PetIQ - Q2 2022

Transcript

Operator (participant)

Good afternoon, and welcome to the PetIQ second quarter 2022 earnings conference call. All participants will be in a listen-only mode. Should you need any assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star then two. Please do note that this event is being recorded. I would now like to turn the conference over to Katie Turner. Please go ahead.

Katie Turner (Head of Investor Relations)

Good afternoon. Thank you for joining us on PetIQ's second quarter 2022 earnings conference call and webcast. On today's call are Cord Christensen, Chairman and Chief Executive Officer, and Zvi Glasman, Chief Financial Officer. Michael Smith, President and Chief Operating Officer, 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 this 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, including adjusted gross profit, adjusted SG&A 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 our reconciliation of non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP.

In addition, PetIQ's posted a supplemental presentation on its website for reference. With that, I'd like to turn the call over to Cord Christensen.

Cord Christensen (Chairman and CEO)

Thank you, Katie, and good afternoon, everyone. We appreciate you joining us today to discuss our second quarter financial results. I'll begin with an overview of our strategic business and financial highlights, then Zvi will review our financial results and outlook. Finally, Zvi, Michael, and I will be available to answer your questions. First, I'd like to begin by thanking all of our dedicated employees for their hard work and contributions in this dynamic and challenging operating environment. We couldn't provide the access to affordable pet healthcare without you, and pet parents everywhere are grateful too.

While net sales of $252 million were below our expectations of $260 million, we still grew consumption of our PetIQ manufactured brands, launched new products which we strategically invested behind, and outperformed in the categories which we compete to deliver continued gross margin expansion and adjusted EBITDA in line with our expectations of $28 million. Year-to-date, our net sales are up 7% on an apples-to-apples basis. Like most companies, for PetIQ, the last few years have proven to be unlike any others in our company's history. Our team has navigated COVID and helped pet parents shop for their pet health and wellness needs. This year, while it's less about COVID, we are seeing higher inflation impact consumers and a tighter veterinary labor market.

As we discussed last quarter, unfavorable weather trends impacted the start of the flea and tick season in April. While weather was still an issue in May, consumption did improve. However, this increase did not fully offset the decline to the start of the flea and tick season. In addition to weather, late in the quarter, we started to experience changes in consumer shopping habits, evidenced by trade down to smaller pack sizes and lower cost brands, as well as certain preventive care purchases occurring more closely to the time of need in this economic environment. We also had $5 million of fill orders to support the start of the flea and tick season that shifted to the first quarter of 2022 from the second quarter of 2022. We remain pleased with how our PetIQ manufactured products performed in light of the broader category weakness in Q2.

Our own manufactured brands represented 28.9% of product segment net sales, up from 28.4% in Q2 last year. We expect PetIQ manufactured brands to increase to over 30% of product segment net sales in the second half of 2022. We generated sales growth across five of our top seven manufactured product categories during the quarter. A few of the highlights from the quarter were pet supplements grew 62% compared to Q2 last year. Dental was up 23% versus the prior year period, and dog treats increased 80% year-over-year. We continue to participate and be a leader in several of the largest growing categories within the pet industry, such as flea and tick solutions and health and wellness.

Our manufactured flea and tick brands are up 6.5% year to date versus the first half of 2021, but less than the 24% that we expected year to date based on the weather and changes in consumer spending habits I mentioned earlier. In terms of market share for the 12 weeks ended June 18th, 2022, the PetIQ portfolio gained 73 basis points of share within the over-the-counter flea and tick category and continues to command the number two market share position at 20.3% total share of the market. This share gain was led by both PetArmor, Capstar, and NextStar. In the health and wellness category, we also continued our momentum in this high-growth segment as we picked up 98 basis points of share.

The segment increased 8% across the market while our portfolio grew 13% for the same 12-week time frame. Both flea and tick and health and wellness segment growth was fueled by disproportionate gains in the e-commerce and the club channels, which are not Nielsen-measured sales channels. We continue to have the largest over-the-counter animal health brand portfolio with over 1,000 SKUs and a dominant market share in pet prescription products sold to retail on- and online. Now focusing on the services segment. Our services segment reported its best quarter since the onset of COVID in 2020, posting its sixth consecutive quarter of positive adjusted EBITDA on net revenue of $33 million, an increase of 17.2%. This was better than we expected. For the first half of 2022, services segment net revenue is $60.9 million, an increase of 16.2%.

We believe our services segment will make sequential and year-over-year improvements as we progress through 2022. In Q2, we continued to optimize the services segment to maximize the results and minimize disappointing our pet parents. First, we continued to adjust our clinic schedules to reduce labor hours and cancellations when labor is unreliable. Second, we continue to focus on veterinarian retention and recruiting programs to support our future wellness center openings. Due to the challenging vet labor market, we opened six new wellness centers in 2Q and 10 wellness centers in the first half of 2022. We remain prudent with our services growth near term given the challenges in the vet labor market. We are also very excited to have added John Pearson to the PetIQ team in the second quarter as Senior Vice President, Head of Services Division, reporting to Michael Smith.

He is responsible for managing all aspects of PetIQ's services division, including strategy and operations to fuel growth in revenue and profitability. John is an incredible operator and strategist with extensive retail experience, including a very strong track record in consumer retail, working across multiple product categories in key leadership roles, having spent much of his career helping to fuel growth at the world's largest retailer. He is here to help us at an important time as we look to further enhance and optimize our services segment to reach more pet parents and their pets with our affordable and convenient access to pet health and wellness products and services. In John's first 60 days, he has already begun to lay out and implement plans with a fresh perspective and constructive ideas to fuel future growth and add stability in our services segment.

I look forward to sharing more of his insights and our strategic growth plans with you in future quarters. Finally, I'd like to address our updated annual outlook, which Zvi will cover in more detail. Multiple consumer trends continue to support the long-term growth of the pet industry and PetIQ's unique position in the market, offering convenient and affordable veterinary products and services. When we provided our annual guidance at the beginning of 2022, we had visibility to consumption patterns across our brands and the categories in which we operate that were growing. We also had planned new wellness center openings. At the time, this information fully supported the total company growing net sales at approximately 10% on a like-for-like basis as compared to 2021.

Now with a much slower start to the flea and tick season due to weather, the changing consumption patterns of pet parents in this economic environment I previously discussed, and fewer wellness center openings than we planned due to the vet labor market, we are taking a more conservative approach to our outlook. We now expect net sales of approximately 4% at the midpoint of our guidance. This reduction in our sales guidance can be broken down into three main areas. First, approximately 1/3 of our reduced net sales expectations are due to lower than expected flea and tick sales as a result of weather, which we don't expect to fully recover in the back half of the year. Second, approximately 1/3 of our guide down is due to the changes in consumer spending that I outlined today and something we continue to closely monitor.

We have also seen the trade down in the flea and tick category that I mentioned earlier, which supports PetIQ's manufacturer brands, but it also means that in 2022 we expect the total category to be down and smaller than in prior years, even though we expect to capture a disproportionate amount of market share. Third, the final 1/3 of our net sales guidance reduction is due to us opening fewer wellness centers than we had expected. Based on the labor market, we opened 10 new wellness centers, a much lower number than we'd budgeted for 2022. The last area I'd like to cover in our guidance is our sales quarter to quarter and the first half to second half of the year.

If you take the second quarter and the first half of 2022 financial results and our updated 2022 outlook, it suggests all of our growth happened in the first half of the year. Simply doing this does not tell the full story. In fact, our year-over-year growth is very balanced when you look at consumption by pet parents. Year-to-date, consumption has increased compared to the first half of 2022, and we expect this trend to continue for the balance of the year. It is important for us to highlight that a number of our retail customers have been balancing their inventory and reducing the weeks of supply. When you normalize these inventory events, our growth is very balanced across the entire year.

In closing, we believe our differentiated position in the animal health industry will continue to fuel our long-term growth along with robust industry tailwinds, including increasing household penetration for pets, the humanization of pets, an increasing pet population, and more pets looking for convenient and affordable pet health and wellness. Our product and services teams continue to execute well on our mission, and we believe PetIQ is well positioned to continue delivering increases in our net sales and profitability as well as generate solid cash flow over the next several years. With that overview, I would like to now turn the call over to Zvi.

Zvi Glasman (CFO)

Thank you, Cord. We are pleased with our year-to-date growth and our ability to manage the controllable aspects of our business to achieve solid gross margin expansion, growth in net income, and adjusted EBITDA in line with our expectations for the quarter. We accomplished this even as our net sales were lower than we anticipated for Q2, as Cord discussed, while simultaneously executing on our planned marketing investments to support new product launches and the growth of our existing brands. We remain pleased with our team's execution and the improvements in key areas of our business, as well as the share gains achieved from new product launches. We are continually evolving our business to provide pet parents with convenient and affordable pet health and wellness where and when they want to shop. Now I will go through key financials in more detail for the quarter and year-to-date period.

Since Cord focused on our top-line results for the quarter in detail, I will start my financial review with gross profit. Second quarter 2022 gross profit increased 3.9% to $62 million, resulting in gross margin of 24.6%, an increase of 260 basis points from the second quarter last year. Adjusted gross profit was $65.2 million, and adjusted gross margin was 26.4% for the second quarter of 2022, representing an improvement of 190 basis points year-over-year. This margin expansion reflects favorable product mix, including the success of the company's manufactured product portfolio, such as the recently launched product, NextStar. We also benefited from service segment optimization.

SG&A expenses for the second quarter of 2022 were $50.6 million, compared to $43.1 million in the second quarter of the prior year. Adjusted SG&A was $44.1 million for the second quarter of 2022, compared to $37.5 million in Q2 of last year. As a percentage of sales, adjusted SG&A was 20.1%, an increase of 420 basis points compared to the prior year period, primarily reflecting $5.8 million of planned incremental marketing to support the launch of our two new brands and continued marketing investments to help accelerate growth of our manufactured brand product portfolio. Our Q2 net income was $4.7 million, an increase of 16%, resulting in EPS of $0.16.

Adjusted EBITDA was $27.6 million, in line with our Q2 guidance for adjusted EBITDA of $28 million. We are very pleased to have still achieved our target for adjusted EBITDA for the quarter despite the lower-than-expected net sales for Q2. We continue to believe this demonstrates the strength of our PetIQ manufactured brands and our team's focus on managing our costs. This resulted in Q2 2022 adjusted EBITDA margin of 10.9%, slightly ahead of our expectations for the quarter. Turning to our balance sheet and liquidity. As of June 30, 2022, the company had cash and cash equivalents of $5.4 million. During the second quarter, we generated approximately $15.8 million of operating cash flow, excluding working capital investments.

We continue to expect 2022 to be the strongest cash generation year in the history of the company. Our working capital as of June 30, 2022 was $224.5 million, an increase of $6.4 million from the same period last year. Our working capital needs are primarily to fund inventory and accounts receivable, both of which can fluctuate based on the seasonality of our business, retailer demand, and the timing of new product launches. The increase in working capital is primarily due to higher than normal levels of inventory, driven by lower sell-through than expected, as well as our decision to maintain adequate weeks of supply given the challenged supply chain environment. We remain comfortable with our levels of inventory.

Our long-term debt, which is comprised of our term loan, ABL, and convertible debt facilities, was $467.4 million as of June 30, 2022. In addition to our cash on hand, the company has $120 million of availability on its revolving credit facility, representing total liquidity, which we define as cash on hand plus availability of $125.4 million as of June 30, 2022. Keep in mind, due to the flexible nature of our debt facilities, the company can expand availability by an additional $150 million if needed.

We continue to believe our available liquidity, consistent growth, contribution from the product segment, and improvement in the service segment positions the company to drive key free cash flow and build cash in the quarters ahead, as well as opportunistically pay down our debt. Now, turning to our guidance. Cord already covered the reasons for our net sales change, so I will focus on specific guidance ranges for both the year and Q3. For 2022, we expect net sales of $920 million-$940 million, in line with 2021, based on the midpoint of the guidance. For comparative purposes, we expect net sales to increase approximately 4% compared to 2021, based on the midpoint of the guidance, excluding $36.1 million of sales in the prior period related to the lost distribution.

We expect adjusted EBITDA of $92 million-$94 million, in line with 2021, based on the midpoint of the guidance. For comparative purposes, we expect adjusted EBITDA increase approximately 3% compared to 2021, based on the midpoint of the guidance. Excluding $1.8 million of adjusted EBITDA in the prior year period related to the loss distribution. We continue to assume adjusted SG&A will increase approximately 100 basis points to 17.3% in 2022 compared to 16.3% in 2021 as our team focuses on managing our controllable expenses and achieving broader, greater cost efficiencies. Keep in mind that our annual outlook also assumes very little incremental adjusted EBITDA contribution from the services segment.

The services segment has not returned to pre-pandemic levels when the business contributed approximately $10 million-$15 million in additional adjusted EBITDA. While we do expect to eventually return to pre-pandemic levels, based on what we are seeing in the veterinary and labor markets, we believe it is prudent to assume the return will not occur in 2022. Now for our third quarter of 2022 guidance. We expect net sales of $200 million-$210 million, a decrease of 1% compared to the third quarter of 2021, based on the midpoint of the guidance.

For comparative purposes, we expect net sales to be in line with the third quarter of 2021 based on the midpoint of the guidance when excluding $3.5 million of sales in the prior period related to the loss distribution. We expect adjusted EBITDA of $16.5 million-$17.5 million, an increase of 3.8% compared to the third quarter of 2021 based on the midpoint of the guidance. For comparative purposes, we expect adjusted EBITDA to increase approximately 5% compared to the third quarter of 2021 based on the midpoint of the guidance, excluding $0.2 million of adjusted EBITDA in the prior period related to the loss distribution. In closing, we are pleased with execution for the first half of the year in a challenging operating environment.

Our team remains optimistic about our growth for the balance of 2022 and over the next several years. We believe we have a strong team in place to provide results for all of our stakeholders while continuing to deliver on our mission of smarter, convenient, and affordable option for pet parents. With that overview, Cord, Michael, and I are available for your questions. Operator.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. Please limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. Our first question will come from Jon Andersen with William Blair. Please go ahead.

Jon Andersen (Research Analyst)

Good afternoon, everybody. I guess I wanted to start with some of the commentary that you had on the consumer and also the late start for the flea season. You know, could you talk a little bit more about what you've seen subsequent to the late start, which I think to your point was weather related, what level of consumer engagement you've seen subsequent to that? When you think about these changes that you're seeing, whether it be trade down or, you know, migration to lower pack sizes, is that good for your profitability? Because I would guess it would often mean trading into some of your manufactured brands, which are higher margin for you.

Cord Christensen (Chairman and CEO)

Yeah. Thanks, Jon, for the question. This is Cord, and I'll answer most of that. Michael Smith may add some points as well. You know, obviously the month of April and part of May, we had, you know, snow and cold weather across the country, which was unusual for the start of the flea and tick season. Flea and tick category in that time period ran negative comps to last year across all data sources that included Nielsen, online club, in the -20%+ to last year. We saw it go into the teens in May, and then we started to see consumption start to pick up, as it started to warm up.

Then as we got later in the quarter, we did start to see the trade down effect you talked about, and we started to see some consumers at the very low end of the retail shopping patterns or retail, as you'd expect to have households with lower household income, units being less than normal. As we went out and investigated, found that there is consumers that are choosing to purchase when they have an issue or closer to deal with an issue versus, you know, having the money to deal with preventative care. From a household penetration standpoint, it represents about a half a point on household penetration. It's not a huge number that left the category.

If you look at the health of the overall category, taking into account trade down from some of the high end, all these issues, weather, year to date, total category is running a negative in the high single digits, which is unusual for this category, when you take all data sources, including online club and Nielsen and you name it. We're fortunate, as we said in the release, that you know, my commentary that our brands are running 6.5% ahead year to date. We're definitely doing better than what the market has done. Based on a healthy season, our placement, the way our brands have been performing, new item launches, we had expected to be 24% ahead this year. That's why you see a more conservative approach.

Right now, based on that consumer consumption piece that we're seeing right now, we're anticipating that if it continues as we've modeled it and as we're seeing it, we would finish the year +4%.

It's still a very good year for us and a very tough year, and we're taking tons of share in the category, but it's definitely not in line with what our expectations were when we started the year and built our modeling and built our budgets for the full year. Michael, anything else you'd like to add?

Michael Smith (President and COO)

Yeah, Jon, I would just add a little bit and largely echo Cord's comments. I think one of the things that if we flash back to March, April, was we were trying to ascertain how much of the impact we were seeing in the category was truly associated with seasonal events like weather, and how much was more macro environment pressure on the consumer. As we moved into the later months of Q2, what was clear was that it was becoming less about weather and more about some of the macro challenges that the consumer is being faced with.

At this point, as we think about the Q2 results and what we're signaling for the back half, is an expectation that those macro challenges continue throughout the rest of 2022, and that we continue to over-deliver from a share perspective and outperform the category on a relative basis.

Jon Andersen (Research Analyst)

Okay. That's helpful. I guess, sticking with products for a minute, but looking a little bit further ahead, you know, you've launched some innovative new products this year, that, you know, I assume you kind of expect to, you know, build upon in 2023. Anything you can talk about based on your line reviews, to the extent that you've had them so far, you know, the innovation that you brought to market this year and how you think that might carry forward into 2023? I think you also have at least one major new launch that you're planning in 2023. Could you correct me on that if I'm wrong and tell us a little bit more about that?

Again, I know I'm looking forward, but you know, it's clear this year is gonna be what it is. Wanna understand what you know, we can you know, look forward to on a distribution and innovation front as we look out a little bit further.

Cord Christensen (Chairman and CEO)

Yeah. I think I'll answer the second part of your question first and let Michael take the first part. As we said in prior quarters, we've been investing heavily in some new items with our R&D team, one of the more extensive investments we've made in a long time. We're very excited for that item and what it could contribute to 2023. We are, you know, not ready to communicate on what's going on with that right now just because we have lots of things we're working through with the EPA and other things, but it will eventually come to market. We believe it's an exciting item for 2023 and should have one of the most meaningful impacts on a step increase in our manufactured brands performance once we're able to launch that. So it's gonna be great.

Michael, if you don't mind taking the first part of that question.

Michael Smith (President and COO)

Yeah, Jon, relative to NextStar's performance, what I would say is that we set share goals for that item in terms of the impact it would have or the portion of the market that it would command, and we're actually turning ahead of that objective. The challenge is obviously the size of the pie this year is a little different than we expected in the flea and tick category. From a share perspective and where it's sourcing volume, we feel very good about what that means as we begin having conversations with retail partners about 2023.

If you recall, when we came and started discussing that launch, we acknowledged that the green light from the EPA came a little bit later than ideal, which meant some of our customers were further down the road in their 2022 planning cycles to be able to incorporate that into their strategy. Those customers who did not build it into their 2022 strategy, I would say we feel very good about it being a focus and an initiative that will very likely be part of their 2023 strategies.

Jon Andersen (Research Analyst)

Okay. That's great to hear. The last one for me. Well, two quick ones. On services, you know, what's it gonna take, you know, to be able to kinda hire and/or retain more vets? You know, is there any light at the end of the tunnel so that you can kind of reaccelerate the center build-out? Then the last one, I'll just hit you with both right now, is just on cash flow. Has there been any change to the free cash flow outlook for the year? I think you've talked about $50 million in or even around that in the past. Any update there would be helpful. Thanks.

Cord Christensen (Chairman and CEO)

Yeah. I'll take the first part, and I'll let Zvi answer the cash flow part when we finish. You know, Jon, no one's working harder than us to recruit, retain, and hire veterinarians. I think as you go out and hear what the entire industry is talking about, this is an issue we're all living with right now. It's gonna be a long-term battle, we feel, as we are out, you know, meeting with the schools and every other place to figure out how to deal with the issue. We recognize for us to get back on track for what we wanna build and open, we have to recruit existing vets from their existing, you know, where they're currently working.

You know, the numbers we've opened, you know, opening 10 so far, you know, was not the goal for the year by any stretch of the word. We also are hiring and getting better labor that's, you know, solving for unreliable labor or other centers that were running partial schedules because we're using temp labor. We have chosen to use almost another 25 veterinarians that were hired to really you know, stabilize the base as well. I think in this environment, we're being prudent with our decisions on how we're using the labor that's there. We're working hard to solve for it. We are unfortunately in a market that this is where it's at right now, just throwing money at it or people at it doesn't seem to be what solves it.

We'll just have to keep you updated as we work through it and as we see the light, we'll definitely be the first ones to share that with the market. Thanks for the question. Zvi, do you wanna answer the cash flow question?

Jon Andersen (Research Analyst)

Can I just quickly follow up on that?

Cord Christensen (Chairman and CEO)

Yeah, yeah, go ahead, John.

Jon Andersen (Research Analyst)

While I have you. How are your retailers? Do they understand this? Is there any pressure from them to try and solve this sooner rather than later? Are they losing? Is there any, I don't wanna say loss of interest, but, you know, as I assume, you know, some of your customers hope to have more centers up and running by this point in time. Is there any risk that this creates to your longer term goal of getting to a thousand centers or more? Thanks.

Cord Christensen (Chairman and CEO)

No, it's just the opposite, Jon. We've never had better engagement and partnerships with our retailers. They're doing more now to make sure the ones we already have are successful, and they're giving us more locations to recruit against so that we can make it easier to get more vets. I would tell you, our top and best customers have never been more engaged. They've never been doing more with us in that area. They're patient because they have similar issues with some of the technical labor in their own businesses. They are, I guess, understanding right now, and they also know that we're bringing them solutions as fast as we can bring them. We don't have any pushback or pressure right now from our customers.

Obviously, they would love more and we would love to give them more, but right now we're all working in partnership to deal with it.

Jon Andersen (Research Analyst)

Makes sense.

Cord Christensen (Chairman and CEO)

I also think, you know, John Pearson is doing some really amazing things to stabilize our base in a number of ways. I think, like I mentioned in my state remarks, very excited to share the successes we're gonna have short-term and long-term as we start to let his plans, kind of take hold. It'll be something that will continue to be a bright spot as we make improvements. It just isn't gonna happen as fast as we want it to, but definitely be going up and to the right and being a positive contributor. Zvi, would you like to comment on cash flow, please?

Zvi Glasman (CFO)

Yeah. On the cash flow, Jon, if you remember last year, we ran a -$11 million in cash flow. We had guided earlier this year would be $40 million-$50 million. Given the lower EBITDA, given the higher interest rates, we now think we'll be more like $30 million-$40 million, which will be our highest cash flow year ever. I think you're gonna continue to see that cash flow improve next year as well.

Jon Andersen (Research Analyst)

Thanks so much.

Operator (participant)

Our next question will come from Rupesh Parikh with Oppenheimer. Please go ahead.

Rupesh Parikh (Managing Director and Senior Analyst)

Good afternoon. Thanks for taking my question. First on the guidance reduction, is there a way to quantify what the impact was from retailers pulling back on orders on your reduced guide for the year?

Cord Christensen (Chairman and CEO)

Yeah, I think. Well, thanks for the question, Rupesh. Good to hear your voice. You know, again, it's difficult to quantify across every retailer, but in general, based on inventory levels and the time it took them to sell off in Q2, there's about three weeks of excess supply we believe across all the market still in Q3 that's burning off. If you basically add back that burn off in Q3 would have been positive. So as you look at the underlying consumption through the various data sources, you're gonna see that the consumption is very good in Q3 in these categories. It really, the only negative part to our sales is this inventory burn off. But it's about an extra three weeks of supply that's being taken down.

Some of it's where people are overextended and some is where some retailers are being more conservative in this economic environment where if they were running eight weeks of supply last year, maybe they're running six weeks this year. It's the best way I can answer it for you.

Rupesh Parikh (Managing Director and Senior Analyst)

Okay, that's helpful. Just on the flea and tick category, can you just talk about the competitive dynamics that you're seeing right now? Like, I know when I'm doing some of my store checks, you see a lot of promotions within the category. I can't tell if that's normal, if that's something unique to the current environment.

Cord Christensen (Chairman and CEO)

Michael, do you wanna take that one, please?

Michael Smith (President and COO)

Yeah, Rupesh, this is Michael. I would say, you know, at the aggregate, we're not seeing disproportionate levels of activity or volume sold on deal beyond historical norms. We are seeing, you know, actually a bit of a pullback in what I would call demand generation, marketing activities, driving awareness and more investment in, pricing actions. The pricing actions that I have seen across the category have largely been at the premium tier. As you look at where the challenges are at in the category, the premium tier has felt, a greater impact of some of the consumer behavior change, and they are attempting to address that. I would say the results that we've seen so far from pulling those levers from some of those brands likely are not delivering the results that those brands or retailers desired.

That has been a play that has been run a bit more often in the last three months. Total promotional investment or spend, I would say, is largely flat to down. It's just a change in the tactics, and we see a pullback in what we would call demand generation and an increase in pricing actions that do not look to be delivering expected results.

Rupesh Parikh (Managing Director and Senior Analyst)

Okay, great. Thank you for all the color. I'll pass it along.

Operator (participant)

Our next question will come from Bill Chappell with Truist Securities. Please go ahead.

Bill Chappell (Managing Director)

Thanks. Good afternoon. Hey, just starting off following up on the vet question. I guess I mean, I understand. I think I understand, you know, the problem, but I'm just not really sure why there's a change in just the past three months. I mean, it would seem like you have a pretty good visibility to the number of vets out there, the number of vets that are coming out of school, and I would assume it takes a three to four-month lead time just to start one of these centers up. So I just don't understand what's changed or what you didn't know three or six months ago in the vet market, why it's gotten that much tougher because it's not like just a general labor market.

These are very specific personnel that you're trying to hire, and you should, at least by their licenses, know where the bodies are. Help me understand that.

Cord Christensen (Chairman and CEO)

Yeah. It's a good question, Bill, and believe me, we study all the time as well and look at it closely. I think what has been interesting is we've seen even more unreliability or instability across our existing market as well as, you know, whether it's our competition being super aggressive coming after our labor like we're coming after theirs. If we make 15-20 hires in the quarter, we're stabilizing our existing store base sometimes more than we anticipated we would need to versus opening new stores. You know, opening six is what we use for new stores.

You know, the real story is there was another, you know, nine or 10 or 12 used to stabilize stores that were having unreliable labor or people that were being recruited away with unreasonable terms to workplaces that were not gonna pay those kind of rates for that type of work. It's really dynamic right now. Everyone's struggling to fight over the same pool. If you go to these conferences like we do, it's funny, we all talk about it, and you hear it every time. We're all stealing each other's recruiters, we're all stealing each other's veterinarians, and we're moving it all around. No one's been able to stabilize it because the pet parent demand is there, and so people wanna open stores to meet the demand.

We don't have it pinned down yet, Bill, is the best way to tell you. We're doing the best we can right now.

Bill Chappell (Managing Director)

Okay. Back to the product kind of commentary about how the year is playing out. I guess I don't fully understand, I mean, talking about weather and also about inventory destock at retail. Seems like that's the same issue. It seems. Is it not that you had shipped in a certain amount to retailers, it was a poor season because of weather, and so now they're just destocking it, they have too much supply? Or is there an incremental, they've decided for some reason at the end of the season they want even less inventory going into next year?

Cord Christensen (Chairman and CEO)

I think, Bill, you know, first and foremost, the less purchases of flea and tick caused by weather and consumers buying less because the economic environment translates into the inventory issue. The inventory issue is less about a sales issue, and it's more about a timing of when the sales occur. As we look at the issue, we really study that the weather that has created less purchasing, on top of that, some consumers not participating in the category or trading down into smaller pack sizes, buying cheaper brands, taking dollars out of the category. The inventory is exactly as you described. It's a component of changing the timing based on the, what causes the less consumption or causes that to happen.

It is destocking, and in some cases it is what you describe, retailers being more conservative on weeks of supply at end of season because they're trying to balance other inventory issues they have across their box. Whether it's seasonal stuff that didn't sell or otherwise. We don't really look at the inventory as being a reason for the dollars in total, unless it's a destock to less weeks than prior year. It's really the cause of the weather and the consumer spending that's really. Then the inventory just follows that per the retailers by, you know, guidelines.

Bill Chappell (Managing Director)

Okay. It's not any sign of any less enthusiasm for the overall category, even though you, like, the worry would be you have higher priced products than kind of the low-end flea and tick, and maybe consumers going into 2023 aren't as interested if they're trading down. That's not what you're saying.

Cord Christensen (Chairman and CEO)

No, not at all. Honestly, the trade down is people buying the very, very high-end, you know, $70, $80, $50 boxes, still wanting the formulas that are similar, which is where our brands play at $25 and $20. Even the private label that we produce for, you know, Amazon and other major retailers like Chewy and others, where we're doing their private label, we're perfectly positioned for people that are still looking for veterinary quality product at a better price. We think we are positioned well in that trade down, where we're not seeing the trade down, people going from the very, very high end down to a $5 box of Hartz. That's not what we're seeing. It's the $50 going to the $25 or a 6-pack going to a 3-pack.

Bill Chappell (Managing Director)

Got it. Thanks so much.

Cord Christensen (Chairman and CEO)

Thanks, Bill.

Operator (participant)

Our next question will come from Elliot Wilbur with Raymond James. Please go ahead.

Elliot Wilbur (Senior Equity Research Analyst)

Thanks. Good afternoon. First question on the services business. If my math is correct, Cord, there's a bit of a bump up in terms of the number of stores or new stores that enter the same store base over the next couple of quarters. I'm wondering if you can just talk about those, how the new stores or newer stores are trending in terms of revenue trajectory relative to what you would normally anticipate in the first 18 months and the overall profitability of new stores versus the historical experience? Then maybe if you could just give a little bit of color in terms of some of the key metrics in the quarter, the key KPIs in terms of you know, pets treated and average ticket price? Then I wanna ask you a question on the parasite market.

You know, outside of the commentary around, you know, a bit of a consumer trade down effect and the weather, one of the larger players in the space.

Last week basically suggested that they've seen significant share gains in the oral category in their RX product by being able to pull demand away from the OTC channel in terms of older topicals and collars and some of the orals, moving to newer generation, you know, triple parasiticide. I'm just wondering if you've seen that impact as well, maybe compounding some of the other trends that you've discussed? Thanks.

Cord Christensen (Chairman and CEO)

Yeah. Okay, well, I'll take the second question first. We haven't seen a huge significant impact from the Trio pulling share back out of retail. Typically, if you look at the last five, six, seven years in the retail segment, there's a very specific consumer that's not going to the veterinarian looking for their parasiticides. When you look at the pricing differential with the vet visit, plus the cost of Trio, we have not seen that. If you look at the share data going on, there's been a lot more share transfer happening between what I'll call the mono orals versus the Trio. You've seen a lot more share transfer there that's happened in OTC.

I think the vets have done a nice job of getting the customers to migrate to the Trio, getting that upsell and the ticket there, and transferring share from, you know, Merck or BI or others that don't have that package. We have not seen the OTC space be significantly impacted, and we don't see that as a huge issue. I think it's an easy target for someone to call out, but not something I believe is translating there. From the services standpoint, when you look at our, you know, kind of key metrics, we're up about 18% on pets per clinic when we run those. That's a pretty significant number over last year, and we're up about 10% since Q1. We're seeing still acceleration in the pets per clinic.

Our average ticket last year was $88, and this year it's over $100, $102. Q1 was $95, so we saw another step change. A big part of the $88 to $102 was price increases we took versus last year. The change between Q1 and Q2 had no price changes, you know, contemplated in that number. You know, we've always prided ourselves to be the $100 visit and really doing that preventative care and that minor emergency stuff in that range. It's in line where we'd expect it to be, and it's hitting our margin criteria from that perspective. Our community clinics are really doing well right now. They've really accelerated back.

We've put in place, and a lot through John the last 60 days, policies that are requiring us not to wait for the market to get back to 2019 to start doing things different. We are putting in tougher operating metrics to drive profitability. We have a lot of aspirations for where that part of the business can be contributing in 2023, without having to get back to kinda pre-2019 type operating kind of environment. That, that's good. As far as the wellness centers go and how they're you know coming into the store base, again, we've never seen better tickets. We've never seen better pet counts accelerating.

They're still running about 15%, 20% behind where we would want them to be at that 18 months. They're a little behind where we want them to be. Some of that we believe is just the start-stop and getting them back and getting that awareness up and running. We definitely are starting to see that acceleration. Obviously you'll be able to see in the base how they're performing, you know, very soon as they are part of the numbers. I think, we're still very optimistic about what they will contribute and how they're going to perform and the long-term, you know, value they're gonna add, to the business.

I think all of us have a lot of neat things we're working on with that model to bring more dollars and more profit dollars into it. We'll be excited to talk about those in the coming quarters as John and others get more time to develop those.

Operator (participant)

Our next question will come from Jon Lawrence with Benchmark. Please go ahead.

Jon Lawrence (Head of Equity Syndicate)

All right. Thanks. Cord, could you comment a little bit about when you look at the retailers and you talk about their inventories and the trade down on pack size, is there any chance that you get stocked out on some of those lower-end pack sizes and are left with the high end that you didn't sell?

Cord Christensen (Chairman and CEO)

Fortunate for us, Jon, you know, we don't have inventory issues. You know, we manufacture our stuff in Omaha, Nebraska. We have plenty of raw materials and packaging and active ingredients to make whatever we need, and we're balancing our inventory levels perfectly to meet that. Our partners we distribute for, we've been out in front of this with them, showing them the trends and working with them on long-term plans. We don't believe we have any risk in not being able to capture every sales dollar that comes through the system, as it comes relative to inventory. I think, you know, we demonstrated pretty clearly for the last two years during the pandemic when we were well over 99% fill rates, even during the pandemic and such a tight supply chain.

The last two years, as you know, this category did extremely well, and we had to do lots of extreme increases in inventory needs during the pandemic to meet people's care when they couldn't get to the veterinarian. We're well positioned and well-trained to meet it. I don't think we'll see any of those issues be an issue in the back half of the year.

Jon Lawrence (Head of Equity Syndicate)

Yeah. Last question for me. Just, you've talked a couple of times about, I guess some new guidelines, operational changes, et cetera, coming next couple quarters. Then we've got some new product intros. Would you say this sort of more news is coming early, late fourth quarter? Would it be more like spring of 2023?

Cord Christensen (Chairman and CEO)

Well, I think there's a lot of different messages that we tell you people that there's different operating procedures and things that we're doing. Anytime you come into an inflationary market and people start talking about recessions, we're looking at everything as a business to make sure that we are running the business the way it was built, that have that same entrepreneurial spirit, that grit, that do more with less, type of an attitude. I think, you know, we've made a lot of acquisitions over the last four years. They've been very good acquisitions. We've taken some time to look at our business.

I think, you know, if you read into one of Zvi's commentary, I think, you know, on lower sales, we still think we can generate the same leverage on SG&A by delivering that same SG&A as a percent, which most companies that have had sales pressure in this environment, you've seen deleveraging on earnings and deleveraging on those numbers. I think we have put together plans and are implementing those now to deliver this year in a way that we think is prudent without remotely putting the long-term at risk. It's just, it's the right way to run the company in this environment and being prepared for the future. As it relates to, you know, big ideas and things that we're doing in the marketplace, that never changes no matter what the environment is.

We're trying to develop items that help people get better access to affordable pet healthcare. We think there's a healthy pet market out there with lots of tailwinds to drive the future of this company. If the market is a little bit smaller in a tighter economic environment, it's still a very large market that has needs for these great ideas to be out there, and we believe we're the best company at developing those, executing those with the best retail partner relationships to execute in this pet health and wellness space. We're still very bullish on the year and very happy where we're going. As we said, it's not 10% growth year-over-year, but it is 4% growth year-over-year in a tough market, and earnings are up year-over-year.

We're happy to work hard to get it, but that's what we're gonna do. We are still very bullish on the company's performance, our team, the execution, our partnerships, and our plans for the future. Hopefully that gives you a little insight to how we're thinking.

Jon Lawrence (Head of Equity Syndicate)

Great. Thanks for that. Good luck.

Operator (participant)

Our next question will come from Corey Grady with Jefferies. Please go ahead.

Corey Grady (VP of Consumer Equity Research)

Hey, thanks for taking my question, and apologies if you've already addressed this. Can you talk about performance and inventory levels by channel, maybe across both your brands and your distribution business? Maybe if you could talk about online versus brick and mortar, and then within brick and mortar, are there any notable differences? Thanks.

Cord Christensen (Chairman and CEO)

Yeah, that'd be great. Michael, do you wanna take that, please?

Michael Smith (President and COO)

Yeah. I think, you know, Corey, in general, as Cord and Zvi referenced earlier, that there is definitely an overhang of inventory throughout Q2 due to the lack of consumption in the category, and that overhang is falling over into Q3. In terms of specifics, I would say at an aggregate, you know, we're looking at a week and a half to two weeks of drawdown that we need to continue to work through here in Q3. That's gonna vary widely by customer, by item. There's some customers and some brands where they're chasing inventory. And then there's other brands and customers where they're very long on inventory. At an aggregate, I would say we're looking at about a week and a half to two weeks left to bleed off as we work through the rest of Q3.

Corey Grady (VP of Consumer Equity Research)

Got it. Thank you.

Cord Christensen (Chairman and CEO)

Thanks, Corey.

Operator (participant)

There are no remaining questions. With that, we will conclude our question and answer session. I would now like to turn the conference back over to management for any closing remarks.

Cord Christensen (Chairman and CEO)

We'd just like to thank everybody for joining us today. Obviously, when we started 2022, we had a very different view of where the market was and what was happening with the consumer. It's been very difficult to have to take the step change to address what the market's doing. We still feel extremely blessed that we're in such a great space with such great tailwinds, that we still are out delivering a significant number for this year and feel great about the leverage we're generating to drive the same EBITDA margin percentages off of those sales that we are doing that. I think we're just grateful for our teams that are working so hard to continue to work in this tough environment to deliver great results.

We're grateful for all of our retail partners and how they continue to lean in as we look into 2023 and start to put plans together to be ready for next year and see a lot of exciting things coming. We really appreciate everyone that joined us today. Look forward to our continued dialogue on the quarter and on the year, and look forward to finishing 2022 as strongly as we can. Thanks, everybody.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.