Q1 2024 PetIQ Inc Earnings Call

Participants

Katie Turner; IR; PetIQ Inc

McCord Christensen; Chairman of the Board, Chief Executive Officer; PetIQ Inc

Zvi Glasman; Chief Financial Officer; PetIQ Inc

Michael Smith; President, Chief Operating Officer; PetIQ Inc

Rupesh Parikh; Analyst; Oppenheimer & Co., Inc.

Jon Andersen; Analyst; William Blair & Company

Bill Chappell; Analyst; Truist Securities

John Lawrence; Analyst; The Benchmark Company LLC

Presentation

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the PETIQ. First Quarter 2024 earnings conference call. (Operator Instructions) Please note that today's event is being recorded.
I would now like to turn the conference over to Katie Turner, Investor Relations. Please go ahead.

Katie Turner

Good afternoon, and thank you for joining us on today's Hughes First Quarter 2024 Earnings Conference Call and Webcast for Christenson Chief Executive Officer, and Brad Glassman, Chief Financial Officer, will review today's prepared remarks.
Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could differ materially from actual events or those described in these forward-looking statements, please refer to the Company's annual report on Form 10 K and other reports filed from time to time with the Securities Exchange Commission and the company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.
Please note on today's call, management will refer to certain non-GAAP financial measures. While the company believes these non-GAAP financial measures will provide useful information for investors. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for definitions and a reconciliation of non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. In addition, package posted a supplemental presentation on its website for reference.
And with that, I'd like to turn the call over to Cord Christensen during Q2.

McCord Christensen

And good afternoon, everyone. We appreciate you joining us today to discuss our Q1 financial results. I'll begin with an overview of our Life Foods. We will review our quarterly financials and 2024 outlook. Finally, the Michael, John and I will be available to answer your questions. We are pleased by our start to 2024. We had a record Q1 with consolidated net sales of $308.4 million at the high end of our guidance. The consistent growth of our products segment fueled our financial results. The strength of these brands in Q1 led to favorable leverage of our costs with gross margin expanding 280 basis points to 24.2%. This helped offset higher SG&A expense when compared to Q1 last year, resulting in record profitability. Our net income of 14.9 million or EPS of $0.48 increased 47.8% from Q1 last year and Q1 2024. Adjusted EBITDA increased 15% year over year to $35.3 million, exceeding our guidance of 31 million to $33 million. This resulted in the highest adjusted EBITDA margin in the Company's history of 11.4%, an increase of 80 basis points from Q1 of last year. Based on the strong year-to-date results, we are pleased to raise our guidance for 2020 for net sales, adjusted EBITDA and free cash flow.
Focusing our product segment in more detail for Q1 of 2020 for the products segment contributed net sales of 276.9 million, an increase of approximately 7% compared to the prior year period. The growth in Q1 of this year was broad-based across all product categories. As we've discussed with you the last few quarters, when you look at all the sales channels combined for 2023, it was one of the strongest seasons in the last 10 years for the OTC flea and tick category, we are lapping that record season in 2024. And yet we continue to generate impressive growth from territories, brands, which were up 14.3% compared to the first quarter last year. This growth rate exceeded our expectations for the quarter. Our in-house sales and marketing teams are building significant brands in the pet categories that are growing both online and brick and mortar retail, while capturing a disproportionate amount of market share. In Q1, we spent an incremental 4.7 million on enhanced advertising and promotional efforts in line with our plan to step up in marketing for 2024. This step-up is included in our Q1 2024 adjusted EBITDA for Q2, we expect to spend 6 million more in brand-building and marketing initiatives than we did in Q2 last year. We are continuing to lean into investments and initiatives that we expect to support the long-term success of our brands.
I'd now like to focus on a few of our key category consumption highlights for the first quarter. In the first quarter of 2024 COTC. flea and tick category grew 6.2%, and Patrick Hughes brands increased 10.6%, got accused flea and tick brands gained share across all channels and at each of our top 10 customers while continuing to capture a disproportionate amount of the growth online and dramatically outperforming the broader category as evidenced by our market share results for the 12 weeks ended March 23rd, 2024 and IQOTC. flea and tick brands captured 15.8% of the category, which is an increase of 63 basis points versus the prior year period. Petsmart on countering total maintained its growth trajectory in the quarter, gaining 14.8% over the prior year period. This fast-growing category has nearly tripled in market size over the last five years and is now the largest category within the OTC animal health market. Our pets Avant brands continued to see accelerated consumption and growth in the first quarter of 2024, where offerings in this space grew 51.2% compared to the prior year period. This growth was driven by organic new brand, along with the successful launch of Racal and Roxy into the premium segment of the category. Strong household penetration trends along with expanded needs states in the past certain categories give us confidence that these double-digit growth rates to continue for many years to come. Competitors positioned very well to continue to gain share in this market. In addition, our pet general and treat offerings also outperformed the category in Q1, cemented and ParAllele brands both grew at three times the total category, leading to significant share gains. The Macy's brand grew 48% and gained 89 basis points of share in the dentistry category. The pure luxury brand also continues to gain momentum as it posted outstanding growth of 65% and Q1 versus a year ago. Our newest brand in our product portfolio, Rocco and Roxy, grew 23.4% from the first quarter of 2024. This growth was driven by our launch into the southern category and the core stain and odor off is also soft, healthy growth and good share within the market.
Shifting to the services segment, we had a slight net sales increase of 0.2% to 31.6 million compared to Q1 last year. We ran more mobile committed clinics across the country than a year ago and increased our pet counts to grow our services segment net sales and essentially offset the lost sales from 149 wellness centers we closed in the second half of 2023. Our services team continues to do an excellent job managing our contract labor to offer pet parents, convenient and affordable pet health and wellness options. We are also pleased with the significant operational improvements we achieved in Q1 of this year, which led to gross margin expansion of 810 basis points for the Services segment.
That completes my Q1 highlights. Before I turn it over to Harvey, I would like to thank our team across the country for their commitment to our mission of providing smarter pet health care and their continued support of Parex these core values.

Zvi Glasman

I'd like to now turn the call over to Steve Sanghi, cord today, I will discuss our Q1 financial results in more detail and our outlook for 2024. We're pleased with our start to the year. Our seasoned team generated strong growth across key brands increased both sales and profitability year over year. And the services segment optimization we completed in the second half of 2024 is already generating significant operational improvements for our business. For Q1 of 2024, the Company reported net sales of 308.4 million, an increase of 6.2% compared to Q1 of last year, driven by growth in the product segment. This was at the high end of our guidance for the quarter, driven by broad-based growth across sales channels and product categories of course, MENTIONED First Quarter 2024 gross profit was 74.5 million, an increase of 19.7% compared to 62.3 million in the prior year period. Gross margin increased 280 basis points to 24.2% from 21.4% for Q1 of last year. Growth and success of our higher margin manufactured brands was the primary driver of our margin expansion as well as operational efficiencies in our facilities. We also benefited from our Services segment optimization with a closure of 149 wellness centers in the second half of 2023.
From an SG&A perspective, as we noted on our Q4 call, we are spending more on marketing in 2024 to support our manufactured brands. As a result, first quarter adjusted SG&A increased 7.8 million to 47.1 million. And as a percentage of net sales. Adjusted SG&A was 15.3%, an increase of 180 basis points compared to the prior year period. The increase in SG&A was primarily due to an increase in marketing expense of 4.7 million, and the remainder was mostly normal increases in annual compensation expenses.
Adjusted net income was $18.5 million and adjusted EPS was $0.53, an increase of 32.5% year over year. Ebitda increased 20.2% to 32.2 million and adjusted EBITDA increased 15% to 35.3 million above our Q1 adjusted EBITDA guidance. Our adjusted EBITDA margin increased 80 basis points year over year to 11.4%. The highest in the Company's history, even with the step-up in marketing expense.
Turning to our balance sheet and liquidity, the company ended Q1 with total cash and cash equivalents of 25.4 million for 2024, we are raising our guidance for annual free cash flow from an excess of 45 million to in excess of 50 million from an inventory perspective, our inventory at the end of Q1 was a bit higher than normal for this time of the year. This is due to our planned seasonal build and the timing of available inventory from our distribution partners. As we progress through the flea and tick season in total from Q2 and into Q3, we expect our inventory to be more in line with our historical levels. Company's total debt, which is comprised of its term loan ABL. and convertible debt, was 443.9 million as of March 31st, 2024. In addition to our cash on hand, the Company's $125 million ABL is undrawn. Total liquidity, which we define as cash on hand, plus debt availability was 150.4 million as of March 31st, 2024. While we continue to have no intention of making additional borrowings, we would note that our liquidity is ample and our credit facilities are flexible. Our net leverage, as calculated under terms of our credit facilities at the end of Q1 was 3.6 times, an improvement from 4.5 times in 2023. Keep in mind, Q1 is always our highest leverage quarter of the year based on seasonal changes in working capital due to the annual increase in inventory to position us well for the flea and tick season on April 30th, 2024. Subsequent to the end of the first quarter we completed the sale of the Company's foreign subsidiary within the product segment, Mark and capital for approximately $4 million in net cash proceeds and the Company will receive future royalties for certain licensed trademarks and related intellectual property. As a result of the transaction, we expect to recognize an approximate 1.7 million loss subject to normal working capital adjustments in the second quarter of 2024.
Now turning to our guidance. As stated in today's earnings release, we are raising our full year 2024 net sales and adjusted EBITDA guidance that we previously provided on February 28th, 2024. Our 2024 full year outlook remains inclusive of the services segment optimization, the sale of the Company's foreign subsidiary, Mark and Chipotle, and a return to a more normal flea and tick season as compared to the record seasonal patterns experienced in 2023. These three items total approximately 52 million of net sales and 8 million of adjusted EBITDA on an annual basis. If you take these into account, our growth in 2024 would be significantly higher or represent a net sales increase of approximately 11% and an adjusted EBITDA increase of approximately 19% as compared to 2023. We've broken these variables out for reference in the outlook section of today's earnings presentation posted on the Investors section of our website, inclusive of the variables I just mentioned for the full year 2024, we expect net sales of $1,135 million, 1,185 million, an increase of approximately 5% based on the midpoint and adjusted EBITDA of 112 million to 117 million, an increase of approximately 10% based on the midpoint, including our step-up in marketing compared to last year, for the second quarter of 2024, we expect net sales of 325 million to $335 million, an increase of approximately 5% based on the midpoint adjusted EBITDA of 34 to 36 million, an increase of approximately 6% based on the midpoint, including the approximate 6 million of incremental marketing spend compared to Q2 of last year. Additionally, I want to reiterate that for modeling purposes going forward, our share count will vary during the course of the year due to the accounting rules regarding the Company's convertible notes. This will depend on a number of factors, including quarterly earnings for certain quarters in 2024, the share count will increase by approximately 4.8 million shares and our diluted EPS will be calculated on the same basis. Importantly, we currently have no intention of satisfying our convertible debt obligation with shares, but are required to report the Company's share count based on the theoretical increase.
That concludes my financial review cord. Michael, John and I are now available for your questions. Operator?

Question and Answer Session

Operator

(Operator Instructions) Rupesh Parikh, Oppenheimer.

Rupesh Parikh

Good afternoon. Thanks for taking my question and also congrats on a really nice quarter. So maybe maybe just starting out with the gross margin line. So your really strong performance across both the product side and the service side. So I know the product side typically mix can impact the delivery there, but at least on the surface, I'm just hoping to get some more color in terms of how you guys think about the sustainability of the level of gross margin delivery we saw in Q1?

McCord Christensen

John, I'll take that one because yes, there's three key factors that are driving it as you call it ever passed. So we just talked about the services element. So that's a key component of it. And then when you look at the mix of what's growing in our business, it's the manufacturing portfolio versus distributed is really benefiting in a big way. We expect that trend to continue. And I'll let Steve talk specifically to some of the key things we expect to continue as we trend into Q2 three and four?

Zvi Glasman

Well, I think if you're thinking about services specifically, we're going to see a lot of increases in services for the balance of the year. There's always some seasonality on, but we are going to be anniversarying closing 140, 49 wellness centers.
In terms of some of the improvements in product.

McCord Christensen

Yes, you're right.

Zvi Glasman

Some of that came from mix. But also we'd like to highlight that we had a fair bit of operational improvements and some of those are in our base in the back half of last year. So in total, we feel really good about margins moving up. And to the right this year, we had previously guided 50 basis points plus of margin improvement. We think it's more like 75 plus. Now we will tell you that every quarter won't be linear mix will impact it, and we're not really prepared to give margin guidance by quarter, but we feel really good about the trajectory of our margins over time on as we continue to contribute or are at which I know we highlighted in our release, our comments, and I'm sure you will have more comments about it as the call goes on freight.

Rupesh Parikh

And then maybe just a related question just on the environment. So you guys have tremendous momentum throughout your portfolio. But the pet category is clearly a challenge out there and you have some concerns about the US consumer as well. So I'd just love to hear just what you guys are seeing that, that category? And then just any shifts you're seeing from a consumer behavior perspective and refreshes according.

McCord Christensen

Thanks for the questions out of the system for their wood. So we're watching the product categories more than we were. There's definitely pressure on some of them that is different. And what we're seeing our categories are still in good organic growth. And obviously, we're growing significantly faster than the category. So we have dot-com seeing the consumer de-prioritizing, their pets' health care, where they are able to trade down and some of the other categories are going down.

Rupesh Parikh

Okay, great. And then just my final question. So just on the flea and tick season or I guess in terms of how you guys plan the year, any changes versus what your initial thoughts are in planning for an average year is essentially how it's playing out so far?

McCord Christensen

And Michael, why don't you take that one?

Michael Smith

Yes, in the past and when we modeled the year, we call it a five on a scale of one to 10 kind of an average year. If you were to look at the first three to four months of the season, we would say that the year to date scored more like a six and what we are projecting for the rest of the year would be consistent with that early read that we're seeing on the season. So slightly favorable compared to our original modeling, which had the category growing 3% category is actually growing closer to 4% to 5%. And as Cord mentioned, we're well north of that performance for our portfolio and we would expect pretty consistent trend throughout the rest of the year.
Looking at the weather patterns, Brian, any different metrics that we get to read, the tea leaves, if you will, on the quality of the season, tell us we should expect something like a five or six on a scale of one to 10.

Rupesh Parikh

Okay, great. Thank you. I'll pass it on.

Operator

Jon Andersen, William Blair.

Jon Andersen

Good afternoon, everybody. Congrats on the quarter. I wanted to ask about the marketing spending. Are you still planning on at this point spending?
I think that's an incremental $12 million for the year. What is the cadence of that? And if you can talk a little bit about how you're applying those dollars, obviously, you don't want to talk too much from competitive reasons, but kind of maybe big picture where those dollars are being applied in the products or and or services businesses.

McCord Christensen

And thanks, Tom. Thanks for the question. Yes, we are adding the 12 million that's on a base of 44. So we have significant investments already being made across the entire year. The incremental $12 million is heavily front year loaded. And so you'll see us spend of close to $10 million in the front half of the year. And then the balance will be spent in the back half, but we have ample spread across that. We don't love talking about where now we're spending for competitive reasons, but I can tell you that as we said before, we are measure it. We're seeing the return why we're exceeding our projections in the categories and on we feel good that we're still going into the right amount of spend for how we can affect our company's brands and our sales and profit. So you definitely can see in the numbers.

Jon Andersen

And are you seeing on the products business? Are you seeing both healthy demand on the the distributed side of your business, which is more national or premium and as well as your own? Or is there a trade down that that's helping manufactured brands I don't know if there's any anything you can kind of tease out from what you've seen so far in terms of consumer behavior and Michael's message.

McCord Christensen

I could take that first?

Michael Smith

Yes, I would say the overall health of the category is solid, right? So our outperformance isn't necessarily coming at the demise of other players in the category should be looked at the health of our distributed brands consumption. It is close to the expectation that we built for the year. If you look at our manufactured brands were obviously well ahead of the expectations that we had modeled. And again, a lot of that growth isn't necessarily coming as cannibalization. We are seeing some new customers come into the category or we're seeing some lapsed customers come into the category that's helping to generate kind of an overall bigger pie than we expected. And we are getting a bigger piece of that pie on than we modeled in the beginning of the year. So it's not that our distributed businesses are performing poorly. It's just that our manufactured brands are really accelerated team member from them.

Jon Andersen

Yes, that's helpful. One quick one. I think I may be wrong in this, but I think fairly unusual for you to raise at this point of the year. And could you talk a little bit about what gives you the conviction that maybe the one or two things that don't know, fitness, the least protect consumer and computer forensics, that incremental marketing spending more on what you're seeing that gives you that kind of conviction to raise at this point? Thanks, Jim.

McCord Christensen

Thanks for the question, John. We can grow. Obviously, we've historically not raised guidance in the end of the first quarter because we want to see second quarter consumption and get a real Paul Reid on some of the seasonal parts of our business. I think first and foremost, you're starting to see our other brands that aren't seasonal, picked up steam and are continuing to gain momentum. Their top line is growing at a higher percentage than what we did last year or projected flea and tick at a six add some incremental to it as well. And so right now, the consumption rates, we're seeing the way that we are seeing the market come. We felt very good about raising all three of those lines and and then lean in that way. And we hope to see the continued acceleration if we can we so maybe we don't see anything in the second quarter or third quarter, but we're definitely seeing the right trends right now.

Jon Andersen

Great. Thanks so much.

Operator

(Operator Instructions) Bill Chappell, Truist Securities.

Bill Chappell

Has the upside of a couple of is there any way to kind of bridge the gross margin expansion in terms of product mix versus it being manufactured versus distributed as compared to just on just channel mix. I'm just trying to understand, so how much of this was your products versus manufactured products and I mean versus versus third party product distribution business? And how much of this was actual just some gains in efficiency and overall sales?

McCord Christensen

I think, Bill, we said a couple of times that our products are doing extremely well at much higher margin. We've seen the overall average margin in that portfolio move up a little above where we were talking about from before. So we're better than the 56 plus some right now on and when your growth rates are 14.3 overall and you have categories where we're 50%, three times the category, flea and tick being a better than two times. That's going to be a contributor. We are getting extremely good at our plants. And as you get more throughput and get bigger with the efficiencies we find are paying dividends at a faster rate and then closing down stores that had a drag on and picking up the 810 basis points in services that we believe that we can retain throughout the year. It gives us a lot of confidence that we're doing the right things at the margin and in the right direction. So our mix for the quarter was really in line with our normal mixes. And so it wasn't a significant mix changes. The other things we just talked about. But obviously if I miss something or yes, Q4 was a court said it right?

Zvi Glasman

We had a little bit of benefit in mix, but it was not the biggest part of the story. It was one or 2% higher manufactured versus distributed versus last year. But by the same token, our manufactured business, our health and wellness brands in our Dental treats are growing faster and they carry a slightly lower margin than our flea and tick. So yes, I think everything cord said is right. This is as the margin improvements are real thing. We expect them to continue, albeit at a different rate throughout the course of the year. That's why we've signaled that will be up 75 bps plus in margin for the year.

Bill Chappell

Got it. Maybe just to follow on from I thought there was a a distributed product, a new product in the market kind of a three and one that was started last year that you thought was going to drive a lot of the revenue growth, which would have pushed down margins. Was that not the case that I guess I was thinking there's there were some headwinds just from that standpoint.

McCord Christensen

Yes. I mean, the product is launched. It's doing extremely well. We're starting to see a pickup. It was a direct contributor to the excess inventory that people will refer to as you look at you talk to them, but again, the timing of the season and what's going on in first quarter was not a volume and was the consumption rates were watching. We've taken that into account. It's a cycling. So capture that 75 plus basis points improvement to margin. We talked about.

Bill Chappell

Okay. And then in terms of kind of what you're seeing for Grove and Roxy, and I thought this was a quarter where you'd see pretty meaningful distribution gains. I think that's that's right. Did you get those gains? Are they on the shelf? And should that show up more as we move forward through this year?

McCord Christensen

Michael, you want take that one please?

Michael Smith

Yes, we had a few big expansions planned that have played out as expected. Last quarter. We talked a little bit about the launch of Rockwater Oxy into the supplement space those points of distribution have played out as expected and they were later in Q1 and will have a bigger impact in Q2 and the rest of the year. Our large bone launch at the mid-teens brand also hit our expectations and a little ahead of that in the quarter. And then a couple of other expansions within our flea and tick portfolio that all have played out as expected as these planograms modulars for the kickoff to 2024 a bit the stores.

Bill Chappell

Okay, great. And then one last one on services. Any changes on kind of just the overall vet population in terms of hiring and even for the mobile clinic side.

McCord Christensen

Now we are the key for us is we've been really focused on the key wellness centers that generate the most income for us. And we've had success in landing events in key locations that we need. But more importantly, we have a very healthy pet sorry, that population and the community clinic side. So continuing to have on average about 35 hundreds that in that population, as a reminder, kind of peak COVID timeframe, we only had about 800. So we're really happy with how that's climbed back up. And we're seeing it in our cancellation numbers, which was called out by cord cancellation numbers are low as low as they've been back in 2019 to really proud of the team and rallying there and getting the for that population back-end.

Bill Chappell

Great. Thanks for the color.

Operator

John Lawrence, The Benchmark Company.

John Lawrence

Congrats. Could you talk about following that last question, just a little bit more on that services optimization, obviously getting that sort of of the fill rates and everything in that business better than what it's been in the last couple of years. Can you dig in a little bit more of what you did to optimize that mobile clinic business? Is it is it all just starting the absenteeism? What did you do to really optimize that.

McCord Christensen

The mobile clinic business? Yes, it's across all the services business, not just to mobile. It's also the wellness centers that some contribute some public when you close stores like we did there is going to be a pickup from underperforming stores. We've put a lot of controls and operational on controls on all of the stores. We're running more community clinics than they have a yes, higher profitability and margins that they drive. And I think just in general, we've really made sure that as we've kind of got further and further away from all the closures that took place during COVID and all the cancellations to where we were. We're really solving for a lot of those problems. So you're overcoming labor issues that we had coming out of COVID. We're closing stores that we're just never going to great like we said, and you add all those up together. And that's why you're seeing the margin improvements and the contribution go in our direction.

John Lawrence

Right, thanks. Secondly, Rocco and Roxy, can you can you go back and talk about the plan when you looked at that ACQUISITION now you've had it for a period of time, is doing extremely well. Is that the is that the best example or a base case how we should look at possibilities? How you extend the business and extend the categories going forward?

McCord Christensen

Yes. Thanks for the question. Joe. Look, we are feel like we're running our all of our brands, our categories in the same way, and we're seeing great results across all of the business by doing that Rocket. Roxy is a great example of when we make an acquisition that we have line of sight to very quick improvement in placement and certainly our product extensions and a number of ways to improve it. And we've done it a number of times, frankly, most of our acquisitions have been very similar to that. So I would say we're very smart to find acquisitions that our great brands that we can input our ability to really improve everything about it, whether it's manufacturing, whether it's efficiencies across just people paid store count, it's products, you name. It is just a great example. And yes, it's done extremely well. And the team has done extremely well is getting placements for the extensions, and we're seeing the brands are really performing well across all channels right now. So we hope we hope to continue to do that across our existing brands, our brand and all the ones that come in the future and not to really go too far with that core.

John Lawrence

But would that be even when you look at that example, it's both top line and bottom line from for their original stripes plan. Is that right?

McCord Christensen

Yes, we're ahead of on our plan on the growth rate for the top line. And we've said many times that we paid in oh eight, 8.5 times trailing and expected to be kind of that four to five on a run-rate basis within six months, and we've been ahead of schedule on both top and bottom.

John Lawrence

Great. Congrats, and thanks.

Operator

(Operator Instructions) And this does conclude our question and answer session for today. And I would like to turn the conference back over to Cord Christensen for any closing remarks.

McCord Christensen

Just first, like to thank all the great people at PetIQ you that keep delivering such great work to deliver great results and just feel really, really great about how the Company continues to get better and better every day.
What we do and thank all the shareholders and analysts I wanted to show up and challenge us and we could interact with as we talk about those great results. So look forward to talking to many of you over the next few days and we look forward to talking again, we get to the end of second quarter and thanks for joining us today for the.

Operator

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.