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(Parenthetical)
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Income
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(Exact name of
registrant as specified in its charter)
iDelaware
i35-2554312
(State or
other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
i230 E. Riverside Dr.
i83616
iEagle,
iIdaho
(Zip Code)
(Address of principal executive offices)
i208-i939-8900
(Registrant’s
telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol
Name of Each Exchange on Which Registered
iClass
A Common Stock, $0.001 par value
iPETQ
iThe Nasdaq Global Select Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days iYesx No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYesx No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and
“emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
iAccelerated filer
x
Non-accelerated filer
¨
Smaller
reporting company
i¨
Emerging growth company
i¨
If an emerging growth company, indicate by check mark if the
registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). i☐ Yes x No
As of August 9, 2023, we had i29,182,311
shares of Class A common stock and i239,540 shares of Class B common stock outstanding.
This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, such as statements about our plans, objectives, expectations, assumptions or future events. In some cases, you can identify forward-looking statements by terminology such as “anticipate,”“believe,”“continuing,”“could,”“estimate,”“expect,”“intend,”“may,”“ongoing,”“plan,”“project,”“should,”“will,” and similar expressions. Examples of forward-looking statements include, without limitation:
•statements regarding our strategies, results of operations or liquidity;
•statements concerning projections, predictions, expectations, estimates or forecasts as to our business, financial and operational results and future economic performance;
•statements of management’s goals and objectives; and
•assumptions underlying statements regarding us or our business.
Forward-looking statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ
materially from any future results, performances, or achievements expressed or implied by the forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time those statements are made or management’s good faith belief as of that time with respect to future events and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to, factors discussed under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q; general economic or market
conditions, including the impacts of the global economic slowdown, increased inflation, rising interest rates and recent and potential bank failures; our ability to successfully grow our business through acquisitions and our ability to integrate acquisitions, including Rocco & Roxie; our dependency on a limited number of customers; our ability to implement our growth strategy effectively; our ability to manage our manufacturing and supply chain effectively; disruptions in our manufacturing and distribution chains; competition from veterinarians and others in our industry; reputational damage to our brands; economic trends and spending on pets; the effectiveness of our marketing and trade promotion programs; recalls or withdrawals of our products or product liability claims; our ability to introduce new products and improve existing products; our failure to protect our intellectual property; costs associated with governmental regulation; our ability to keep and retain
key employees; our ability to sustain profitability; and the risks set forth under the “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2022, and other reports filed from time to time with the Securities and Exchange Commission.
Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or operating results. The forward-looking statements speak only as of the date on which they are made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor,
or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Consequently, you should not place undue reliance on forward-looking statements.
Notes to the Condensed Consolidated Financial Statements (unaudited)
i
Note
1 — Principal Business Activity and Significant Accounting Policies
Principal Business Activity and Principles of Consolidation
PetIQ, Inc. ("PetIQ", the "Company", "we", "our", or "us") is a leading pet medication and wellness company delivering a smarter way for pet parents to help their pets live their best lives through convenient access to affordable veterinary products and services. We engage with customers through more than i60,000 points of distribution across retail
and e-commerce channels with our branded and distributed medications as well as health and wellness items, which are further supported by our world-class medications manufacturing facility in Omaha, Nebraska and health and wellness manufacturing facility in Springville, Utah. Our national service platform operates in over i2,600 retail partner locations in i41
states, providing cost effective and convenient veterinary wellness services. PetIQ believes that pets are an important part of the family and deserve the best products and care that we can give them.
PetIQ has itwo reporting segments: (i) Products; and (ii) Services. The Products segment consists of our manufacturing and distribution business. The Services segment consists of veterinary and wellness services and related product sales provided by the Company directly to consumers.
PetIQ
is the managing member of PetIQ Holdings, LLC (“HoldCo”), a Delaware limited liability company, which is the sole member of PetIQ, LLC (“OpCo”) and, through HoldCo, operates and controls all of the business and affairs of OpCo.
The condensed consolidated financial statements as of June 30, 2023 and December 31, 2022 and for the three and six months ended June 30, 2023 and 2022 are unaudited. The condensed consolidated balance sheet as of December 31, 2022 has been derived from the audited financial statements at that date but does not include all of the disclosures required by U.S. GAAP. These interim condensed consolidated financial statements
should be read in conjunction with the consolidated financial statements as of and for the year ended December 31, 2022 and related notes thereto included in the most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 28, 2023 (the "Annual Report"). Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year.
i
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of property, plant, and equipment and intangible assets; the valuation of property, plant, and equipment, intangible assets and goodwill, the valuation of deferred tax assets, the valuation of inventories, and reserves for legal contingencies.
Significant Accounting Policies
The Company's significant accounting policies are discussed in Note 1 –
Principal Business Activity and Significant Accounting Policies in the Annual Report. There have been no significant changes to these policies that have had a material impact on the Company's unaudited condensed financial statements and related notes during the three and six months ended June 30, 2023.
/i
Note
2 — Business Combination
Rocco & Roxie
The Company completed the acquisition of all of the membership units of Rocco & Roxie Supply Co, LLC ("R&R") on January 13, 2023, (the "R&R Acquisition"), which resulted in R&R becoming a wholly owned subsidiary of the Company. The R&R Acquisition expands the Company's brand and product portfolio to include stain and odor products and enables the Company to extend its offerings into premium dog supplements and jerky
treats. The Company paid $i26.5 million for the membership interests of R&R using cash on hand. The purchase is subject to normal working capital adjustments.
The following table summarizes the preliminary allocations of the consideration paid of $i27.6 million,
which included the $i26.5 million purchase price plus $i1.1 million of working capital, to the assets acquired and liabilities assumed, based on our current estimates of the fair value at the date of the R&R
Acquisition:
$'s in 000's
Preliminary Estimated Fair Value
Adjustments
As Retrospectively Adjusted
Current assets
$
i3,020
$
—
$
i3,020
Other
assets
i1,208
—
i1,208
Amortizable
intangibles
Trade name
i7,600
(i500)
i7,100
Customer
relationships
i320
—
i320
Total
amortizable intangibles
$
i7,920
$
(i500)
$
i7,420
Goodwill
i20,266
i500
i20,766
Total
assets
$
i32,414
$
—
$
i32,414
Current
liabilities
i1,000
—
i1,000
Other
tax liabilities
i3,780
—
i3,780
Total
liabilities
i4,780
—
i4,780
Purchase
price, net of cash acquired
$
i27,634
$
—
$
i27,634
/
Intangible
assets will be amortized over the estimated useful lives of the assets through January 2033. The weighted average amortization period of the amortizable intangible assets is approximately i9.9 years. The identifiable intangible assets are measured at fair value as Level III in accordance with the fair value hierarchy.
Goodwill represents the future economic benefits that do not qualify for separate recognition and primarily includes the assembled workforce and other non-contractual relationships, as well as expected future synergies. Approximately $i19.5 million
of the $i20.8 million of Goodwill will not be tax deductible, and the remaining balance is expected to be deductible for tax purposes. Goodwill was allocated to the Products segment. Transaction costs of $i0.5 million were incurred and
are recorded in Selling, General, and Administrative costs on the condensed consolidated statement of operations.
The estimate of fair value and purchase price allocation were based on information available at the time of closing the R&R Acquisition. These preliminary estimates are subject to retrospective adjustments during the measurement period, not to exceed one year, based upon new information obtained about facts and circumstances that existed as of the date of closing the R&R Acquisition. The primary areas of the purchase price allocation that are not yet finalized relate to the valuation of identifiable intangible assets, residual goodwill and deferred taxes.
On April 13, 2021, OpCo entered into an asset-based revolving credit agreement with KeyBank National Association, as administrative agent and collateral agent, and the lenders’ party thereto, that provides revolving credit commitments of $i125.0 million, subject to a borrowing base limitation (the "ABL"). The borrowing base for the ABL at any time equals the sum of:
(i) i90% of eligible investment-grade accounts receivable; plus (ii) i85% of eligible other accounts receivable; plus, (iii) i85%
of the net orderly liquidation value of the cost of certain eligible on-hand and in-transit inventory; plus, (iv) at the option of OpCo, i100% of qualified cash; minus (v) reserves. The ABL bears interest at a variable rate plus a margin, with the variable rate being based on a base rate or LIBOR at the option of the Company. On February 3, 2023, HoldCo and Opco, entered into the First Amendment Agreement to the ABL to replace the interest rate benchmark from LIBOR to Secured Overnight Financing
Rate ("SOFR"). The interest rate at June 30, 2023 was i6.31% The Company also pays a commitment fee on unused borrowings at a rate of i0.35%.
The ABL Facility is secured by substantially all the assets of HoldCo and its wholly-owned domestic subsidiaries including a first-priority security interest in personal property consisting of accounts receivable, inventory, cash, and deposit accounts (such collateral subject to first-priority security interest, "ABL Priority Collateral"), and a second-priority security interest in all other personal and
real property of HoldCo and its wholly-owned domestic subsidiaries (such collateral subject to such second-priority security interest, “Term Priority Collateral”), in each case, subject to customary exceptions. The ABL contains customary representations and warranties, affirmative and negative covenants and events of default, including negative covenants that restrict the ability of HoldCo and its restricted subsidiaries to incur additional indebtedness, pay dividends, make investments, loans, and acquisitions, among other restrictions. As of June 30, 2023, ino
amounts were outstanding under the ABL.
Senior Secured Term Loan Facility - Term Loan B
On April 13, 2021, OpCo entered into a term credit and guaranty agreement with Jefferies Finance LLC, as administrative agent and collateral agent, and the lenders’ party thereto, that provides senior secured term loans of $i300.0 million (which may be increased in certain circumstances) (the "Term Loan B"). The Term Loan B bears interest at
a variable rate of either prime, federal funds effective rate or LIBOR, plus an applicable margin of between i3.25% and i4.25% depending on the underlying base rate. LIBOR rates are subject to a i0.50%
floor. The interest rate at June 30, 2023 was i9.46%. The Term Loan B requires quarterly payments of i0.25% of the original principal amount, with the balance due on April
13, 2028. On May 25, 2023, the Term Loan B was amended to replace the interest rate benchmark from the Adjusted Eurodollar Rate to SOFR.
The Term Loan B is secured by substantially all the assets of HoldCo and its wholly-owned domestic subsidiaries, including a first-priority security interest in Term Priority Collateral and a second-priority security interest in ABL Priority Collateral, in each case, subject to customary exceptions. The Term Loan B contains customary representations and warranties, affirmative and negative covenants and events of default, including negative covenants that restrict the ability of HoldCo and its restricted subsidiaries to incur additional indebtedness, pay
dividends, make investments, loans, and acquisitions, among other restrictions.
Convertible Notes
On May 19, 2020, the Company issued $i143.8 million in aggregate principal amount of i4.00%
Convertible Senior Notes due 2026 (the “Notes”) pursuant to the indenture (the “Indenture”), dated as of May 19, 2020. The Notes accrue interest at a rate of i4.00% per annum, payable semi-annually in arrears on June 1 and December 1 of each year, beginning on December 1, 2020. The Notes will mature on June
1, 2026, unless earlier repurchased, redeemed or converted. Before January 15, 2026, holders will have the right to convert their Notes only upon the occurrence of certain events. From and after January 15, 2026, holders may convert their Notes at any time at their election until the close of business on the scheduled trading day immediately before the maturity date. The Company will settle conversions by paying or delivering, as applicable, cash, shares of its Class A common stock, or a combination of cash and shares of its Class A common stock, at its election. The initial conversion rate is 33.7268 shares of Class A common stock per $1,000 principal amount of Notes. The conversion rate and conversion price will be subject to customary adjustments upon the occurrence of certain
events. In addition, if certain corporate events that constitute a “Make-Whole Fundamental Change” (as defined in the Indenture) occur, then the conversion rate will, in certain circumstances, be increased for a specified period of time.
i
The following represents the Company’s long-term debt as of:
Intangible
assets, net of accumulated amortization
$
i169,182
$
i172,479
/
Certain
intangible assets are denominated in currencies other than the U.S. Dollar; therefore, their gross and net carrying values are subject to foreign currency movements. Amortization expense for the three months ended June 30, 2023 and 2022 was $i6.5 million and $i4.5
million, respectively. Amortization expense for the six months ended June 30, 2023, and 2022 was $i10.7 million and $i9.0 million, respectively. During
the three months ended June 30, 2023, the Company opted out of the final acquired project included in in-process research and development, effectively abandoning the associated research and development effort. Accordingly, the Company wrote off the associated intangible asset of $i1.7 million in the Products segment, the expense for which is included as amortization expense in selling,
general and administrative expenses on the condensed consolidated statement of operations.
i
Estimated future amortization expense for each of the following years is as follows:
Our effective tax rate from continuing operations was i2.0% and i3.2% for the three and six months ended June 30, 2023, respectively, and i11.4%
and i8.5% for the three and six months ended June 30, 2022, respectively, including discrete items. Income tax expense for the three and six months ended June 30, 2023 and 2022 was different than the U.S federal statutory income tax rate of 21% primarily due to the effects of the change in valuation allowance, state taxes, and the foreign rate differential.
The
Company has assessed the realizability of the net deferred tax assets as of June 30, 2023 and in that analysis has considered the relevant positive and negative evidence available to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The realization of the gross deferred tax assets is dependent on several factors, including the generation of sufficient taxable income to realize its deferred tax assets. The Company believes it is more likely than not that the benefit from recorded deferred tax assets will not be realized. In future periods, if we conclude we have future taxable income sufficient to recognize the deferred tax assets, we may reduce or eliminate the valuation allowance.
/i
Note
6 — Earnings per Share
Basic and Diluted Earnings per Share
Basic earnings per share of Class A common stock is computed by dividing net income available to PetIQ, Inc. by the weighted-average number of shares of Class A common stock outstanding during the period. Diluted earnings per share of Class A common stock is computed by dividing net income available to PetIQ, Inc. by the weighted-average number of shares of Class A common stock outstanding adjusted to give effect to potentially dilutive securities.
The
following table sets forth reconciliations of the numerators and denominators used to compute basic and diluted earnings per share of Class A common stock:
Three months ended June 30,
Six months
ended June 30,
(in 000's, except for per share amounts)
2023
2022
2023
2022
Numerator:
Net
income
$
i9,553
$
i4,678
$
i19,334
$
i7,838
Less:
net income attributable to non-controlling interests
i85
i46
i167
i75
Net
income attributable to PetIQ, Inc. — basic and diluted
i9,468
i4,632
i19,167
i7,763
Denominator(1):
Weighted-average
shares of Class A common stock outstanding — basic
i29,136
i29,283
i29,083
i29,223
Dilutive
impact of share-based compensation awards (2)
i237
i46
i135
i81
Dilutive
effect of conversion of Notes (3)
i—
i—
i—
i—
Weighted-average
shares of Class A common stock outstanding — diluted
i29,373
i29,329
i29,218
i29,304
Income
per share of Class A common stock — basic
$
i0.32
$
i0.16
$
i0.66
$
i0.27
Income
per share of Class A common stock — diluted
$
i0.32
$
i0.16
$
i0.66
$
i0.26
(1)
- Shares of the Company’s Class B common stock do not share in the earnings of the Company and are therefore not participating securities. As such, separate presentation of basic and diluted earnings per share of Class B common stock under the two-class method has not been presented.
(2) - For the three and six months ended June 30, 2023, i2,134
thousand and i2,199 thousand of outstanding share-based compensation awards were excluded from the computation of diluted earnings per share, as the effect of including those shares would be anti-dilutive. For the three and six months ended June 30, 2022, i2,376
thousand and i2,334 thousand of outstanding share-based compensation awards were excluded from the computation of diluted earnings per share, as the effect of including those shares would be anti-dilutive.
/
(3) - For the three and six months ended June 30, 2023
and 2022, iiii4,848///
thousand shares of common stock associated with the assumed conversion of the Notes have been excluded from the computation of diluted earnings per share, as the effect of including those shares would be anti-dilutive.
i
Note 7 — Stock Based Compensation
PetIQ, Inc. Omnibus Incentive Plan
The
Amended and Restated PetIQ, Inc. Omnibus Incentive Plan, (the “Plan”), provides for the grant of various equity-based incentive awards to directors of the Company, employees, and consultants. The types of equity-based awards that may be granted under the Plan include: stock options, stock appreciation rights ("SARs"), restricted stock, RSUs, and other stock-based awards, up to a total of i5,804,000 shares of Class A common stock issuable under the Plan. As
of June 30, 2023 and 2022, i1,227,691 and i1,914,000
shares were available for issuance under the Plan, respectively. All awards issued under the Plan may only be settled in shares of Class A common stock. Shares issued pursuant to awards under the incentive plans are from our authorized but unissued shares.
PetIQ, Inc. 2018 Inducement and Retention Stock Plan for CVC Employees
The PetIQ, Inc. 2018 Inducement and Retention Stock Plan for CVC Employees (the “Inducement Plan”) provided for the grant of stock options to employees hired in connection with an acquisition in 2018 as employment inducement awards pursuant to NASDAQ Listing Rule 5635(c)(4). The Inducement Plan reserved i800,000
shares of Class A common stock of the Company, of which i760,000 were granted. No further grants may be made under the Inducement Plan. All awards issued under the Inducement Plan may only be settled in shares of Class A common stock.
The Company awards stock options to certain employees under the Plan and previously issued stock options under the Inducement Plan, which are subject to time-based vesting conditions, typically i25% on each anniversary of the grant date until fully vested. Upon a termination of service
relationship by the Company, all unvested options are typically forfeited and the shares of common stock underlying such awards will become available for issuance under the Plan. The maximum contractual term for stock options is i10 years.
The fair value of these equity awards is amortized to equity based compensation expense over the vesting period, which totaled $i0.4
million and $i0.9 million for the three and six months ended June 30, 2023, respectively, and $i0.9 million and $i2.2
million for the three and six months ended June 30, 2022, respectively. All stock based compensation expense is included in selling, general and administrative expenses based on the role of recipients. iThe fair value of the stock option awards was determined on the grant dates using the Black-Scholes valuation model based on the following weighted-average assumptions for the period ended June 30, 2022.
No options were issued for the period ended June 30, 2023:
(1)The Company utilized the simplified method to determine the expected term of the stock options since we do not
have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term.
(2)The expected volatility assumption was calculated based on a peer group analysis of stock price volatility with a look back period consistent with the expected option term.
(3)The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the time of grant, which corresponds to the expected term of the stock options.
(4)The Company has not paid and does not anticipate paying a cash dividend on our common stock.
As of June 30, 2023, total unrecognized compensation
cost related to unvested stock options was $i2.6 million and is expected to be recognized over a weighted-average period of i1.5
years.
i
Stock Options (in
000's)
Weighted Average Exercise Price
Aggregate Intrinsic Value (in 000's)
Weighted Average Remaining Contractual Life (years)
The Company awards RSUs to certain employees and directors under the Plan, which are subject to time-based vesting conditions. Typically, upon a termination of service relationship by the Company, all unvested RSUs will be forfeited and the shares of common stock underlying such awards will become available for issuance under the Plan. The fair value of
RSUs are measured based on the closing fair market
value of the Company’s Class A common stock on the date of grant. At June 30, 2023, total unrecognized compensation cost related to unvested RSUs was $i24.9 million and is expected to vest over a weighted average period of i3.2
years.
The fair value of these equity awards is amortized to equity based compensation expense over the vesting period, which totaled $i2.3 million and $i4.3 million for the three and six months ended June 30,
2023, and $i2.0 million and $i4.4 million for the three and six months ended June 30, 2022, respectively. All stock based compensation expense is included in selling, general and administrative expenses based on the role of
recipients.
i
The following table summarizes the activity of the Company’s RSUs for the period ended June 30, 2023.
Note
that certain figures shown in the table above may not recalculate due to rounding.
/
For the three and six months ended June 30, 2023, the Company owned a weighted average of ii99.2/%,
of HoldCo, and for the three and six months ended June 30, 2022the Company owned a weighted average of ii99.1/%,
respectively.
/i
Note 9 — Customer Concentration
The Company has significant exposure to customer concentration. During the three and six months ended June 30,
2023, three and two customers individually accounted for more than 10% of sales, comprising i54% and i42% of net sales in aggregate, respectively for such periods. During the three and six months ended June 30, 2022 three customers individually
accounted for more than 10% of sales, comprising i48% and i43% of net sales, respectively for such periods.
At June 30, 2023, one Products segment customer individually accounted for more than 10% of outstanding trade receivables, and accounted for i44% of outstanding trade receivables, net. At December 31, 2022, one Products segment customer individually accounted for more than 10% of outstanding trade receivables, and accounted for i46%
of outstanding trade receivables, net.
i
Note 10 — Commitments and Contingencies
Litigation Contingencies
The Company records a liability when a particular contingency is probable and estimable and provides disclosure for contingencies that are at least reasonably possible of resulting in a loss including an estimate
which we currently cannot make. The Company has not accrued for any contingency as of June 30, 2023 and December 31, 2022 as the Company does not consider any contingency to be probable or estimable.
The Company recorded $i1.0
million and $i3.5 million of expense in the three and six months ended June 30, 2022, respectively, related to a lawsuit brought by a former supplier to the Company related to the redemption of ownership interest, which is included within selling, general and administrative expenses on the condensed consolidated statements of operations. The matter was settled and paid during 2022.
Commitments
We
have commitments for long-term debt that are discussed further in Note - 3, Debt, and leases. In addition, we have purchase obligations for goods and services, capital expenditures, and raw materials entered into in the normal course of business.
/i
Note 11 — Segments
The
Company has itwo operating segments: Products and Services. The Products segment consists of the Company’s manufacturing and distribution business. The Services segment consists of the Company’s veterinary services and related product sales. The segments are based on the discrete financial information reviewed by the Chief Operating Decision Maker (“CODM”) to make resource allocation decisions and to evaluate performance. We measure
and evaluate our reportable segments based on their respective Segment Adjusted EBITDA performance. Beginning in the fourth quarter of 2022, we allocate to our segments capital expenditures and certain costs and expenses, such as accounting, legal, human resources, information technology and corporate headquarters expenses, on a pro rata basis based on net sales to better align with the discrete financial information reviewed by our CODM. Such expenses previously were not allocated to segments. The Company has recast prior periods to give effect to this change. This change in presentation had no impact on the Condensed Consolidated Statements of Operations.
(1)Beginning
in the fourth quarter of 2022, the Company is allocating corporate expenses to each segment pro rata based on net sales for each segment. The presentation of Products Segment Adjusted EBITDA and Services Segment Adjusted EBITDA for the three and six months ended June 30, 2022 has been recast for comparability. For the three and six months ended June 30, 2022, total corporate expenses were $i20.5 million, of which $i17.8 million
was allocated to Products and $i2.7 million was allocated to Services, and $i39.9 million, of which $i35.3 million
was allocated to Products and $i4.6 million was allocated to Services, respectively.
(2) Acquisition costs include legal, accounting, banking, consulting, diligence, and other costs related to completed and contemplated acquisitions.
(3) Non same-store adjustment includes revenue and costs, and associated gross profit, related to our Services segment wellness centers and host partners with less than six full quarters of operating results, and also include pre-opening expenses.
(4)
Integration costs represent costs related to integrating the acquired businesses including personnel costs such as severance and retention bonuses, consulting costs, contract termination, and IT conversion costs. The costs are primarily within the Products segment.
Chris Christensen, the brother of CEO, McCord Christensen, acts as the Company’s agent at Moreton Insurance, which acts as a broker for a number of the Company’s insurance policies. The Company’s premium expense, which is generally paid directly to the relevant insurance company, amounted to $i6.6
million and $i6.9 million for policies that cover the six months ended June 30, 2023 and 2022, respectively. Mr. Chris Christensen earns various forms of compensation based on the specifics of each policy.
Katie Turner, the spouse of CEO, McCord Christensen, is the owner of Acadia Investor Relations LLC, (“Acadia”) which acts as the Company’s
investor relations consultant. Acadia was paid $i0.06 million and $ii0.1/
million for the three and six months ended June 30, 2023 and 2022, respectively.
Mike Glasman, the brother of CFO, Zvi Glasman, acted as a broker in connection with the Company's entry into a Master Services Agreement with Syndeo, LLC d/b/a Broadvoice ("Broadvoice") in February 2023 for the provision of certain information technology related services. The amount to be paid to Broadvoice over the i39-month
agreement is estimated at $i0.4 million. iiNo/
payments were made in the three and six months ended June 30, 2023.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following is a discussion
of our results of operations and current financial condition. This should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements for the year ended December 31, 2022 and related notes included in the Annual Report on Form 10-K for the year ended December 31 filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2023. This discussion contains forward-looking statements that reflect our plans, estimates, and beliefs and involve numerous risks and uncertainties. Actual results may differ materially from those contained in any forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements.” Unless the context requires otherwise, references in this
Quarterly Report on Form 10-Q to “we,”“us” and “our” refer to PetIQ, Inc. and our consolidated subsidiaries.
Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “we,”“us” and “our” refer to PetIQ, Inc. and our consolidated subsidiaries.
Business Overview
PetIQ is a leading pet medication and wellness company delivering a smarter way for pet parents to help their pets
live their best lives through convenient access to affordable veterinary products and services. We engage with customers through more than 60,000 points of distribution across retail and e-commerce channels with our branded and distributed medications as well as health and wellness items, which are further supported by our world-class medications manufacturing facility in Omaha, Nebraska and health and wellness manufacturing facility in Springville, Utah. Our national service platform, operates in over 2,600 retail partner locations in 41 states, providing cost effective and convenient veterinary wellness services. PetIQ believes that pets are an important part of the family and deserve the best products and care that we can give them.
We have two reporting segments: (i) Products; and (ii) Services. The Products segment consists of our manufacturing and distribution business. The Services segments consists of veterinary and
wellness services and products provided by the Company directly to consumers.
On January 13, 2023, the Company completed the acquisition of all of the membership units of Rocco and Roxie Supply Co, LLC ("R&R"), after which R&R became a wholly owned and consolidated subsidiary of the Company. The acquisition expands the Company's product portfolio to include stain and odor products, jerky treats and behavioral products as well as expands sales channels in e-commerce.
We are
the managing member of PetIQ Holdings, LLC (“HoldCo”), a Delaware limited liability company, which is the sole member of PetIQ, LLC (“OpCo”) and, through HoldCo, operates and controls all of the business and affairs of OpCo.
The following tables set forth our condensed consolidated statements of operations in dollars
and as a percentage of net sales for the periods presented:
Consolidated net sales increased $62.5 million or 24.8%, to $314.5 million for the three months ended June 30, 2023, compared to $252.0 million for the three months ended June 30, 2022. Net sales growth of $59.2 million within the Products segment was driven by broad strength across nearly all product categories on strong consumer demand, including distributed flea and tick, prescription medication, and multiple manufactured categories, as well as sales from the acquisition of R&R, which occurred in January 2023. The Services segment revenues grew by $3.4 million driven by increased dollar per pet served during the second quarter of 2023.
Products
Segment
Product sales increased $59.2 million, or 27.0%, to $278.2 million for the three months ended June 30, 2023, compared to $219.0 million for the three months ended June 30, 2022. The increase was driven by broad strength across nearly all categories on strong consumer demand. Additionally, the Company added R&R products related to the acquisition that occurred in January 2023, for which there are no comparable sales in the prior period.
Services Segment
Services revenue increased $3.4 million, or 10.2%, to $36.4 million for the three months ended June 30, 2023, compared to $33.0 million for
the three months ended June 30, 2022. Same-store sales increased $5.3 million, or 19.0%, to $33.6 million for the three months ended June 30, 2023, compared to $28.3 million for the three months ended June 30, 2022. The increased service revenue was driven by operational improvements which drove increases in average dollar per clinic and average dollar per pet served during the second quarter of 2023.
Gross profit
Gross profit increased by $11.9 million, or 19.2%, to $73.9 million for the three months ended June 30, 2023, compared to $62.0 million for the three months ended June 30, 2022. This increase is driven by the Products segment
gross profit increasing by $12.3 million due to net sales growth, partially offset by $0.4 million gross profit decrease within the Services segment primarily due to $0.9 million of incremental depreciation and lease termination costs related to closed stores.
Gross margin decreased to 23.5% for the three months ended June 30, 2023, compared to 24.6% for the three months ended June 30, 2022. The decrease was due to Products segment gross margin decrease of approximately 100 basis points primarily due to the impact of changes in product mix and due to incremental depreciation and lease termination costs in our Services segment.
Selling, general and administrative expenses
Consolidated selling, general and administrative expenses (“SG&A”)
increased by $4.6 million, or 9.0%, to $55.2 million for the three months ended June 30, 2023, compared to $50.6 million for the three months ended June 30, 2022. As a percentage of net sales, SG&A decreased from 20.1% for the three months ended June 30, 2022 to 17.5% for the three months ended June 30, 2023 on continued leverage of costs and increased business expense efficiencies relative to the growth in sales. The $4.6 million increase was driven by increased compensation expense of $2.1 million, increased amortization expense of $1.7 million related to termination of an in process research and development agreement, increased variable R&R expenses of $1.5 million, partially offset by decreased research and development
expenses of $0.7 million.
Products Segment
Products segment SG&A increased $5.9 million or approximately 14.9% to $45.5 million for the three months ended June 30, 2023, compared to $39.6 million for the three months ended June 30, 2022. This increase was primarily due to variable R&R expenses. Additionally, marketing and advertising increased to support our branded portfolio and we incurred higher compensation costs.
Services
segment SG&A decreased $1.5 million, or 12.7%, to $9.6 million for the three months ended June 30, 2023, compared to $11.1 million for the three months ended June 30, 2022. This decrease was driven by operational improvements, and lower marketing spend due to fewer new store openings.
Interest expense, net
Interest expense, net, increased $2.5 million to $8.8 million for the three months ended June 30, 2023, compared to $6.3 million for the three months ended June 30, 2022. This increase was driven by the higher rates on the Company's variable rate debt due to rising interest rates, partially offset
by lower debt balances.
Provision for income taxes
Our effective tax rate was 2.0% and 11.4% for the three months ended June 30, 2023 and 2022, respectively, with a tax expense of $0.2 million and $0.6 million, respectively. The tax rate is different than the U.S federal statutory income tax rate of 21% primarily due to the effects of the change in valuation allowance, state taxes, and the foreign rate differential.
Consolidated net sales increased $77.3 million, or 14.6%, to $605.0 million for the six months ended June 30, 2023, compared to $527.7 million for the six months ended June 30, 2022. Net sales growth of $70.4 million within the Products segment was driven by broad strength across nearly all product categories on strong consumer demand, including distributed flea and tick, prescription medication, and multiple manufactured categories, as well as sales from the acquisition of R&R, which occurred in January 2023. The Services segment revenues grew by $7.0 million driven by increased pets served and increased average dollar per pet served.
Products Segment
Product sales
increased $70.4 million, or 15.1%, to $537.2 million for the six months ended June 30, 2023, compared to $466.8 million for the six months ended June 30, 2022. This increase was driven by broad strength across nearly all categories, and increased sales of R&R products related to the acquisition that occurred in January 2023, for which there is no comparable sales in the prior period.
Services Segment
Services revenue increased $7.0 million, or 11.5%, to $67.9 million for the six months ended June 30, 2023, compared to $60.9 million for the six months ended June 30, 2022. This increase was driven by increased pets served and increased average dollar per pet served year to date 2023.
Gross
profit
Gross profit increased by $16.5 million, or 13.8%, to $136.1 million for the six months ended June 30, 2023, compared to $119.6 million for the six months ended June 30, 2022. This increase is driven by the Products segment gross profit increasing by $13.5 million due to net sales growth, and Services segment gross profit increasing $3.0 million due to operational improvements.
Gross margin decreased to 22.5% for the six months ended June 30, 2023, compared to 22.7% for the six months ended June 30, 2022. The slight decrease of margin was primarily due to the impact of changes in product mix.
Selling, general and administrative expenses
Consolidated SG&A decreased by $0.3 million, or 0.3%, to $98.5 million for the six months ended June 30, 2023, compared to $98.8 million for the six months ended June 30, 2022. As a percentage of net sales, SG&A decreased from
18.7% for the six months ended June 30, 2022 to 16.3% for the six months ended June 30, 2023, primarily driven by decreases in legal expenses, decreased stock
compensation expense, partially offset by increased variable R&R expenses and increased amortization expenses related to termination of an in process research and development agreement.
Products Segment
Products segment SG&A increased $2.2 million or approximately 2.8% to $80.5 million for the six months ended June 30, 2023, compared to $78.3 million for the six months ended June 30, 2022. This increase was driven by variable R&R expenses.
Services Segment
Services segment SG&A decreased $2.5 million, or 12.4%, to $17.9 million for the six months ended June 30, 2023, compared to $20.5 million for the six months ended June
30, 2022. This decrease was driven by operational improvements and lower marketing spend due to fewer new store openings.
Interest expense, net
Interest expense, net, increased $5.2 million to $17.6 million for the six months ended June 30, 2023, compared to $12.4 million for the six months ended June 30, 2022. This increase was driven by the higher rates on the Company's variable rate debt due to rising interest rates.
Provision for income taxes
Our effective tax rate was 3.2% and 8.5% for the six months ended June 30, 2023 and 2022,
respectively, with a tax expense of $0.6 million and $0.7 million, respectively. The tax rate is different than the U.S federal statutory income tax rate of 21% primarily due to the effects of a change in valuation allowance, state taxes, and the foreign rate differential.
Consolidated Non-GAAP Financial Measures
EBITDA and Adjusted EBITDA are non-GAAP financial measures. We calculate EBITDA as net income adjusted for income tax expense, depreciation, amortization, goodwill impairment, and interest expense, net. We calculate Adjusted EBITDA as EBITDA adjusted for acquisition costs, stock based compensation expense, integration costs, litigation expenses, and other one-time transactions that management does not believe are representative of our core ongoing business. Adjusted EBITDA is utilized by management in evaluating the
Company's performance the effectiveness of our business strategies. The Company presents EBITDA because it is a necessary component for computing Adjusted EBITDA.
We believe that the use of EBITDA and Adjusted EBITDA provides an additional tool for investors to use in evaluating ongoing operating results and trends. In addition, you should be aware when evaluating EBITDA and Adjusted EBITDA that in the future we may incur expenses similar to those excluded when calculating these measures. Our presentation of these measures should not be construed as an inference that our future results will be unaffected by these or other unusual or non-recurring items. Our computation of EBITDA and Adjusted EBITDA may not be comparable to other similarly titled measures computed by other companies, because all companies do not calculate EBITDA and Adjusted
EBITDA in the same manner.
Beginning in the fourth quarter of 2022, the Company no longer adds back non-same store adjustments in its calculation of
Adjusted EBITDA and has recast prior year periods to reflect this change
Our management does not, and you should not, consider EBITDA or Adjusted EBITDA in isolation or as an alternative to financial measures determined in accordance with GAAP. The principal limitation of EBITDA and Adjusted EBITDA is that they exclude significant expenses and income that are required by GAAP to be recorded in our financial statements. Some of these limitations are:
•EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or
contractual commitments;
•EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
•EBITDA does not reflect the interest expenses, or the cash requirements necessary to service interest or principal payments, on our debts;
•Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;
•Adjusted
EBITDA does not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing core operations; and
•Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
Because of these limitations, EBITDA and Adjusted EBITDA should not be considered in isolation or as a substitute for performance measures calculated in accordance with GAAP. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA and Adjusted EBITDA only supplementary. You should review the reconciliations of net income to EBITDA and Adjusted EBITDA below and not rely on any single financial measure to evaluate our business.
The following table reconciles net income to EBITDA and Adjusted EBITDA
for the periods presented.
(1) Acquisition costs include legal, accounting, banking, consulting, diligence, and other costs related to completed and contemplated acquisitions.
(2) Integration costs represent costs related to integrating the acquired businesses including
personnel costs such as severance and retention bonuses, consulting costs, contract termination costs, and IT conversion costs. The costs are primarily within the Products segment.
Financial Condition, Liquidity, and Capital Resources
Historically, our primary sources of liquidity have been cash flows from operations, borrowings, and equity financing. As of June 30, 2023 and December 31, 2022, our cash and cash equivalents were $78.4 million and $101.3 million, respectively. As of June 30, 2023,
we had an unused revolving credit facility with availability of $125.0 million, $294.0 million outstanding under our term loan, $143.8 million of outstanding convertible notes, and $17.7 million in other debt. Our debt agreements bear interest at rates between 4.0% and 9.46%. See “Note 3 – Debt” to our condensed consolidated financial statements included herein for a description of each of our debt arrangements.
Our primary cash needs are for working capital. Our maintenance capital expenditures have typically been less than 1.0% of net sales, but we may make additional capital expenditures as necessary to support our growth. Our primary working capital requirements are to fund inventory and accounts receivable to support our sales. Fluctuations in working capital are primarily driven by the timing of new product launches and seasonal retailer demand. As of June 30,
2023 and December 31, 2022, we had working capital (current assets less current liabilities) of $230.7 million and $220.6 million,
respectively. The Company has not historically made significant non-contractual debt pay downs, but may choose to do so in the future as part of its capital allocation strategy.
We believe that our operating cash flow, cash on hand, and debt proceeds from our borrowings under
our debt facilities will be adequate to meet our operating, investing, and financing needs for at least the next 12 months. We believe we will meet our longer-term expected future cash requirements primarily from a combination of cash flow from operating activities, borrowings under our debt facilities and available cash and cash equivalents.To the extent additional funds are necessary to meet long-term liquidity needs as we continue to execute our business strategy, we anticipate that they will be obtained through the incurrence of additional indebtedness, equity financings, or a combination of these potential sources of funds, although we can provide no assurance that these sources of funding will be available on reasonable terms or at all. As in the past, we will continue to explore opportunities to optimize our capital structure.
Cash
Flows
Cash provided by (used in) Operating Activities
Net cash provided by operating activities was $14.4 million for the six months ended June 30, 2023, compared to $65.4 million used in operating activities for the six months ended June 30, 2022. The change in operating cash flows primarily reflects higher earnings and lower cash usage from working capital of $67.8 million. Working capital changes are driven primarily by growth in accounts receivable, which is related to the higher sales of the Company, and accounts payable growth. Inventory provided a small amount of cash compared to significant cash usage in the 2022. In the prior year period inventory growth required significant cash outlays
due to the unusually low inventory at the beginning of 2022.
Cash used in Investing Activities
Net cash used in investing activities was $31.8 million for the six months ended June 30, 2023, compared to $8.0 million for the six months ended June 30, 2022. The increase in net cash used in investing activities was primarily the result of $27.6 million of the cash utilized in the acquisition of R&R partially offset by lower purchases of fixed assets.
Cash used in Financing Activities
Net cash used in financing activities was $5.6 million for the six months ended June 30, 2023, compared to $0.3 million
for the six months ended June 30, 2022. The change in cash used in financing activities is primarily driven by increased debt pay downs by the Company for the six months ended June 30, 2023.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
We are exposed to certain market risks arising from transactions in the normal course of our business. Such risk is principally associated with interest rates. We currently do not enter into derivatives or other financial instruments for trading or speculative purposes.
Interest
Rate Risk
We are exposed to changes in interest rates because the indebtedness incurred under our ABL and our Term Loan B are variable rate debt. Interest rate changes generally do not affect the recorded value of our credit agreements but do affect the amount of our interest payments and, therefore, our future earnings and cash flows. As of June 30, 2023, we had variable rate debt of approximately $305.1 million, primarily under our Revolver and Term Loan. An increase of 1% would have increased our interest expense for the three months ended June 30, 2023 by approximately $0.7 million.
Inflation
Inflation is a factor in our business and we continue to seek ways to mitigate its effect. Inflation has affected our performance in terms of higher
costs for employees compensation and benefits, products that we distribute, and components of products we manufacture. We believe the effects of inflation, if any, on our historical results of operations and financial condition have not been material as we have been able to effectively implement price adjustments to pass-through the additional costs. However, in the future, we may not be able to increase prices to our customers sufficiently to offset these increased costs.
We maintain disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
Our management, with the participation of our
Chief Executive Officer and our Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that as of such date, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting that occurred during our fiscal quarter ended June 30, 2023, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART
II—OTHER INFORMATION
Item 1. Legal Proceedings.
We are from time to time subject to, and are presently involved in, litigation and other proceedings. We believe that there are no pending lawsuits or claims that, individually or in the aggregate, may have a material adverse effect on our business, financial condition or results of operations.
The Company records a liability when a particular contingency is both probable and estimable. If the probable loss cannot be reasonably estimated, no accrual is recorded, but the loss contingency and the reasons to the effect that it cannot be reasonably estimated are disclosed. If a loss is reasonably
possible, the Company will provide disclosure to that affect. The Company expenses legal costs as incurred within selling, general and administrative expenses on the condensed consolidated statements of operations. For information on legal proceedings, please refer to "Note 10 — Commitments and Contingencies" in the Notes to the Condensed Consolidated Financial Statements included in Part I Item 1 of this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors.
Factors that could cause our actual results to differ materially from those in this report are any of the risks disclosed in our
Annual Report on Form 10-K, which was filed with the SEC on February 28, 2023. Any of these factors could result in a significant or material adverse effect on our results of operations or financial condition. Additional risk factors not presently known to us or that we currently deem immaterial may also impair our business or results of operations.
Item 2.Unregistered Sales of Equity Securities and Results of Operations
On September 6, 2022, the
Company's Board of Directors authorized a stock repurchase program for up to $30 million of the Company’s outstanding shares of Class A common stock. Repurchases of Class A common stock may be made at management’s discretion from time to time in one or more transactions on the open market or in privately negotiated purchase and/or through other legally permissible means, depending on market conditions and in accordance with applicable rules and regulations promulgated under Securities Exchange Act. The Company did not purchase any shares during the quarter ended June 30, 2023. As of June 30, 2023, $26.1 million in aggregate dollar value of shares remained available for purchase under the stock
repurchase program.
During the three months ended June 30, 2023, no director or officer of the Companyiiadopted/
or iiterminated/ a "Rule 10b5-1 trading arrangement" or "non-Rule 10b5-1 trading arrangement," as such term is defined in Item 408(a) of Regulation S-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
