Thanks Bill.
Our next question comes from the lineup John Anderson with William Blair. Please we'll see what's your question.
Good afternoon everybody.
Hi, John.
Alright.
On the start on the product side of the business. The <unk>. The manufactured items were up I think.
You said, 76% you're on year very strong could you talk about that was that more on the B O T. C side of your business was more on the health and wellness side, you know it kind of characterize what's driving that growth and.
How sustainable you see it at this point in time I know you have some new initiatives and club you know, but there were probably some puts and takes as well in terms of Phil versus sell through so again, what what's driving the manufactured growth and and and how sustainable is that he should look look ahead.
I think John I. Appreciate the question good to hear 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 and E Commerce category, but 76% was our business flea and tick we were up 16% health and wellness were up 24%.
All very positive numbers relative to the category and exceeding kind of category you over your growth and I think it speaks to our brand that he get rich speaks to our marketing execution I need to speak to however, retaining and connected with our customers and retaining them to to make the base stay in place, but I also remind you were very active right now developing new items are.
R&D pipeline has never been more active.
You, obviously, we talked about the success B that we paid this quarter for an item we've had in development that we will launch in some time in 2023, we had 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.
And are manufactured goods delivered higher margins.
We just delivered the best mix, we've had in the history of the company with 31% of our sales and manufactured up from 28 last quarter.
And for more 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 businesses.
Hitting on all cylinders and honestly doesn't get talked about enough based on what it's doing and how it's growing in the numbers, it's delivering in their earnings growth year over year that we're living in total is a company that right now we're carrying definitely more water with a product business has the service organization recovers, but we.
We feel great about the girls.
Yeah that that's kind of why I ask cause I I tend to agree with you on that the the the lack of.
Credit for that so again to kind of Peel the onion the manufactured side of the products business, you know, 31%. It sounds like you see as a floor, it's probably likely to get better for me or given.
I think some of the innovation that you have and programs on the health and wellness side of the business and some of the new item success is reflected in this milestone payment is that is that fair.
Very firm and that's exactly how we see the next couple of years that as we can continue to develop it'll be extended beyond that but you've definitely captured it right. That's definitely a part that we want to have people look at and understand the stability that was provided to the top line, but more importantly, the margin expansion EBIDTA expansion, that's being driven through the business. So yeah. We're <unk>.
Are you excited about R&D projects and what they will deliver we're very excited about the team is his delivery and just with our base core items outpacing the market growth outpacing the execution in the key categories that we're in uhm. So it again very very please.
And and.
Just so I understand that the the 2 million dollar R&D milestone payment that wasn't reconciled out of the 16.4 million in EBIDTA. So so is it should we be thinking about kind of the underlying EBIDTA in the corner of closer to 18 and a half million dollars.
That's exactly what it was and if you look at the slide deck, we published we actually show that visibly on the Sly, we we had 18 and a half million dollars of adjusted EBITDA and we made that payment for that product that will benefit us in 2023.
So I believe it was a fantastic quarter from uneven perspective, when you look at it through that lens that.
The sales were about a significant improvement over where we thought we'd be and then then I was the 18th floor was a couple of million dollars better than what we thought we were gonna deliver for the quarter and was still able to come in line with a great deliver even with that payment.
Okay, and then just I don't want to beat it to death, but uhm on the labor issues headwinds in in in the services business because that is sounds like the primary issue.
I know Susan you mentioned some of the actions you're taking I mean, how <unk>.
<unk>.
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 it did really affect with the numbers you provided the the number of clinics you could run you know with a quarter. This year versus last year. So I mean are you seen anything really kind of tangible through these actions that you outlined that suggest we could be back on Ah Ah more of kind of a normal plain early in 2022.
Yeah, John Thank you for the question a couple of things first of all I would just start out by saying that and when we talk about the the labour 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 staffed.
<unk> as well tail. So we we really have had to take a two pronged approach and we are confident in in our approach with our with our clinic staffing and we already see starting to see ads free tomorrow Labour in regards to that being able to recruit staff members. So we have and we we basically focused on areas.
Where we've got issues, when we have problems and and ma'am pepper efforts and to get that that staffing level back up to that piece I am I am confident that we will see a start to see a turn in fourth quarter in regards to to just lifted the clinic staff in regard to veterinarians, we we've already seen a vast improvement and and Q3 <unk>.
We basically rolled out all of the plans that we talked about rolling out there that I talked about them in the call. We rolled it was out really at the beginning of two three when we started to see the headlines and we started to see them, but like maybe around the middle of the second quarter and maybe getting to the end of the second quarter and we weren't seen them at all and first corner.
So when we started to see those we we literally started to put all the plans together in order for us to be able to refocus our efforts on on veterinarians and what we started in two three uhm a 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 it will start to see the corner will start to see ourselves turn a corner here in Q4.
Alright, thanks, so much good luck.
Thanks, John.
Our next question comes from the lineup Stephanie listening for.
Jeffries. Please proceed with your foot.
Hi, this is cord grading on for staff. So first on your contract with your largest distribution customer hasn't been officially renewed meaningfully signed sealed delivered on terms consistent with prior years and how long has that contract for if it has.
Yeah, the contracts through 2024, all the things we're finished with the contract.
And we are still operating the same thing there's no change in our pricing model of no dilution to the margins. So we just continue with the same terms.
Got it and then I wanted to follow up on that so I'll need that the 2 million R&D milestone payment for the future helpfulness product.
Additional color you can add on that program.
Yeah, we don't disclose new items, obviously because to review those as competitive advantages we have in going to market with things that only we have ours, you'll want absolutely won't tell you what the items are but we have two significant items that we are planning that would be launched sometime in 2023. Both are consist.
With our margins structure, we have in our manufactured goods, so they're not dilutive to the business and we believe the sides of the fries for those items is that 25 to 60 million dollar item opportunity that we think it'll 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 <unk>.
Product category.
That's really helpful and then on the the the the club.
Club program watching this quarter can you remind us how much EBIDTA you expect that program to generate this year.
This year is gonna be just what we generate off a really pulling up the stores. We've now ships T. First order the first orders of chips and so let's fill order is is <unk>, obviously, a retail partners or 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. 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 your 2022, and the 15 plus million dollar sales range.
But again, it's it's an item that we see is just being able to deliver somewhere between six and $11 million would be without based on ourselves come in.
Got it yeah, sorry, I meant to say for 22 [noise].
And then just last one maybe you can quantify the the scope of the distribution business just in terms of Princess percent of sales and percent of profits that might be helpful. Just as a reminder of the distribution businesses contribution to the for profit based on the company.
Yeah, so a gun or 31% of thousands manufactured.
69% is what we distribute.
From a from a <unk> perspective, if you look at the business that you know $100 million of EBIDTA, 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 manufactured are from the distribution business.
Little over $70 million from the manufactured business. So that eve at all and then we were at full capacity, we would run it about 15 million and our service organization and growing with our store expansion.
Got it thank you very much.
Alright next question come from the line of alien.
Raymond James. Please proceed with your question.
Thanks can I pay a couple of 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 the clinic.
You mentioned something like having labor on established 60 days before advancing or.
Opening the clinic, but just curious how that new approach may impact your pie assumptions in terms of the ramp to.
Profitability.
Yeah. Good question I <unk> I mean, I think what you have to appreciate is when we're running a a cancellation rate as high as the yard which include the new stores.
This model actually reduces the current performance against those models the the stores the tower staffed or obviously running on.
Case with our current projections.
And will deliver that so if you add the extra 60 days, where it really it's only labor they get trained and working it in our community clinic business. So they are contributing to revenue during that time period. So 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 have 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 $20000, but that $20000. We believe we can get a lot of it returned back from our customer. So our community Clinton said there'll be actively working.
Other store so the net effect is in 100 per cent or stood yet, but it is not a significant impact the overall plans and more importantly, it as a significant improvement from opening stores and having to you know not run 25 per cent of them because you don't have the labor.
Okay, and I think recently you talk about implementing uhm, a price increase roughly six per cent and that side of a model, giving some of the inflationary impacts that you've seen in terms of the labor pool just wondering.
What the actual experience has been Ah.
Against that 6%.
Increase you know whether or not that is.
Sufficient to.
Cover the inflationary pressures that you're saying or whether that guess kind of the recent trend here in terms of the labor force may actually have inflation running slightly above that right.
So would you want to take that.
Yeah, No I, it's a it's a it's a good question actually when we raised our prices in September which is very much uhm I've cycled for us we traditionally raise prices in January at the very beginning of the year and we did we implemented in off cycle because in order to be able to cover the be Ingram.
And Ah labor expenses at we're currently occurring today, and we would fully expect to be taking it another pricing action at the beginning of the 20th 22, 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 pets.
Mark and so are <unk>, if you think about the first quarter of this year and what was happening still with Covid and we've really been blowing and go in and these clinics with with with our pet count. So we have not seen our pet counts slowed down at all and it hasn't slowed down as as as.
With us with our pricing action either.
Okay, then maybe just a couple of quick questions on the on the product side as well I've been cord you referred to strong growth rates in the E Commerce business.
Both for the combined business and for the manufactured products beige could you give us a sense of what.
That bucket represents in in terms of the overall.
Product revenue base.
Total sales to that channel.
Correct.
I don't have that number in front of me I don't want to misspeak.
Do that so I think it's something we need to follow up with you offline earlier to get you that answer.
That'd be that'd be close but not.
Okay got it wrong.
Okay got it.
And then with respect to the the new.
Health and wellness offering me a missing you're prepared commentary, but an update there in terms of whether that was <unk>.
Launched this quarter is.
Would you like to be launched in the near term.
Yeah, we're very excited we've already shipped the first spill order orders out the remainder of those orders will ship next week. So all fill orders will be out it'll start hitting and club very very soon obviously health and wellness becomes a hot topic for humans, but what the humanization of pet it becomes a very hot topics, so you'll see significant promotion.
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 cole your 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 six and $11 million to the company.
Okay and is this product competing in what you term the you know the Super premium portion.
Of the market <unk>.
It does it would be in line with the <unk>.
Highest portion or formulations that are available on the market. It's I mean, Michael probably better to describe the items have you I'll take it Michael.
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 put in to market and the help him on his category, but what you would find in a category period.
If you look at the price point, clearly Costco has a strategy that it is heavily weighted towards a member of values. So this is a product.
Say, the raw price point would be competitive with the high end of the market today, but give their member of product that is significantly superior to equally priced alternatives in the market found in under other brands.
Okay.
And then last question for you accord I guess, given the current dynamics in the services.
Segment with a slightly.
Mm slower than previously anticipated build out of a 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 you know how do you think about potentially pursuing larger manufactured product opportunities just given the strong growth that you continue to see that portfolio, they're very high return on on and that's that's the capital very quick payback period versus what machine and.
Uh-huh services business.
Yeah, I mean I like the way I'm. Just question every time, we we have the gas pushed down all the way on the product business, we're generating enough capital to more than investing outside aggressively and deliver the type of growth we have and if you remember that the division that was.
$260 million in sales, making less than $18 million of EBIDTA, but now is you know over 800 million on a run rate basis, making close to 100 million on its own. So we're gonna continue to aggressively push their with capital to do it we have the people the r&d's machine running <unk>.
And we're gonna do everything that's available in that category irrespective of what happened to the service organization. The service organization cause complimentary to that business. It helps it grow sometimes people can't visibly see the benefit that organization brings that 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 gonna push on both sides right now and coming out of this pandemic, it's the right decision.
So let the labor be the the gardening 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 in the Susan said, we're getting better traction than we ever have on monthly recruiting.
And so this 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 deployment of capital and taking risks.
In this current environment and is this this opportunity or the flavor issue subsides. When you usually can go back and push the gas to make the construction the first domino not the labor, but right now that's the right decision for you some cash we're very balanced and what our cash generation is versus what we're using this service organization. So nothing's changed there and we feel great about our castle.
For this year and what we end up using on that basis, and what we generated leftover our excess cash to pay down debt or have it ready to invest in things like additional product offerings. So the company has never been stronger never been executing better.
Alright, Thank you [noise].
And our next question comes from the line of O'brien Eaglewood Oppenheimer. Please proceed with your question.
Hi, This is Andrew chazanoff onto Brian.
Two quick questions for you. The first one I guess just on the on the demand side of the product business.
You, you've kind of discussed and it's been recovering pretty well throughout the quarter have you noticed any lumpiness or have sales now be interesting.
Over the last three months.
No I think just to be clear the the product business actually has done extremely well in a total trailing basis compared to the year is over a year, we have lumpiness with COVID-19 with peaks and valleys on some of the consumption.
What we saw in third quarter is the consumption normalized where inventory was being purchase that rate of consumption. So we were able to see actual kind of performance.
The overall category. It obviously felt very strong resolve where we saw you know 22 per cent your over your growth, but 33%. If you exclude that piece of business. It's not in the base any longer so we can't ask for any better execution number some of that's driven off the plane fixed season gig extending longer than normal and being better.
It's also just broadbased execution for the company doing better across all the channels and continue to be very focused on the animal health category and what we do in it. So uhm, we feel great about other businesses is reacted historically, how it reacted this quarter, especially but more importantly, we felt great about where it's going in the future.
Thank you and the last question is I don't hate to.
The labor that the labor labor pressures, but.
You know I understand that you've taken some proactive measures to mitigate those pressures, namely raising prices that you think <unk>, what kind of come come into into gear in the next year.
Quantify how much the labor shortages and even wait on sales, particularly in the last quarter.
Yeah, I mean, we re are.
I don't know if it's easy to quantify specifically I mean, we had the roughly 25 per cent of our clinics not operate last quarter that were expected to operate now.
Some of those renews some of those were mature so on a blended basis, it's probably not far from our average clinic performance.
But again, it's it's something that the clinics that were operating the 75 per cent of Iran had the best keep your eyes on pets and dollars per pet and delivered well within our line of what we'd expect from our margin in a in a in a delivery for contribution to the company because the price increase is covered the inflation part of it so.
<unk>, we're taking <unk> to reduce that number we think we've made the right decisions on how to do that as we've stopped up on recruiting teams and and looked at our build scheduled differently, but again, it's it's a business that you know if if if it was running at full tilt in 2021, they should've delivered over 160 million for the full year.
And and we're not gonna go over that with these cancellations so.
Alright I appreciate it thank you.
And we have reached the end of the question and answer session on now I'll turn the call over to management for closing remarks.
Thank you everybody for attending the call today, obviously, we're very excited with the signs that were seen 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 fails to consumption.
I was incredibly great to see a 17 million dollar a year over your improving our service organizations revenue with a positive adjusted EBITDA contribution versus the last last year, all great signs that were running the business properly. We're heading the right direction as a company were super Grateful for our team. Our team members are veterinarians are staff members out there.
The front lines and the works that they're doing to deliver these results and we're excited to finish the you're strongly and come back and have a call to get off the new year and and show you. How we finished and there's a very positive way and put it position the company to continue to have the growth in the execution of next year. So thank you for your time today and we appreciate look forward to talking to you all soon.
And this concludes today's conference and you may disconnect your lines at this time thank.
Thank you for your participation.
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