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Edited Transcript of CVET.OQ earnings conference call or presentation 10-Nov-20 9:30pm GMT

·39 min read

Q3 2020 Covetrus Inc Earnings Call Nov 11, 2020 (Thomson StreetEvents) -- Edited Transcript of Covetrus Inc earnings conference call or presentation Tuesday, November 10, 2020 at 9:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Benjamin Wolin Covetrus, Inc. - CEO, President & Director * Matthew J. Foulston Covetrus, Inc. - Global CFO * Nicholas Michael Jansen Covetrus, Inc. - VP of IR ================================================================================ Conference Call Participants ================================================================================ * Andrew Harris Cooper Raymond James & Associates, Inc., Research Division - Senior Research Associate * John Charles Kreger William Blair & Company L.L.C., Research Division - Partner & Healthcare Services Analyst * Jonathan David Block Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst * Nathan Allen Rich Goldman Sachs Group, Inc., Research Division - Research Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good afternoon, ladies and gentlemen, and welcome to the Covetrus Third quarter Earnings conference call. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Mr. Nick Jansen, Vice President, Strategy and Corporate Development. -------------------------------------------------------------------------------- Nicholas Michael Jansen, Covetrus, Inc. - VP of IR [2] -------------------------------------------------------------------------------- Thank you, Ashley. Good afternoon, and thank you for joining us for our third quarter 2020 earnings conference call. Joining me on today's call are Ben Wolin, our President and Chief Executive Officer; and Matthew Foulston, our Executive Vice President and Chief Financial Officer. Ben and Matthew will begin with prepared remarks, and then we'll be happy to take your questions. During today's conference call, we anticipate making projections and forward-looking statements based on our current expectations. All statements other than statements of historical fact made during this conference call are forward-looking, including statements regarding management's expectations for future financial business, operational performance and operating expenditures. Forward-looking statements may be identified with words such as will, expect, believe, should, or similar terminology and the negative of these terms. Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those contemplated in these forward-looking statements. These risks and uncertainties include those under the heading Risk Factors in our most recent annual report on Form 10-K, quarterly report on Form 10-Q and other periodic reports filed with the Securities and Exchange Commission, which are available on the Investors section of our website at ir.covetrus.com and on the SEC's website at www.sec.gov. Forward-looking statements speak only as the date hereof, and except as required by law, we undertake no obligation to update or revise these forward-looking statements. You can find this afternoon's press release announcing our third quarter 2020 results and the accompanying slide presentation for this call on ir.covetrus.com. The release and presentation also contain further information about the non-GAAP financial measures that we will discuss today. Please refer to those documents for a reconciliation of non-GAAP measures to our GAAP financial results. With that, I will now turn it over to Ben to provide the highlights beginning on Slide 3. -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [3] -------------------------------------------------------------------------------- Thanks, Nick, and good afternoon, everyone. We hope everyone listening in on today's call remains well and is successfully managing through the stress and challenges created by COVID-19 as safely as possible. On the call today, we will summarize our quarterly financial results, update you on our improving market position amid strong and resilient end markets, detail the progress we are making on executing on our strategic priorities, highlight our recent investment in veterinary study groups and describe how we are positioning ourselves for success and growth in 2021 and beyond. To start, I want to emphasize how proud I am of our team. Across the globe, the Covetrus team has continued to rise to the challenge. Most recently, we successfully executed and delivered strong results during the third quarter despite continued headwinds created by the COVID-19 pandemic. I am thrilled at how we have created a shared culture of success and how we have embodied our mission in everything we do, always striving to support veterinarians and animal health professionals across the globe, to manage and grow their businesses and deliver exceptional clinical care. It is clear that our focused approach, commitment to our team and our customers and our investment in service and innovation has served us well and enabled us to win new business and drive greater alignment with our strategic partners. Our foundation is solid. Our industry is growing. Our differentiation in the market is evident, and our outlook is bright. Now turning to the numbers. We delivered 12% year-over-year organic net sales growth and 20% year-over-year adjusted EBITDA growth in Q3 and have increased our 2020 guidance again. Importantly, our robust Q3 performance cut across all 3 business segments where we not only grew adjusted EBITDA, but also expanded our adjusted EBITDA margins. This strong growth was accomplished without the incremental COVID-19 tailwind in our prescription management business that was present in the first half of the year. Still, our prescription management business was able to deliver net sales growth of 43% year-over-year, a number we are quite pleased with. This growth rate is notably faster than our pre-COVID-19 growth rates as our focus on customer engagement continues to gain steam. We are encouraged by the progress this business has made in scaling its operations while significantly investing in pharmacy capacity and innovation during Q3 in preparation for another projected year of strong growth in 2021. Our progress and improved financial condition also enabled us to make an investment in veterinary study groups in October, which accelerates our strategy to strengthen our customer relationships. Clearly, there was a lot to be encouraged by in our fiscal third quarter, and I'm proud of our team's efforts and accomplishments over the last 12 months, including definitely navigating our business operations during this global pandemic. And yet, there are still many growth opportunities for us in the year ahead as we drive forward with our technology-enabled strategy. These possibilities keep me optimistic about our future as we further synchronize our capabilities in 2021 and beyond. Now briefly turning to our end market on Slide 4. Activity inside veterinary clinics in the U.S. remained strong throughout the third quarter tied to pent-up demand and increased pet ownership and related spending during the pandemic with veterinary practice revenue growth rates now back to or above pre-COVID-19 levels. This positive trend has generally continued through the month of October. Additionally, it is becoming more apparent that COVID-19 and social distancing has further strengthened the human companion animal bond, which bodes well for the future growth rate of our category. These same trends are also occurring globally with many of our international markets, seeing strong growth during Q3, following the pandemic driven slowdown in Q2. While there are still many unknowns as we learn of new shutdowns and emerging coronavirus cases to start Q4 across many of our geographies around the world, we are still encouraged by the resiliency of consumer demand and the animal health community to date. Regardless of short-term ebbs and flows, it is clear that the long-term trajectory of the global companion animal market is on a strong footing, and we remain enthusiastic about our differentiated portfolio of capabilities. Our unique value proposition positions us to capitalize on the tailwinds and emerging trends in the market. Turning to Slide 5. We outlined 4 priorities earlier this year to drive our strategy forward. Overall, I'm pleased with our progress and execution, the energy inside the company and the momentum we are seeing across our business. First, driving our new way of working, along with retaining and recruiting the best talent has and will continue to be a critical focus of ours. During Q3, for example, we added several senior leaders in crucial roles to support business' needs. Additionally, to drive real and lasting change and in support of an anti-racist, diverse, inclusive and equitable culture at Covetrus and we have now devoted dedicated resources and launched a new global diversity and inclusion, or D&I, governance and community program at the company. This includes establishing a global advisory board and naming a number of global business unit and regional D&I leaders dedicated to driving forward with our commitments, focusing on strategic D&I areas and ensuring local support. In August, we also launched the Covetrus hardship fund to help our colleagues with COVID-19 illness related hardship. I am convinced we can make our company, our industry and our society a better place to be, and I'm energized by the passion our team has in driving our mission forward. Second, we expanded adjusted EBITDA margins across all of our business segments during the quarter as we continue to make progress on our commitment to drive focus improve effectiveness and increase efficiency throughout the organization. Cost containment and resource allocation remain key priorities for our team as we are committed to taking concrete action to drive long-term margin expansion across our business. One example of this would be our recent decision to exit our distribution operations in France. While we will maintain our technology footprint in France, the distribution business had gross margins well below our corporate average and was losing money, given our lack of scale in the market. While this was a difficult decision to make, it was the correct one as we are focused on investing in markets and businesses that can help accelerate the company's growth, returns and margin profile long term. Differentiating our capabilities and driving our proprietary products and solutions was our third strategic area of focus, and I would highlight another quarter of solid net sales performance and profit contribution delivered by our prescription management business. As we expected and described on our Q2 call, the COVID-19 related demand that benefited our first half results slowed in Q3 as veterinary clinics and specialty retail stores opened up more broadly as shutdown restrictions eased across most states. However, year-over-year net sales growth of 43% during the quarter was still in excess of what we experienced in 2019 and in early 2020 prior to COVID-19. Demonstrating the underlying strength of the online channel and our strategic positioning within it. In addition, we delivered 23% year-over-year same-store sales growth during the third quarter compared to 16% growth for all of 2019. Highlighting the success of our customer engagement initiatives that we launched this year and showcasing the significant opportunity we still have in growing our customers' market prospects and driving incremental demand for our supplier partners. With deeper engagement and continued manufacturer support of the online channel, we believe we can sustain this elevated level of same-store sales growth annually over the medium term. I would like to point out that this robust same-store sales growth happened during a quarter when we also delivered strong distribution sales as clinics were ordering more products from us to service increased patient activity inside their practices. This signals that these 2 channels in clinic and online can be complementary with the platform helping our customers strengthen their client relationships, improve medical care and prescription compliance and grow their businesses. Moving to our final strategic priority, globalize. During the third quarter, we finalized the framework for our next-generation practice management software road map where we plan to embed prescription management, client communications and various other third-party applications inside the PIMS, creating a singular platform experience for our customers. The development of this unified cloud-based solution is expected to take 12 to 18 months to complete. We also furthered our progress on the technical development work to bring prescription management to Australia and New Zealand in the second half of 2021. We have a significant distribution and software footprint in these markets, and these customers are eager for us to bring e-commerce and prescription management capabilities into their practices to help them compete more effectively and grow their businesses. Now turning to Slide 6. I would like to spend the next few minutes discussing our recent strategic investment in Veterinary Study Groups, the leading provider of peer-to-peer learning experiences for veterinary practice leaders in North America. VSG manages a family of more than 50 veterinary management groups or VMGs in the United States and Canada, with these groups comprising more than 1,100 members who together own more than 1,500 veterinary practices. This expanded relationship brought together 2 highly complementary organizations, each dedicated to veterinary practices and committed to driving enhanced patient care empowering veterinarians to run better businesses and advocating for the veterinary professions. We anticipate our deeper partnership, along with our scale and portfolio of solutions, will provide tangible improvements to VMG membership benefits over time as well as help VSG identify potential new members that would benefit from the VMG experience. The investment also serves an opportunity for us to accelerate our strategy to drive increased customer alignment and engagement, similar to what we did when we acquired PSIvet in the U.S. and the Premier Buying Group in the U.K. several years ago. These investments were highly successful for Covetrus. With PSI net sales and adjusted EBITDA, for example, growing in excess of 40% and 50%, respectively, since our deeper partnership was formed back in late 2016. And while Matthew will provide more detail on our capital allocation strategy later in the prepared remarks, VSG is consistent with our philosophy of looking for investments in the veterinary channel that are accretive, at scale, offer new avenues for driving our proprietary products and solutions and enhance our overall growth and margin profile. In short, we are enthusiastic about the growth prospects of VSG as we work together to build upon their long-standing success in the marketplace and drive new value for their members. Finally, turning to Slide 7. Let me address how we are positioning Covetrus for growth in 2021 and beyond. We are focused on improving our commercial effectiveness in order to create greater strategic and financial alignment with our customers in support of our goal of making it even easier and more profitable for them to do business with Covetrus. And in 2021, we will work hard to continue to drive increased alignment across our commercial teams to support a more seamless and technology-enabled end-to-end experience for our customers, which we believe drives better health care outcomes, efficiency and revenue growth for their practices. Greater teamwork and enhanced collaboration will also help us secure new business, expand our share of wallet and reduce our cost to serve. Supporting our proprietary brands and compounding businesses and executing against our platform engagement strategies in North America should also improve our margins and afford us the opportunity to further invest in our growth initiatives. We will focus in 2021 on helping our veterinary practice partners leverage technology to market their businesses more effectively and to deliver an enhanced consumer experience. These customer investments will provide a halo-like effect for Covetrus as increased activity inside the practice supports growth in our distribution business and an improved pet owner experience on the prescription management platform should drive increased adoption and engagement for the online pharmacy service. As a reminder, approximately 5% of our customers' clients currently shop on their online storefront, highlighting the significant growth still available to us as we make it easier for the pet owner to shop on their veterinarian's website. We also have the opportunity to improve engagement with the 1.5 million unique pet owners we have provided service to year-to-date. Lastly, I would highlight our ongoing investment in B2B e-commerce and new software integrations and partnerships, which are designed to make it easier and more seamless to order products from Covetrus, including our proprietary products. This and our investment in sourcing excellence will enable us to provide greater value to our customers while also enhancing our margins over time. Overall, I'm very enthusiastic about our ability to drive the business forward. 2020 has been a foundational year, and our focus on the core drivers of our business are now ingrained into our day-to-day operations. We are making investments to support our momentum and are confident in our ability to drive growth in 2021 and beyond. I will now turn the call over to Matthew to provide a financial review of our third quarter. -------------------------------------------------------------------------------- Matthew J. Foulston, Covetrus, Inc. - Global CFO [4] -------------------------------------------------------------------------------- Thanks, Ben. Good afternoon, everyone, and thanks for joining us today. I will now review our third quarter 2020 financial results, discuss our outlook for full year 2020, and provide some preliminary thoughts for 2021. The focus of my comments will be on our non-GAAP results where applicable as these items provide the most insight into the underlying trends impacting our businesses. Please refer to today's press release for a more detailed description of our second quarter GAAP results. As summarized on Slide 9, Q3 was another strong quarter for Covetrus, with all 3 reporting segments contributing to our significant growth and outperformance versus external net sales and adjusted EBITDA expectations for the quarter. Robust end market demand, our strong operating execution and the continued scaling of our fast-growing prescription management business drove a 20% year-over-year increase in adjusted EBITDA and fueled 40 basis points of year-over-year adjusted EBITDA margin expansion during the third quarter. Additionally, with strong earnings and ample liquidity, the team can act more strategically with respect to capital deployment, including our investment in VSG, which Ben described earlier. Turning to the details and starting at the top of the income statement on Slide 10. Covetrus net sales were approximately $1.13 billion in Q3, an increase of 11% year-over-year on a reported basis. Organic year-over-year net sales growth was 12% during the third quarter, reflecting healthy companion animal market trends, that are tracking at or above pre-COVID-19 levels across many of our major geographies, improving sales execution and market position in a number of our key markets and the positive trajectory of our prescription management business. In fact, the 12% organic year-over-year net sales growth delivered during Q3 was the strongest in the company's history, and reflects broad-based momentum across all businesses. Turning to Slide 11. Consolidated non-GAAP adjusted EBITDA was $59 million for the third quarter of 2020 and versus $49 million in the prior year. The 20% year-over-year improvement reflected increased contributions from all of our segments, even as we made investments in the business, and certain costs were slowly added back in Q3 as COVID-related cost containment measures were eased. Moving to our operating segments, beginning on Slide 12. North America organic net sales increased 14% year-over-year in Q3, and segment adjusted EBITDA increased 15% year-over-year with segment adjusted EBITDA margins expanding 10 basis points versus the prior year. Strong organic net sales growth in our distribution business, and another quarter of greater than 40% net sales growth in our prescription management business contributed to our positive performance. Drilling deeper into North American segment trends, our distribution business, organic net sales increased approximately 10% year-over-year in Q3 reflective of healthy end market demand and our improved market position. External third-party data indicated that our U.S. distribution business experienced continued improvement in companion animal market share during the third quarter relative to the prior year, reflective of our better execution over the last 12 months. Our software business in North America also delivered modestly increased revenue and profitability year-over-year during Q3, with strong performance in our credit card processing business, tied to increased patient volume inside our partner practices. Turning to Slide 13 and our prescription management business in North America. During the third quarter of 2020, net sales increased 43% year-over-year to $104 million, and we ended the quarter closing in on nearly 11,000 practices on the platform. As we expected, net sales growth decelerated from the record growth rates witnessed in March and Q2, reflecting COVID-19 peak e-commerce demand. However, the 43% year-over-year prescription management net sales growth tracked above our pre-COVID trajectory as the business continues to benefit from new customer and client engagement strategies. Encouragingly, we have not yet seen any behavior differences between those pet owners who began shopping on their vets online storefront, powered by Covetrus during COVID-19 as compared to prior cohorts providing a foundation for future growth in the quarters ahead. In aggregate, and without a COVID-19 tailwind like last quarter, same-store prescription management platform net sales defined as veterinary practices enrolled on the platform in 2018 or earlier, increased 23% year-over-year during Q3, which was well ahead of our historical mid-teens same-store sales growth trajectory. We are also seeing strong performance out of our 2019 cohort, with average first year revenue per practice of nearly $20,000 for those practices with a full year of data. This is a 20% increase over our previous high watermark for first year revenue with our 2015 cohort and a 34% increase as compared to our 2018 cohort. This reflects more engaged and productive enrollments since the merger closed. Importantly, the early data out of our 2020 cohort would suggest similar successes. We are also very pleased with how the prescription management business is scaling. With Q3 adjusted EBITDA of $6 million or a $4 million improvement versus the prior year. As anticipated, adjusted EBITDA declined sequentially as COVID-19 cost measures were eased, and we invested in pharmacy operations, the pet owner experience and technology enhancements to advance our market-leading position. Year-to-date, 20% of the year-over-year dollar growth in net sales has dropped down to adjusted EBITDA, and we continue to target 15% to 20% on a rolling 12 months basis. And that still allows room for significant investment back into the business. Turning to our European business segment on Slide 14. Organic net sales increased 8% year-over-year in Q3 reflecting COVID-19 recovery in many of our markets as well as another quarter of strong sales execution by our European team. We had healthy Q3 organic net sales performance from our businesses operating in Ireland, The Netherlands and Belgium. In the U.K. Our largest European market, net sales increased by more than 10% organically year-over-year as the COVID-19 recovery in that market that started in late Q2 continued throughout the third quarter. Strength in these markets helped offset weakness in Germany and France, with our French distribution business continuing to suffer from a lack of scale in a very competitive market. Given this challenge, we have made the decision to close our distribution operations in France and prioritize our efforts in our other European markets, where we have momentum and opportunity to profitably grow our share. Turning to profitability. European segment adjusted EBITDA increased 27% year-over-year to $19 million with margins expanding 80 basis points year-over-year to 4.7%, reflecting strong operating leverage and good expense control. Moving on to our APAC and Emerging Markets segment on Slide 15. Our team delivered a 16% year-over-year increase in organic net sales in Q3, building on our recent momentum, and reflecting strong sales execution. Similar to last quarter, we saw notable strength in Australia and Brazil, with recent customer wins, driving the accelerated performance. New Zealand returned to year-over-year organic net sales growth in Q3, but is still tracking below pre COVID-19 growth rates. Segment adjusted EBITDA increased 60% year-over-year during Q3, and margins expanded by more than 200 basis points year-over-year, driven by the operating leverage from better-than-expected net sales activity as well as continued cost discipline. Turning briefly back to our consolidated results. Q3 GAAP net loss was $35 million or a loss of $0.33 per diluted share. Non-GAAP adjusted net income, which excludes special items as well as acquisition intangibles amortization and other items was $30 million in Q2 versus $19 million in the prior year period. Now turning to our balance sheet on Slide 16. Our reported net leverage at the end of the third quarter was 3.6x as compared to the 3.5x at the end of the second quarter as working capital increased versus Q2 levels. Primarily tied to inventory buying to support higher sales activity. This resulted in our cash balance dropping to approximately $355 million at the end of September. However, the significant improvement in adjusted EBITDA year-over-year provided a nearly corresponding offset in the net leverage calculation. We ended the third quarter with more than $650 million in available liquidity and with 1.9 turns of headroom under our net leverage covenant defined in our credit agreement. Now turning to our guidance, as outlined on Slide 17. We forecast adjusted EBITDA in the range of $213 million to $218 million for 2020, which compares to our prior outlook of $200 million to $210 million. This is the second increase to our guidance since the start of the year. This outlook presumes no new major lockdowns tied to COVID-19 in Q4 and no substantial changes to the current environment. As we think about the fourth quarter, our outlook factors in the planned investments in people, technology advancements and capacity to support our growth plans in 2021, particularly prescription management. Additionally, we expect higher shipping costs in Q4 as a result of COVID-19 related surcharges, and we anticipate moderate disruption in Europe, tied to our 3PL transition in Germany in October, which has created some short-term challenges for our business in that market. We also remind investors that Q4 2019 results included scil, which generated $3 million in adjusted EBITDA, and there is also a $2 million year-over-year headwind tied to higher bonus accruals, given our strong operating performance this year. Adjusting for these impacts, the underlying business continues to show healthy earnings growth. While the animal health category has clearly outperformed in 2020, there still remain a number of COVID-19 related uncertainties around the world, which is keeping us conservative with how we manage and approach the business. Given this on where we are in our 2021 planning process, we are not yet able to provide specific guidance for the upcoming fiscal year. However, based on our preliminary assessment of some of the critical moving pieces for 2021, we are currently targeting approximately 10% to 15% adjusted EBITDA growth in 2021 from the midpoint of our 2020 guidance. This is an acceleration in the rate of growth expected for 2020 and compares favorably to the current consensus growth outlook of 10%. Note that this early 2021 preliminary assessment does not include any material incremental COVID-19 impacts. Key tailwinds for 2021 and including include an increasing contribution from our prescription management business, ongoing supply chain share gains, modest accretion from our VSG investment and the benefit from certain cost reduction initiatives. Headwinds include further investments necessary to support innovation and to deliver a better practice and pet owner experience, increased head count to complete the build-out of our corporate functions. Manufacturer changes in the U.K. that will significantly reduce net sales in that market, but at below corporate average margin. Higher employee costs as COVID-19 cost containment measures have been relaxed and more normalized levels of travel. We will look to provide official guidance when we report Q4 results in late February, or early March next year. With our balance sheet now in better shape, tied to the strategic actions we have taken this year, I thought it would also be useful to outline our capital allocation priorities and how we think about leverage and capital deployment moving forward. This can be found on Slide 18 of the deck. We target reported net leverage in the range of 3 to 3.5x over the long term, a level we believe is appropriate given the stability of our business and the inherent free cash flow generation of the company, which should approach 50% of adjusted EBITDA over time, particularly now that some of the major onetime costs tied to the formation of Covetrus are winding down. As we think about capital deployment, we will continue to pay down debt as required by the mandatory amortization schedule, and we'll look to selectively deploy the balance of our available capital into internal growth projects and potential tuck-in M&A transactions, all with an eye towards our strategic focus areas: compounding, software and proprietary products and solutions. We would opportunistically consider larger scale M&A, but always with an eye towards generating double-digit returns by the end of year 3 post-transaction date, and getting back to our targeted net leverage range within 12 to 18 months of any potential future transaction. In all situations, our focus would be on higher growth and/or higher-margin acquisition targets. Finally, before handing the call back over to Ben, I want to provide a brief update on our 7.5% Series A convertible preferred stock on Slide 19. With the doubling of our stock price since issuing the preferred stock, we were able to convert approximately 2/3 of those shares into common stock in September, which saved us $12 million in annual cash dividend payments. We are currently seeking shareholder approval to convert the remaining shares of preferred stock into shares of common stock with a special shareholders' meeting scheduled for next week. If successful, we will save an additional $6.8 million in annual dividend payments, and our pro forma common shares outstanding would be approximately 136 million with no preferred shares remaining outstanding. With that, I'll now turn the call back over to Ben for some brief closing remarks. -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [5] -------------------------------------------------------------------------------- Thanks, Matthew. In closing, and as outlined on Slide 20, our end market is strong and has proven durable during COVID-19. And our value proposition is clearly resonating in the marketplace, which is giving us confidence to further invest in people and innovation to advance our customers' growth objectives. We are confident in our strategy, which is centered around winning with the veterinarian and the pet owner on behalf of the veterinarian, and we now have a strong foundation in place that we can leverage moving forward. We entered the last quarter of 2020 with good visibility and are cautiously optimistic about our growth prospects in 2021 and beyond. This concludes our prepared remarks. And I will now turn the call back over to Nicholas Jansen to moderate the Q&A session. -------------------------------------------------------------------------------- Nicholas Michael Jansen, Covetrus, Inc. - VP of IR [6] -------------------------------------------------------------------------------- Thanks, Ben. Now we begin the Q&A section of our call. We want to take as many questions as possible, so we ask that you limit them to 2 and then reenter the queue. Should you have additional ones. So Ashley, please provide instructions, and we are ready to take the first question. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) And your first question comes from John Kreger with William Blair. -------------------------------------------------------------------------------- John Charles Kreger, William Blair & Company L.L.C., Research Division - Partner & Healthcare Services Analyst [2] -------------------------------------------------------------------------------- Ben, you mentioned the exit of the distribution in France. Can you just size that top and bottom line impact for next year? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [3] -------------------------------------------------------------------------------- Sure. John, good to hear from you. The business, nominal impact on the bottom line and several hundred million dollars on the top line. -------------------------------------------------------------------------------- John Charles Kreger, William Blair & Company L.L.C., Research Division - Partner & Healthcare Services Analyst [4] -------------------------------------------------------------------------------- Great. And then I think you mentioned earlier in the call, a decision on the -- sort of to move to a cloud-based integrated PIMs for the non-U.S. business. Can you just kind of elaborate on that a little bit more? And does that change your plan for rolling out prescription management ex U.S.? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [5] -------------------------------------------------------------------------------- Yes. And John, to clarify, our long-term vision is to move to cloud-based technology for the PIMs globally, not just ex U.S. We'll, of course, continue to maintain, upgrade and improve the existing on-prem products and services, but we definitely see that in terms of new customers in the market that will migrate to a cloud-based plan. I think in addition to that, the benefit isn't just more maintainable piece of software that can be easily upgraded, but it's also a software that allows us to integrate in prescription management, appointment management and a host of other services. So it really sits as kind of the operating system and the foundation of what we have and is a great gateway for the other parts of our business. -------------------------------------------------------------------------------- John Charles Kreger, William Blair & Company L.L.C., Research Division - Partner & Healthcare Services Analyst [6] -------------------------------------------------------------------------------- And again, just to clarify, does that change the time line to roll prescription management out ex U.S. -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [7] -------------------------------------------------------------------------------- No. It does not. We're still scheduled to do that in the back half of '21. -------------------------------------------------------------------------------- Operator [8] -------------------------------------------------------------------------------- Your next question comes from Jon Block with Stifel. -------------------------------------------------------------------------------- Jonathan David Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [9] -------------------------------------------------------------------------------- Great. I'll start with the North American distribution business, I think you cited stable market share gains. Ben, maybe just your confidence that this is the new normal, the stable share, which seems to have been the case the past couple of quarters. And with what you're willing to share or willing to provide, can you just talk to some of the changes that you made within the organization, which arguably helped stabilize the market share? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [10] -------------------------------------------------------------------------------- Yes. I think -- well, first of all, Jon, good to hear from you. I think actually, we've seen a slight tick up in share. If you look at the overall growth rate of the market, in the stats that we had and then our growth rate in North America, you can see that the growth rate in North America exceeds the market growth. So we feel good that we're actually probably have a slight expansion of share. And while we still feel like we have a lot of work to do and lots of opportunities in front of us. We feel like there's a good stable foundation. And this is now several quarters in a row where we've either stabilized and held share or expanded it. So we feel good about our position and how the next year is shaping up. -------------------------------------------------------------------------------- Jonathan David Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [11] -------------------------------------------------------------------------------- Okay. Fair enough. And maybe Ben or Matthew on the next one. The prescription management, what we call drop-through step down from -- I think last quarter was a record and around 28%. You guys certainly signaled that it'd be lower. You were going to come up on some investments. It moved to low double digits, still 20% year-to-date. And I think, Matt, you might have mentioned 15% to 20% drop-through going forward. Maybe a 2-part question. What's the delta between a 15% drop-through to 20% drop-through going forward? Is that strictly just a function of the top line? And then do we think about it being closer to the lower band, the 15% over the next handful of quarters? As arguably, you put in place some investments in front of the international launch. -------------------------------------------------------------------------------- Matthew J. Foulston, Covetrus, Inc. - Global CFO [12] -------------------------------------------------------------------------------- Yes. It's Matthew. I did mention a drop-through over time in that 15% to 20% range. And I think it really relates to the calendarization of investments they won't be completely linear with the way the top line is moving. So we'll put some costs in. Revenue will catch up. It may get a little bit ahead, and then we'll put some more cost in. But that's why we couch that objective to stay between that band on a sort of rolling 12-month average. -------------------------------------------------------------------------------- Operator [13] -------------------------------------------------------------------------------- Your next question comes from Nathan Rich with Goldman Sachs. -------------------------------------------------------------------------------- Nathan Allen Rich, Goldman Sachs Group, Inc., Research Division - Research Analyst [14] -------------------------------------------------------------------------------- I appreciate all the detail that you gave on the call. Maybe starting with the initial outlook for 2021. Can you maybe at a high level, just kind of talk about your assumptions for revenue and margins next year. You kind of pointed to conservatism and consensus with where it stands now. Just curious, from your standpoint, whether you see that more on the top line or more on margins or growth? Just a little extra color there would be helpful. -------------------------------------------------------------------------------- Matthew J. Foulston, Covetrus, Inc. - Global CFO [15] -------------------------------------------------------------------------------- I think it's really going to be a combination of both. We still see robust top line market environment here. As Ben just mentioned, I think our share has been picking up a little bit, where we can measure it. And obviously, we've got strong aspirations for the prescription management side of the business and continuing to grow that. But also cost management is an important part of this. And as you know, distribution is a game of pennies, and operational excellence is going to be key for us. So I think you should look to a blend of both in terms of driving those numbers that we were indicating for next year. -------------------------------------------------------------------------------- Nathan Allen Rich, Goldman Sachs Group, Inc., Research Division - Research Analyst [16] -------------------------------------------------------------------------------- Okay. Great. And then, Matt, maybe a quick follow-up. You talked about targeting the free cash flow conversion of 50% of EBITDA longer term. When do you think we start to see free cash flow normalize? Obviously, you called out some kind of onetime pressures this year. But as we think about 2021, would you expect to kind of be closer to that target level in that time frame? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [17] -------------------------------------------------------------------------------- Yes. I would think of as sort of being clear of the things that impinge on that systemically by the time we get into 2022, we'll still be carrying into the start of next year. Some onetime costs and start-up costs that are a little abnormal, but I do think this year has been particularly choppy with the huge spikes in demand, and then the slackening off. And it's been a really tricky environment to manage working capital. I would think with our hopes for what we think about next year for the broader economy, that things are a little smoother as we move to the end of the pandemic. And I would think we can manage that working capital in a much more linear fashion. So you shouldn't see as much choppy quarter-to-quarter move. -------------------------------------------------------------------------------- Operator [18] -------------------------------------------------------------------------------- Your next question comes from David Westenberg with Guggenheim Securities. -------------------------------------------------------------------------------- Unidentified Analyst, [19] -------------------------------------------------------------------------------- This is [John Peterson] on for David Westenberg. The first one is that we've been seeing large order sizes in vet clinics. Do you think there's any stocking behaviors from pet owners? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [20] -------------------------------------------------------------------------------- [John], good to hear from you. I don't think so, not in this most recent quarter. Maybe in Q2, you saw the consumer buying a little bit ahead of their needs. So maybe instead of buying 1 month supply, they got 2-month supply. But certainly, in the most recent quarter, we look at the average order value as an example and see a pretty normalized number versus the beginning of the year and last year. -------------------------------------------------------------------------------- Unidentified Analyst, [21] -------------------------------------------------------------------------------- Okay. Great. And also, sorry if I missed it, but can you remind me of any onetime items in the fourth quarter last year? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [22] -------------------------------------------------------------------------------- I think just in terms of kind of year-over-year comp, I think the 2 things that Matthew highlighted, 1 was the scil that scil was in our business at that point in time, which is about $3 million of EBITDA. And then last year, we also underachieved the original plans and had some $2 million of bonus cushion -- or $2 million less in bonus versus a fully achieved plan are expected to be fully achieved planned this year. So you've got basically about $5 million delta of EBITDA that was in Q4 of 2019, that wouldn't be in Q4 of 2020. -------------------------------------------------------------------------------- Operator [23] -------------------------------------------------------------------------------- (Operator Instructions) And your next question comes from Andrew Cooper with Raymond James. -------------------------------------------------------------------------------- Andrew Harris Cooper, Raymond James & Associates, Inc., Research Division - Senior Research Associate [24] -------------------------------------------------------------------------------- A lot has already been asked. So maybe just 1 on the incremental investment in capacity expansion in prescription management, obviously, not a surprise, but just curious any color you could give on how or if COVID and sort of some of the accelerated growth we've seen the last 2 quarters has shifted any time lines or any way you think about sort of reinvesting in that business relative to where you were thinking in, say, February? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [25] -------------------------------------------------------------------------------- No. I mean, if anything COVID, reinforced our desire to invest in that business. The value proposition is clear. The consumer response is great. So we -- if anything, we just have more conviction. And the investments really fall into 2 main categories. There's on the operations side of pharmacies and systems, and then second, really is on the technology side to make the process both smoother for the vet as well as smoother for the pet owner. So we expect to continue to invest in that business over time. -------------------------------------------------------------------------------- Matthew J. Foulston, Covetrus, Inc. - Global CFO [26] -------------------------------------------------------------------------------- The only thing I'd add is that spike in demand was so acute in the second quarter that we were doing everything we possibly could to meet customer demand. And probably slowed down some of those investments in the quarter just because we were focused on the customer, not the future. Fortunately, we got that back in balance now with these more normalized growth rates. -------------------------------------------------------------------------------- Andrew Harris Cooper, Raymond James & Associates, Inc., Research Division - Senior Research Associate [27] -------------------------------------------------------------------------------- Okay. That's helpful. And then maybe just 1 more. As we think about, I think, the comment on the U.K. change from one of the manufacturers. Just any more color you could give there? And then any change in terms of conversations with some of the manufacturers as we're getting to lapping more of the go directs in the alternative channels and sort of things settling out a little bit. We've had some M&A. So just what's the latest and greatest as you have those conversations? Any shift in sort of the tone from your side or their side, frankly, particularly around preventives where I think there's been some new products and things like that to think about as well? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [28] -------------------------------------------------------------------------------- Yes. I think in the U.K., we anticipated that change occurring earlier in the year. And as you know, the U.K. is probably our lowest margin business globally. So we don't love the revenue headwind, but it doesn't have a significant impact on the EBITDA side of things. In terms of your kind of general question about tone, we feel good about our position with manufacturers. And continued evidence that on the parasiticide side of things that manufacturers will continue to work with distributors and are increasingly reliant on our e-commerce solution and the online channel in general. -------------------------------------------------------------------------------- Operator [29] -------------------------------------------------------------------------------- (Operator Instructions) And you do have a question now from John Kreger with William Blair. -------------------------------------------------------------------------------- John Charles Kreger, William Blair & Company L.L.C., Research Division - Partner & Healthcare Services Analyst [30] -------------------------------------------------------------------------------- I don't think you talked about the specialty pharmacy business. Can you just give us an update on how that's going? And where that stands relative to more of a non-U.S. rollout of prescription management? -------------------------------------------------------------------------------- Benjamin Wolin, Covetrus, Inc. - CEO, President & Director [31] -------------------------------------------------------------------------------- I'm glad to let you back in the queue, John. As we've said in the past, we are definitely focused on the compounding business. It's an important component of our North America offering. It's growing faster than the total business in North America. It's higher-margin than the rest of the business in North America. So it will continue to be primary focus here in the U.S. There definitely are opportunities internationally, but it is a different regulatory environment and a less mature market. So I would say the majority of the effort on that front is going to be in the U.S., and we feel like we just have a great position, given our scale and our platform where a lot of that compounding business is running through on a patient-specific basis. So it's a real differentiated offering versus the competition in the market and one that we will continue to push hard on in 2021. -------------------------------------------------------------------------------- Operator [32] -------------------------------------------------------------------------------- And there are no further questions at this time. I will now hand the call back to Nick Jansen for closing remarks. -------------------------------------------------------------------------------- Nicholas Michael Jansen, Covetrus, Inc. - VP of IR [33] -------------------------------------------------------------------------------- Thanks, everyone, for joining today. We'll be looking forward to catching up with all of you soon. Have a great night. -------------------------------------------------------------------------------- Operator [34] -------------------------------------------------------------------------------- That concludes today's conference. Thank you for your participation. You may now disconnect.