COVETRUS, INC. Forward-looking Statements
Certain matters discussed in this Form 10-Q, and in particular, this management's discussion and analysis of financial condition and results of operations, contain statements, estimates, and projections that are "forward-looking statements" as defined underU.S. federal securities laws and involve substantial risks and uncertainties. When used in this Report, the words "anticipate," "assume," "believe," "budget," "continue," "could," "estimate," "expect," "future," "intend," "may," "plan," "potential," "predict," "project," "should," "will," and the negative of these or similar terms and phrases are intended to identify forward-looking statements. Such statements are subject to numerous risks and uncertainties, and actual results could differ materially from those anticipated due to a number of factors including but not limited to: •the potential for political, social, or economic unrest, terrorism, hostilities, or war, including the ongoing war betweenRussia andUkraine and the impact of financial and economic sanctions on the regional and global economy •the impact of the Merger Agreement, including the disruption of management's attention from ongoing operations, inability to complete the Merger due to failure to obtain shareholder approval or satisfy other closing conditions, risk that if the Merger is not completed, the market price of our common stock could decline, risk that we may not be able to retain key personnel, the impact on our relationships with our customers and suppliers, the impact on our operations, the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement, including a termination under circumstances that could require the Company to pay a termination fee toCorgi Bidco, Inc. •the impact of inflationary effects and changes in foreign currency exchange rates on the Company •access to financial markets, the impact of interest rates on our debt service costs and any new debt financing we may seek to execute •the effect of health epidemics, including the COVID-19 pandemic, on our business and the success of any measures we have taken or may take in the future in response thereto, including compliance with prolonged measures to contain the spread of COVID-19, which may impact our ability to continue operations at our distribution centers and pharmacies •the ability to achieve performance targets, including managing our growth effectively •the ability to launch new products •the ability to successfully integrate acquisitions, operations, and employees •the ability to continue to execute on our strategic plan •the ability to attract and retain key personnel •the ability to manage relationships with our supplier network, including negotiating acceptable pricing and other terms with these partners •the ability to attract and retain customers in a price sensitive environment •the ability to maintain quality standards in our technology product offerings, as well as associated customer service interactions to minimize loss of existing Customers, and attract new Customers •changes in the legislative landscape in which we operate, including potential corporate tax reform, and our ability to adapt to those changes as well as adaptation by the third parties we are dependent upon for supply and distribution •the impact of litigation •the impact of accounting pronouncements, seasonality of our business, leases, expenses, interest expense, and debt •sufficiency of cash and access to liquidity •cybersecurity risks, including risk associated with our dependence on third-party service providers as a large portion of our workforce is working from home •additional risks and factors discussed under the heading Risk Factors in this Report, in our Form 10-K filed onFebruary 28, 2022 , and in our otherSEC filings Our forward-looking statements are based on current beliefs and expectations of our management team and, except as required by law, we undertake no obligations to make any revisions to the forward-looking statements contained in this Report or to update them to reflect events or circumstances occurring after the date of this Report, whether as a result of new information, future developments, or otherwise. Although we believe the expectations reflected in the forward-looking statements are reasonable, we can give no assurance that these expectations will prove to have been correct. These expectations may or may not be realized. Some of these expectations may be based upon assumptions, data, or judgments that prove to be incorrect. Actual events, results, and outcomes may differ materially from our expectations due to a variety of known and unknown risks, uncertainties, and other factors. Important factors that could cause actual results to differ materially from those indicated by such forward-looking statements include those set forth in this Form 10-Q and under the caption Item 1A. Risk Factors in our Form 10-K.Covetrus, Inc. 2022 Q2 Form 10-Q 17
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We operate in a very competitive and rapidly changing market. New risks emerge from time to time, and it is not possible for our management to predict all risks, nor can we assess the impact of all factors 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. The results of operations for the three and six months endedJune 30, 2022 are not necessarily indicative of what our operating results for the full fiscal year will be. For the foregoing reasons, you are cautioned against relying on any forward-looking statements. You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes thereto appearing elsewhere in this Form 10-Q and our audited consolidated financial statements and the related notes and other financial information included in our Form 10-K. Rounding adjustments applied to individual numbers and percentages shown in this Report may result in these figures differing immaterially from their absolute values and certain tables may not foot or cross-foot.
Overview
We are a global animal-health technology and services company dedicated to supporting the companion, equine, and large-animal veterinary markets. Our mission is to provide a broad array of products, services, and technology to veterinarians and animal-health practitioners across the globe, so they can deliver exceptional care to their patients when and where it is needed.
We are currently in the third year of our three-year strategic roadmap to drive long-term value creation: •2020 - Streamline - Focus our business •2021 - Synchronize - Harmonize our capabilities •2022 - Accelerate - Expand our offering
See Item 1. Business - Our Strategy in our Form 10-K for more information on our three-year strategy and our synchronization priorities for 2022.
Proposed Merger
OnMay 24, 2022 , we entered into a Merger Agreement by and among the Company,Corgi Bidco, Inc. , andCorgi Merger Sub, Inc. , providing for the acquisition of the Company byCorgi Bidco, Inc. The Merger Agreement provides that, among other things, upon the terms and subject to the conditions set forth in the Merger Agreement,Corgi Merger Sub, Inc. will merge with and into the Company, with the Company continuing as the surviving corporation and a direct wholly owned subsidiary of Corgi,Bidco, Inc. Pursuant to the Merger Agreement, each share of common stock, par value$0.01 per share, of the Company issued and outstanding immediately prior to the Effective Time of the Merger (other than (i) Shares owned byCorgi Bidco, Inc. , and Corgi Merger Sub or any of their respective subsidiaries (including the Shares to be transferred byCD&R Holdings ), toCorgi Bidco, Inc. immediately prior to the Effective Time), (ii) Shares owned by the Company as treasury stock, and (iii) Shares that are owned by the shareholders of the Company who will not have voted in favor of the adoption of the Merger Agreement and will have properly exercised appraisal rights in respect of such Shares in accordance with Section 262 of the Delaware General Corporation Law) will be converted into the right to receive$21.00 per Share in cash, without interest thereon. The parties' obligations to consummate the Merger are subject to the satisfaction or waiver of certain customary closing conditions set forth in the Merger Agreement, including, among others: (i) the adoption of the Merger Agreement by the holders of a majority of the outstanding Shares, (ii) receipt of certain consents and approvals from governmental entities, (iii) the absence of any law or governmental order prohibiting the Merger, (iv) no Company Material Adverse Effect having occurred since the signing of the Merger Agreement and (v) certain other customary conditions relating to the parties' representations and warranties in the Merger Agreement and the performance of their respective obligations. The Merger is currently expected to close in the second half of 2022, subject to the satisfaction or waiver of the closing conditions. Additional information about the Merger is set forth in our Current Report on Form 8-K filed with theSEC onMay 25, 2022 , and our preliminary proxy statement filed with theSEC onJune 30, 2022 , which disclosure is incorporated by reference herein. SegmentsCovetrus, Inc. 2022 Q2 Form 10-Q 18
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We are organized based upon geographic region and focus on delivering our platform of products and services to our Customers on a geographical basis. Our reportable segments are (i)North America , (ii)Europe , and (iii) APAC & Emerging Markets. Our major product groups that we disaggregate within our reportable segments are (i) supply chain services, (ii) prescription management, and (iii) software services. See Note 2 - Segment Data and Note 3 - Revenue from Contracts with Customers. North America Segment: Has the most expansive collection of products, services, and technologies for our Customers and Animal-Owners. In broad categories, we offer supply chain services, prescription management, and software services. Prescription management includes our prescription management platform, compounding services, and Great Pet Care.
Europe Segment: We offer supply chain services and software services to our Customers and Animal Owners.
APAC and Emerging Markets Segment: We offer supply chain services and software services to our Customers and Animal Owners.
Across our segments and major product groups, the willingness of Animal Owners to spend with their veterinarians on preventative and therapeutic treatments and procedures is critical to our financial performance. In the companion-animal market specifically, there is an ongoing trend of owners humanizing, or providing the best possible lives for their pets. Across the companion-animal, equine, and large animal markets, we anticipate that for us to succeed on our strategic roadmap, we should prioritize value creation with our Customers so that we can seek to strengthen the relationship between Customers and Animal Owners as well as enable our Customers to provide proactive healthcare options to Animal Owners.
Key Factors and Trends Affecting our Results
COVID-19
During the COVID-19 pandemic, all of our distribution centers and pharmacies have remained open as veterinary medicine has been deemed an essential service in most geographies across the globe. The required responses to mitigate the spread of COVID-19 shifted Customer and Animal-Owner demand to our prescription management and online pharmacy services. We adhere to the regulations and guidelines instituted by local authorities in our area of operations and make judgments with the best available information at the time. We are continuing to actively monitor how COVID-19 and related variants are impacting our business operation and the industry and may take further actions to alter our business operations in the best interests of our employees, Customers, partners, suppliers, and other stakeholders, or as required by federal, state, or local authorities. Revenue Growth The net sales growth for the six months endedJune 30, 2022 is reflective of companion-animal end market growth rates returning to pre-COVID-19 levels, our improved sales execution which was furthered by our commercial organization realignment within ourNorth America segment from late 2020 into 2021, and continued growth in usage of prescription management and online pharmacy services by Customers and Animal Owners. Our prescription management and online pharmacy service are currently available in ourNorth America segment. We believe the retention of Customers and their Animal-Owner clients brought to us during the COVID-19 pandemic in 2020 and beyond, our continued market penetration, and the introduction of product and service offerings aimed at driving greater utilization of our online pharmacy services could lead to long-term net sales growth.
Seasonality
Our quarterly sales and operating results have varied from period to period in the past and will likely continue to do so in the future. In the companion-animal market, sales of parasite protection products have historically tended to be stronger during the spring and summer months, primarily due to an increase in vector-borne diseases during that time.
Buying patterns can also be affected by manufacturers' and distributors' marketing programs or price increase announcements, which can cause veterinarians to purchase animal-health products earlier than when those products are needed. This kind of early purchasing may reduce our sales in the quarters these purchases would have otherwise been made.
Covetrus, Inc. 2022 Q2 Form 10-Q 19 -------------------------------------------------------------------------------- Table of Contents The sales of animal health products can also vary due to changes in the price of commodities used in manufacturing the products and weather patterns, which may also affect period-over-period financial results. We expect our historical seasonality trends to continue in the foreseeable future despite that the climate change around the world may have an increased effect on both the timing and magnitude of these seasonal impacts.
Cost Inflation and Labor Availability
We are also closely tracking macroeconomic factors, including rising inflation, that is increasing costs for our operations, which our expense management practices may or may not be able to offset. For example, costs have risen related to elevated labor turnover beginning in the spring of 2021, worker shortages and increased competition for a diminished labor pool, employee retention programs, global supply chain disruptions, and increased transportation rate and fuel cost. We also expect indirect impacts of inflation on our business, for example, inflation and rising fuel costs resulting in increased travel expenses, beyond volume-related increases in travel in 2022, as COVID-19 restrictions continue to be lifted across many of the geographies where we have operations. We expect cost inflation and transportation costs to remain elevated throughout the rest of fiscal 2022. As our estimates of inflation for fiscal 2022 continue to change, it is impractical to quantify the impact at this time.
Terms with Key Suppliers, Customers, and Partners
Each year, suppliers engage in negotiations with us regarding pricing terms, including performance rebates and other growth incentives. Our supply chain services are dependent upon third-party suppliers, and the results of these negotiations, including whether the contractual relationship remains in place, can have a material impact on the financial performance of our business. We are focused on developing stronger relationships with our manufacturers and suppliers, and we expect to utilize our strategic growth initiatives to influence Customer and Animal-Owner brand loyalty in our efforts to drive value for our suppliers. However, if a competitor is able to obtain better terms with suppliers in the veterinary channel or obtain exclusivity on products we typically sell to our Customers within the global animal-health market or if a supplier decides to go directly to the Customer or Animal-Owner and bypass our services, our business could be impacted beyond the short-term. Our supplier relationships are concentrated with five suppliers accounting for approximately 50% and 48% of our purchases for the six months endedJune 30, 2022 and year endedDecember 31, 2021 , respectively. If we were to lose one of these five major manufacturing relationships, our global financial performance could be materially affected. Our ability to exercise influence over the terms with these suppliers has historically been limited, resulting in pressure on our ability to grow our gross profit margins.
Foreign Currency Translation Effect
Our performance was impacted by the appreciation of the USD as compared to other currencies for the three and six months endedJune 30, 2022 as compared to the same periods of 2021. However, this effect may be temporary and reverse. The table below presents the foreign currency translation effect on our results of operations for the three and six months endedJune 30, 2022 by applying the rates in effect for the comparable prior-year period. Effect on the APAC & Emerging (In millions) total Company(1) Europe(2) Markets(3) Three Months EndedJune 30, 2022 Net sales $ (45) $ (38) $ (7) Adjusted EBITDA $ (2) $ (2) $ - Six Months EndedJune 30, 2022 Net sales $ (70) $ (58) $ (12) Adjusted EBITDA $ (4) $ (3) $ (1) (1) Adjusted EBITDA is our segment measure of profitability. Total company Adjusted EBITDA is a non-GAAP measure and is reconciled in our segment footnote in accordance with ASC 280. (2) The British Pound, Euro, and Polish Zloty were the foreign currencies with the largest translation impact on our results within our Europe Segment (3) The Australian Dollar and the New Zealand Dollar were the foreign currencies with the largest translation impact on our results within our APAC & Emerging Markets segment
Investing in Innovation
Our strategic initiatives in the near and long-term are focused on executing on
our connected care strategy which seeks to align a connected veterinary practice
with a connected consumer through bridging in-clinic engagement to a healthy
at-home lifestyle, which we expect to deliver value to both Customers and Animal
Owners. A key component of this strategy is our all-in cloud-
Covetrus, Inc. 2022 Q2 Form 10-Q 20
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based veterinary operating system, Covetrus Pulse™, which was released in North
America in May 2022 . Covetrus Pulse™ is intended to unite the applications
veterinary practices rely on into one secure cloud platform driving improved
efficiencies in business operations, animal health, and client experiences. With
Covetrus Pulse™, we expect to enable our Customers to create, renew, and approve
prescriptions, communicate with Animal Owners and coworkers, personalize
dashboards used in practice management, and customize in-clinic and Animal Owner
experiences using a suite of preferred third-party applications. In May 2022 , we
launched our international cloud-based practice management solution, Ascend, and
we plan on launching additional new products during the year. Additionally, new
features added to our on-premise software solutions and our next generation
prescription management capabilities are expected to improve our Customers' and
Animal-Owners' experiences as well as drive growth for our Customers' practices.
Our priorities also include focusing on accelerating the contribution provided
by our higher margin technology, e-commerce, and proprietary products and
solutions, including aligning our organization structure to harmonize and
advance these offerings in a coordinated go-to-market strategy. SmartPak and
Covetrus -branded products and proprietary brands like Kruuse, Vi, and Calibra
are included within our supply chain services major product category. To support
these strategic initiatives, our spending will likely further increase to
support our organic growth initiatives and acquisition strategy in the
animal-health market. We will closely monitor the expenses we deem necessary for
growth and maintain ongoing cost management practices to align expenses with
expected volumes and provide long-term flexibility for our transformation.
Acquisition-driven Amortization
As we pursue a growth strategy through acquisitions, we are likely to acquire
intangible assets, such as customer relationships, trademarks, patents, product
development (including formulas), and non-compete agreements. Our intangibles
are predominately composed of intangibles acquired through our acquisition of
Vets First Choice. These acquired intangibles have useful lives of 5 years for
trademarks and trade names, 11 years for product formulas, 11 years for customer
relationships, and 5 years for developed technologies.
The amortization of these intangibles has a long-term effect on our expense
recognition. Product formulas are amortized to Cost of sales as these formulas
are directly tied to the production of compounded products as alternatives to
back-ordered solutions, patient-specific customized medications, and in-clinic
use medications. Amortization expense for our other intangible assets not
directly related to sales-generating activities is included in SG&A.
Three Months Ended June 30, Six Months Ended June 30,
(In millions) 2022 2021 2022 2021
Cost of sales $ 2 $ 1 $ 5 $ 2
Selling, general and administrative 29 33 57 67
Total amortization expense $ 31 $ 34 $ 62 $ 69 Definition of Non-GAAP Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization
Adjusted EBITDA is a non-GAAP financial measure used to (i) aid management and investors with year-over-year comparability, (ii) determine management performance under our compensation plans, (iii) plan and forecast, (iv) communicate our financial performance to our Board of Directors, shareholders, and investment analysts, and (v) understand our operating performance without regard to items we do not consider a component of our core ongoing operating performance. Adjusted EBITDA has certain limitations in that it does not consider the impact of certain expenses to our condensed consolidated statements of operations. Adjusted EBITDA excludes share-based compensation, strategic consulting, transaction costs, formation ofCovetrus expenses, separation programs and executive severance, certain IT infrastructure expenses necessary to establish ourselves as a newly public company, goodwill impairment charges, other impairments, capital structure-related fees, the proportionate share of the adjustments to EBITDA of consolidated and non-consolidated affiliates whereCovetrus ownership is less than 100%, and other income and expense items, net. Currently, we do not allocate expenses managed at the corporate level, such as corporate wages and related benefits, corporate occupancy costs, professional services utilized at the corporate level, and non-recurring expenses to our operating segments. Other companies may not define or calculate Adjusted EBITDA in the same way. We provide Adjusted EBITDA by segment as a supplemental measure to GAAP as well as on a consolidated, non-GAAP basis. Non-GAAP Adjusted EBITDA on a total segment basis is reconciled in Note 2 - Segment Data as required by ASC 280.
Key Factors and Trends Affecting our Results, as discussed above, presented by Segment
North America Segment
Covetrus, Inc. 2022 Q2 Form 10-Q 21
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•Continued strong growth in prescription management revenues driven by increases
in the number of both veterinarians and Animal Owners using our prescription
management platform
•Positive end-market demand, albeit moderating off the strong growth rates
experienced during the pandemic
•Increasing wage and logistics costs driven by continued, global supply chain
disruption and inflation, partially offset by higher product prices
•Acquisition of Great Pet Care to expand on our consumer capabilities to support
our Customers' delivery of care beyond the exam room
Europe Segment
•Continuing our progress on rationalizing our operations in the U.K. and
Germany : our efforts in Germany are delivering improved profitability albeit at
a reduced sales baseline. Our operations in the U.K. have experienced a decline
in sales following the loss of Merck & Co. as a supply partner effective January
1, 2021 as well as a subsequent loss of a customer during the first quarter of
2021 resulting in unfavorable comparisons through the first quarter of 2022.
•Foreign currency translation effects due to a stronger USD
•Although we do not have operations in Russia and Ukraine , we have experienced
increased costs for transportation, energy, and raw material due in part to the
negative impact of the Russian invasion of Ukraine on the global economy. To
date, the Russian invasion of Ukraine has not had a material impact on our
business, financial condition, or result of operations.
Asia-Pacific and Emerging Markets Segment
•Foreign currency translation effects due to a stronger USD
Results of Operations
Three Months Ended June 30, Six Months Ended June 30,
$ Change % Change $ Change % Change
(In millions) 2022 2021 B/(W) B(W) 2022 2021 B/(W) B/(W)
Net sales $ 1,217 $ 1,189 $ 28 2 % $ 2,365 $ 2,291 $ 74 3 %
Cost of sales 988 969 (19) (2) 1,911 1,861 (50) (3)
Gross profit 229 220 9 4 454 430 24 6
Operating expenses:
Selling, general and
administrative 225 229 4 2 444 442 (2) -
Operating income (loss) $ 4 $ (9) $ 13 NM $ 10 $ (12) $ 22 NM
Interest expense, net $ (7) $ (9) $ 2 22 % $ (14) $ (18) $ 4 22 %
Other, net $ - $ - $ - NM $ 2 $ - $ 2 NM
Net income (loss) $ (4) $ (31) $ 27 87 % $ (6) $ (47) $ 41 87 %
Net income (loss) attributable to
Covetrus $ (4) $ (31) $ 27 87 % $ (6) $ (47) $ 41 87 %
Year-Over-Year Period Comparisons
Net Sales Three Months Ended June 30, (In millions) 2022 2021 $ Change % Change North America$ 783 $ 713 $ 70 10 % Europe 327 366 (39) (11) APAC & Emerging Markets 109 114 (5) (4) Eliminations (2) (4) 2 NM Total net sales$ 1,217 $ 1,189 $ 28 2 % Covetrus, Inc. 2022 Q2 Form 10-Q 22 -------------------------------------------------------------------------------- Table of ContentsNorth America net sales+$70 million I +10% 3 months Q2 2022 v Q2 2021
Primarily due to
companion animal parasiticide sales,
? driven by increased utilization from a growing number of Customers and Animal Owners
as well as sales of
the first quarter of 2022 and VCP in the third quarter of 2021
Europe net sales -$(39) million I -(11)% 3 months Q2 2022 v Q2 2021
Largely due to
USD,
? and consolidation within our customer groups, a
related to opportunistic sales in 2021 that did not recur in 2022, and a decline in
proprietary brands sales relative to higher sales in 2021 associated with COVID-19
? Primarily due to
APAC & Emerging Markets net sales -
? More than explained by
Primarily due to
? by price increases as well as elevated sales volume, in particular within
Zealand
Consolidated net sales +$28 million I +2%
3 months Q2 2022 v Q2 2021
Primarily due to net, supply chain organic sales growth in
? Emerging Markets as well as certain markets within
growth driven by increased utilization from a growing number of Customers and Animal
Owners as well as sales associated with acquisitions
Largely due to
APAC & Emerging Markets from a stronger USD, declining sales in the
? corporate market softness and consolidation within our customer groups, decline in
sales in
well as decline in proprietary brands sales relative to higher sales in 2021 associated
with COVID-19
Net Sales
Six Months Ended June 30,
(In millions) 2022 2021 $ Change % Change
North America $ 1,479 $ 1,348 $ 131 10 %
Europe 671 727 (56) (8)
APAC & Emerging Markets 221 226 (5) (2)
Eliminations (6) (10) 4 (40)
Total net sales $ 2,365 $ 2,291 $ 74 3 %
North America net sales +$131 million I +10%
6 months Q2 2022 v Q2 2021
Primarily due to
companion animal parasiticide sales and continued strong performance in proprietary
? brands,
utilization from a growing number of Customers and Animal Owners as well as
million in sales associated with our acquisitions of Great Pet Care in the first
quarter of 2022 and VCP in the third quarter of 2021
? Largely due to
loss of legacy data contracts with certain manufacturer partners
Europe net sales -$(56) million I -(8)% 6 months Q2 2022 v Q2 2021Covetrus, Inc. 2022 Q2 Form 10-Q 23
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More than explained by
stronger USD,
softness and consolidation within our customer groups and the loss of Merck & Co. as a
? supply partner as well as a loss of a customer in the first quarter of 2021, a decline in
proprietary brands sales relative to higher sales in 2021 associated with COVID-19, and a
decline in sales in
2022
Primarily due to
?
first quarter of 2022
APAC & Emerging Markets net sales -
? More than explained by
stronger USD
Primarily due to
? by price increases as well as elevated sales volume, in particular within
Zealand
Consolidated net sales +$74 million I +3%
6 months Q2 2022 v Q2 2021
Primarily due to net, supply chain organic sales growth in
? Emerging Markets as well as certain markets within
growth driven by increased utilization from a growing number of Customers and Animal
Owners, as well as sales associated with acquisitions
Largely due to
APAC & Emerging Markets from a stronger USD, declining sales in the
corporate market softness and consolidation within our customer groups and the loss of
? Merck & Co. as a supply partner as well as a loss of a customer in the first quarter of
2021, a decline in proprietary brands sales relative to higher sales in 2021 associated
with COVID-19 as well as a decline in sales in
in 2021 that did not recur in 2022
Gross Profit and Gross Profit Margin
Three Months Ended
Gross Margin Gross Margin Gross Profit %
(In millions) 2022 % 2021 % $ Change Change
North America $ 158 20.2 % $ 144 20.2 % $ 14 10 %
Europe 50 15.3 53 14.5 (3) (6)
APAC & Emerging Markets 21 19.3 23 20.2 (2) (9)
Total Gross profit $ 229 18.8 % $ 220 18.5 % $ 9 4 %
North America gross profit +$14 million I +10%
3 months Q2 2022 v Q2 2021
Primarily due to
utilization from a growing number of Customers and Animal Owners,
? growth driven by growth in the companion animal market as well as the net contribution from
acquisitions of Great Pet Care in the first quarter of 2022 and VCP and AppointMaster in the
third quarter of 2021
Europe gross profit -$(3) million I -(6)% 3 months Q2 2022 v Q2 2021
? Largely due to
USD
Primarily due to
?
quarter of 2022
APAC & Emerging Markets gross profit -
? Largely due to
USD
Covetrus, Inc. 2022 Q2 Form 10-Q 24
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Consolidated gross profit+$9 million I +4% 3 months Q2 2022 v Q2 2021
Primarily due to prescription management growth driven by increased utilization from a
? growing number of Customers and Animal Owners, supply chain organic sales growth in
sales growth within certain markets in
? Largely driven by an unfavorable foreign exchange rate impact from a stronger USD
Gross Profit and Gross Profit Margin
Six Months Ended
Gross Margin Gross Margin Gross Profit %
(In millions) 2022 % 2021 % $ Change Change
North America $ 306 20.7 % $ 275 20.4 % $ 31 11 %
Europe 103 15.4 109 15.0 (6) (6)
APAC & Emerging Markets 45 20.4 46 20.4 (1) (2)
Total Gross profit $ 454 19.2 % $ 430 18.8 % $ 24 6 %
North America gross profit +$31 million I +11%
6 months Q2 2022 v Q2 2021
Primarily due to
utilization from a growing number of Customers and Animal Owners,
? chain organic sales growth driven by continued strong performance in proprietary brands and
the companion animal market as well as the net contribution from acquisitions of Great Pet
Care in the first quarter of 2022 and VCP and AppointMaster in the third quarter of 2021
Largely due to a
? of legacy data contracts with manufacturer partners and increased amortization expense tied
to acquisitions completed in 2021
Europe gross profit -$(6) million I -(6)% 6 months Q2 2022 v Q2 2021
Largely due to
USD and
? Merck & Co. as a supply partner as well as a loss of a customer, both in the
the first quarter of 2021, as well as a decline in proprietary brands sales relative to
higher sales in 2021 associated with COVID-19
? Primarily due to
APAC & Emerging Markets gross profit -
? Largely due to
USD
? Primarily due to
particular within
Consolidated gross profit+$24 million I +6% 6 months Q2 2022 v Q2 2021
Primarily due to prescription management growth driven by increased utilization from a
growing number of Customers and Animal Owners, supply chain organic sales growth in North
? America driven by continued strong performance in proprietary brands and the companion
animal market, net supply chain organic sales growth within certain markets in
acquisitions, and APAC & Emerging Markets net supply chain organic sales growth
Largely driven by an unfavorable foreign exchange rate impact from a stronger USD, a
? decrease in software services primarily a result of the loss of legacy data contracts with
certain manufacturer partners, and the loss of Merck & Co. as a supply partner as well as a
loss of a customer, both in the U.K. , in the first quarter of 2021
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SG&A
Three Months Ended June 30,
(In millions) 2022 2021 $ Change % Change
North America $ 137 $ 127 $ 10 8 %
Europe 39 42 (3) (7)
APAC & Emerging Markets 15 16 (1) (6)
Corporate 34 44 (10) (23)
Total SG&A $ 225 $ 229 $ (4) (2) %
North America SG&A +$10 million I +8%
3 months Q2 2022 v Q2 2021
Largely due to
support sales growth,
first quarter of 2022 and VCP and AppointMaster in the third quarter of 2021,
? increase in facilities costs, including costs related to our new
pharmacies and our new North America Distribution Center in
show costs of
increased software expense particularly in prescription management due to increased
utilization from a growing number of Customers
? Primarily due to
that became fully amortized prior to 2022
Acquisition-related intangible amortization was 19% of North America SG&A in 2022 and 23% in 2021
Europe SG&A -$(3) million I -(7)% 3 months Q2 2022 v Q2 2021
? Largely due to
Primarily due to
? activities have resumed in 2022, and
an enterprise resource planning system
APAC & Emerging Markets SG&A -
? Largely due to favorable foreign exchange rate impacts Corporate SG&A -$(10) million I -(23)% 3 months Q2 2022 v Q2 2021
Primarily due to
? share-based compensation expense related to our long-term incentive program grants, as well as a decrease
of
? Largely due to a
Consolidated SG&A -$(4) million I -(2)% 3 months Q2 2022 v Q2 2021
Largely due to increased personnel costs as we continue to invest in certain business to
support growth, increased transaction costs, acquisitions, increased travel and trade show
? costs as certain of these activities have begun to resume in 2022, increased software
expense as we roll out an enterprise resource planning system and utilization, and increased
facilities costs in
Primarily due to decreases in strategic consulting fees, favorable foreign exchange rate
? impacts, reduced amortization of intangibles related to assets that became fully amortized
prior to 2022, a decrease in share-based compensation expense related to our long-term
incentive program grants as well as a decrease in consulting and professional fees
Covetrus, Inc. 2022 Q2 Form 10-Q 26
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SG&A
Six Months Ended June 30,
(In millions) 2022 2021 $ Change % Change
North America $ 267 $ 251 $ 16 6 %
Europe 82 84 (2) (2)
APAC & Emerging Markets 30 30 - -
Corporate 65 77 (12) (16)
Total SG&A $ 444 $ 442 $ 2 - %
North America SG&A +$16 million I +6%
6 months Q2 2022 v Q2 2021
Largely due to
support sales growth,
first quarter of 2022 and VCP and AppointMaster in the third quarter of 2021,
? increase in facilities costs, including costs related to our new
pharmacies and our new North America Distribution Center in
show costs of
million in increased software expense particularly in prescription management due to
increased utilization from a growing number of Customers
Primarily due to
? that became fully amortized prior to 2022 and
intangible asset impairments in the prior year
Acquisition-related intangible amortization was 19% of North America SG&A in 2022 and 24% in 2021
Europe SG&A -$(2) million I -(2)% 6 months Q2 2022 v Q2 2021
? Largely due to
Primarily due to
? supply chain operations,
enterprise resource planning system, and
costs as certain of these activities have begun to resume in 2022
APAC & Emerging Markets SG&A $- million I -%
6 months Q2 2022 v Q2 2021
? Largely due to $(1) million in favorable foreign exchange rate impacts
? Primarily due to $1 million in increased personnel costs
Corporate SG&A -$(12) million I -(16)%
6 months Q2 2022 v Q2 2021
Primarily due to
legal fee insurance recoveries related to the Securities Litigation Matter and other
? legal matters,
did not recur in 2022,
related to our long-term incentive program grants as well as a decrease in consulting
and professional fees
? Largely due to
and a
Consolidated SG&A+$2 million I -% 6 months Q2 2022 v Q2 2021Covetrus, Inc. 2022 Q2 Form 10-Q 27
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Largely due to increased personnel costs as we continue to invest in certain business to
support growth, increased transaction costs, acquisitions, increased travel and trade show
? costs as certain of these activities have begun to resume in 2022, increased facilities
costs in
planning system and utilization, the Securities Litigation Matter settlement, and increased
expense in
Primarily due to a decrease in strategic consulting fees, reduced amortization of
intangibles related to assets that became fully amortized prior to 2022, favorable foreign
exchange rate impacts, legal fee insurance recoveries related to the Securities Litigation
? Matter and other legal matters, expense related to the formation of
share-based compensation expense related to our long-term incentive program grants, and
customer relationship intangible impairments in the prior year as well as decreased
consulting and professional fees
Income Taxes
3 months Q2 2022
Income tax expense of
The difference between our tax expense and the tax expense using the statutory tax rates for the jurisdictions in which we operate, for this period, primarily relates to valuation allowances due to uncertainty regarding the realization of future tax benefits from certainU.S. and non-U.S. losses.
3 months Q2 2021
Income tax expense of
The difference between our tax expense and the tax expense using the statutory tax rates for the jurisdictions in which we operate, for this period, primarily related to valuation allowances due to uncertainty regarding the realization of future tax benefits from certainU.S. deferred tax assets and certain expenses not deductible in theU.S.
6 months Q2 2022
Income tax expense of
The difference between our tax expense and the tax expense using the statutory tax rates for the jurisdictions in which we operate, for this period, primarily relates to valuation allowances due to uncertainty regarding the realization of future tax benefits from certainU.S. and non-U.S. losses and items recorded discretely.
6 months Q2 2021
Income tax expense of
The difference between our tax expense and the tax expense using the statutory tax rates for the jurisdictions in which we operate, for this period, primarily related to valuation allowances due to uncertainty regarding the realization of future tax benefits from certainU.S. deferred tax assets and certain expenses not deductible in theU.S. Adjusted EBITDA Three Months Ended June 30, (In millions) 2022 2021 $ Change % Change North America$ 63 $ 59 $ 4 7 % Europe 17 20 (3) (15) APAC & Emerging Markets 8 9 (1) (11) Corporate (22) (22) - - Total adjusted EBITDA$ 66 $ 66 $ - - % North America Adjusted EBITDA+$4 million I +7% 3 months Q2 2022 v Q2 2021
Primarily due to prescription management growth of
? utilization from a growing number of Customers and Animal Owners as well as
acquisitions
Europe Adjusted EBITDA -$(3) million I -(15)%
3 months Q2 2022 v Q2 2021
Covetrus, Inc. 2022 Q2 Form 10-Q 28
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Largely due to
? USD and a
effect of higher than normal net sales in the prior year period and increased SG&A expenses
as we invest in this higher-margin business
APAC & Emerging Markets Adjusted EBITDA -
? Largely due to a decrease in supply chain, particularly inBrazil
Corporate Non-GAAP Adjusted EBITDA $- million I -% 3 months Q2 2022 v Q2 2021
? Primarily due to a
Largely due to foreign exchange transaction effects associated with intercompany notes
? of
entered into monthly foreign exchange hedges to minimize the impact of our non-USD
denominated intercompany notes
Consolidated Non-GAAP Adjusted EBITDA $- million I -% 3 months Q2 2022 v Q2 2021
? Primarily due to prescription management growth driven by increased utilization from a growing
number of Customers and Animal Owners and decreased consulting and professional fees
Largely due to an unfavorable foreign exchange rate impact due to a stronger USD, foreign
? exchange transaction effects associated with intercompany notes, and a decrease in our
proprietary brands, Kruuse and Vi, in
Adjusted EBITDA
Six Months Ended June 30,
(In millions) 2022 2021 $ Change % Change
North America $ 120 $ 111 $ 9 8 %
Europe 35 41 (6) (15)
APAC & Emerging Markets 18 19 (1) (5)
Corporate (44) (48) 4 8
Total adjusted EBITDA $ 129 $ 123 $ 6 5 %
North America Adjusted EBITDA +$9 million I +8%
6 months Q2 2022 v Q2 2021
Primarily due to prescription management growth of
? utilization from a growing number of Customers and Animal Owners,
organic sales growth driven by continued strong performance in proprietary brands, and
additional contributions from acquisitions
Largely due to a
? of legacy data contracts with certain manufacturer partners and investments to support
upcoming product launches later in 2022
Europe Adjusted EBITDA -$(6) million I -(15)% 6 months Q2 2022 v Q2 2021
Largely due to a
the effect of higher than normal net sales in the prior year period and increased SG&A
? expenses as we invest in this higher-margin business,
exchange rate impact due to a stronger USD, and
driven by the loss of Merck & Co. as a supply partner as well as a loss of a customer, both
in the
? Primarily due to
Covetrus, Inc. 2022 Q2 Form 10-Q 29
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APAC & Emerging Markets Adjusted EBITDA -
? Largely due to
stronger USD
Corporate Adjusted EBITDA +$4 million I +8%
6 months Q2 2022 v Q2 2021
Largely due to
Litigation Matter and other legal matters, foreign exchange transaction effects
? associated with intercompany notes of
have entered into monthly foreign exchange hedges to minimize the impact of our non-USD
denominated intercompany notes in 2022 as well as a decrease in consulting and
professional fees
? Largely due to
Consolidated Adjusted EBITDA+$6 million I +5% 6 months Q2 2022 v Q2 2021
Primarily due to prescription management growth driven by increased utilization from a
growing number of Customers and Animal Owners, legal fee insurance recoveries, net supply
? chain organic sales growth within certain markets in
growth in
intercompany notes as well as a decrease in consulting and professional fees
Largely due to an unfavorable foreign exchange rate impact due to a stronger USD, a decrease
in our proprietary brands, Kruuse and Vi, a decrease in supply chain driven by the loss of
? Merck & Co. as a supply partner as well as a loss of a customer, both in the
first quarter of 2021 in
Securities Litigation Matter settlement
Liquidity and Capital Resources
Overview
Our primary sources of liquidity are cash and cash equivalents, cash flows from the operations of our business, and available borrowing capacity under our Credit Facilities. Our principal uses of cash include working capital-related items, capital expenditures, debt service, and strategic investments.
Credit Facilities
The Credit Facilities include a term loan facility and a revolving line of credit. The following table reflects the average borrowings on our revolving line of credit during the period.
Revolving Line of Credit Borrowings
Three Months Ended Six Months Ended Year Ended
(In millions) June 30, 2022 June 30, 2022 December 31, 2021
Average borrowing on our revolving line
of credit (1) 13 $ 14 $ -
(1) Interest payments related to borrowings on our revolving line of credit have not been material to date.
Short-Term
Our liquidity fluctuates during the year due to sales seasonality. Generally, our sales of parasite protection products in the companion-animal market peak during the spring and summer months, which are hemisphere dependent, as vector-borne diseases typically increase during these seasons. This seasonality also affects the timing and amount of our inventory purchases, and subsequently our accounts payable balances. We have obligations related to our operations that require the use of cash in both the short- and long-term: •Long-term obligations related to borrowing arrangements, in particular our term loan facility that has required annual amortization payments of$60 million and covenant limitations on our leverage which may affect our ability to grow through acquisitions in future periods •Leases that we enter into in the normal course of business, andCovetrus, Inc. 2022 Q2 Form 10-Q 30 -------------------------------------------------------------------------------- Table of Contents •Unconditional purchase obligations, such as an exclusive supply agreement we have which obligates us to purchase$29 million of products throughSeptember 30, 2025 . In 2022, we are obligated to buy$8 million of inventory. see Note 5 - Commitments and Contingencies We also have short- and long-term sources of cash: •Accounts receivable, which has historically been highly liquid is an ongoing short-term source of cash. AtJune 30, 2022 andDecember 31, 2021 , we had accounts receivable of$550 million , net of$4 million allowance, and$480 million , net of$4 million allowance, respectively •Borrowing availability under our revolving line of credit, subject to our covenant restrictions, as applicable, and •Accessing the capital and credit markets for incremental liquidity Planned uses of liquidity included in our near-term strategic plan: •Completing our pharmacy innovation and operational capacity expansion inArizona andMaine •Enhancing the consumer experience through continuous improvements in e-commerce, appointment management, wellness, and veterinarian-to-pet-owner connectivity •Expanding our value proposition communication to the market and refinement of our commercial organization go-to market strategy •Developing or acquiring cloud-based practice management software and technology coordination with select existing service offerings, including our recently acquired software from VCP and AppointMaster •Enabling business-to-business ordering capabilities focused on our compounding services, distribution, and inventory management services •Optimizing our distribution network inNorth America , including investments in the systems and facilities that support our network •Rolling out a European enterprise resource planning system to reduce complexity in our enterprise resource planning landscape •Investing in external growth opportunities to support our strategic objectives and potentially making acquisitions and investments earlier or later than we expect, and •Mandatory term loan facility amortization payments and related interest
Acquisitions
We acquired Great Pet Care inMarch 2022 , for$14 million in cash and$10 million in common stock. We have accounted for$1.5 million of common stock consideration as deferred compensation for continuing employees. This acquisition advances our strategy to support Customers in providing Animal Owners with a complete experience that supports the everyday health and wellness of their pets. Trends Our operational plans to manage our liquidity continue to involve seeking opportunities to reduce non-critical capital expenditures, managing opportunistic inventory purchases as we carefully monitor sales forecasts and timing of projected price increases, reducing our other costs, and maximizing our payment terms wherever possible. We also continue to monitor cash flow projections and will consider additional borrowings, if needed, based on availability under our revolving credit facility. We believe we have sufficient sources of funding to meet our business requirements, including remaining in compliance with the covenants within our Credit Facilities, for the next 12 months. InDecember 2021 , we prepaid$30 million of the term loan facility's$60 million mandatory amortization payments for 2022, which reduced our outstanding balance, and in turn, will lower our future interest payments. We are permitted to make optional prepayments at any time without premium or penalty. The next quarterly mandatory principal amortization payment of$15 million is due onSeptember 30, 2022 . As per the revised schedule contained in the 2020 amendment to our Credit Facilities, we are required to remain compliant with a Credit Facilities-defined leverage covenant that, as ofJune 30, 2022 is 3.75x, through maturity of the Credit Facilities inFebruary 2024 . We were in compliance with the covenants in our Credit Facilities as ofJune 30, 2022 . Based on our expected Credit Facilities-defined leverage as ofJune 30, 2022 , once the quarterly compliance filing is made, we expect the current applicable margin on our borrowings outstanding to remain constant at least until the next compliance filing is made for the three months endedSeptember 30, 2022 .Covetrus, Inc. 2022 Q2 Form 10-Q 31
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Our term loan facility and revolving credit facility bear interest on a floating rate basis, which are referenced to LIBOR. One-week and two-month USD LIBOR, as well as all non-USD LIBOR tenors, ceased publication afterDecember 31, 2021 , while three-month, six-month, and one-year USD LIBOR will cease publication afterJune 30, 2023 . As a result, in lieu of amending or waiving any term of the Credit Facility, we notified the administrative agent to the Credit Facility that non-USD currencies would not be available to us either as a revolving line of credit or term loan facility borrowing, and further we suspended our rights to borrow at the two-month USD LIBOR tenor until such time as the Credit Facility is amended with an alternative benchmark rate to USD LIBOR. The duration of the COVID-19 pandemic continues to be unknown and the global economy continues to be subjected to uncertainty that currently affects our operations or could further affect our operations through increasing cost inflation, rising freight costs, continued supply chain disruption, and the war inUkraine . Should the severity of variant strains increase and reduce the effectiveness of vaccines, inflation remain elevated and freight costs continue to rise without offsetting cost reductions internally, then we may experience a negative impact on our liquidity position. Therefore, we continuously assess steps we can take to improve working capital, increase cash on our balance sheet and closely monitor the capital markets for additional opportunities to improve our liquidity position. Long-term Our long-term liquidity is expected to be aligned with our strategic development, and the needs of our growing business in terms of investment to fund growth, as well as availability of financing. We currently anticipate the following long-term liquidity trends for our business: Uses of liquidity: •Investing in our expansion of global sales and marketing efforts •Launching new products and services •Pursuit of strategic, higher-margin acquisition and investment targets •Increasing our pharmaceutical compounding operations capacity •International expansion •Term loan facility debt service •Ongoing operating lease payments •Capital investments •Pursuit and maintenance of appropriate regulatory clearances, approvals for existing products, and any new products that may be developed Sources of liquidity: •Operations-driven cash generation •Borrowings under our revolving line of credit •Availability of financing through the capital markets •Sales of businesses or assets if those actions align with our strategic objectives Longer term, if we desire to access alternative sources of funding through the capital and credit markets, challenging global economic conditions, such as steep inflationary effects, the COVID-19 pandemic or an extended war inUkraine , resulting in an economic downturn could adversely impact our ability to do so.
Cash and Cash Equivalents
As ofJune 30, 2022 , we had cash and cash equivalents of$87 million . We consider all highly liquid short-term investments with an original maturity of three months or less to be cash equivalents. Due to the short-term maturity of such investments, the carrying amounts are a reasonable estimate of fair value. Of the$87 million in cash and cash equivalents atJune 30, 2022 ,$54 million was held in foreign countries. Repatriation of foreign earnings may result in payment of withholding taxes in certain jurisdictions,U.S. state income taxes for certain states and result in tax impacts related to foreign exchange fluctuations. Deferred tax impacts are recorded on all undistributed earnings for these items. We may, from time-to-time, execute short-term intercompany loans based on timing of cash flows and needs in different geographies.
Cash Flows
Covetrus, Inc. 2022 Q2 Form 10-Q 32
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Six Months Ended June 30,
(In millions) 2022 2021 $ Change
Net cash provided by (used for) operating
activities $ (39) $ 3 $ (42)
Net cash provided by (used for) investing
activities (44) (28) (16)
Net cash provided by (used for) financing
activities (6) (34) 28
Total net cash flows $ (89) $ (59) $ (30) Cash inflows and outflows from changes in operating activities for the 6 months ended Q2 2022 v Q2 2021
Net cash used for operating activities of
Primarily driven by net changes in working capital and other assets offset by improved profitability in certain of our markets, in particular fromNorth America prescription management business. Net changes in working capital and other assets include: •Higher accounts receivable growth in the six months endedJune 30, 2022 driven by the increase in net sales growth; •A larger increase in inventories during the six months endedJune 30, 2021 compared to the six months endedJune 30, 2022 , reflecting higher than normal inventory purchases in the prior year •A larger increase in accounts payable and accrued expenses during the six months endedJune 30, 2022 reflecting the timing of certain supplier payments •A larger increase in receivables for supplier rebates and incentives during the six months endedJune 30, 2022 , driven by an increase in volumes subject to these programs
Cash inflows and outflows from changes in investing activities for the 6 months ended Q2 2022 v Q2 2021
In 2022, net cash used for investing activities of
In 2021, net cash used for investing activities of
Cash inflows and outflows from changes in financing activities for the 6 months ended Q2 2022 v Q2 2021
In 2022, net cash used for financing activities of$(6) million was: ? Primarily due to$(7) million in tax payments related to share-based awards,$(3) million to acquire the remaining minority interests held by our former partners in certain of our Brazilian entities, and$(1) million in payments associated with previous acquisitions ? Due to$5 million in proceeds from share-based awards
All borrowings under the revolving line of credit were repaid as of
In 2021, net cash used for financing activities of$(34) million was: ? Largely due to$(13) million in tax payments related to share-based awards,$(13) million in payments to the former owners ofDistrivet S.A. on the one-year anniversary of closing,April 30, 2021 ,$(10) million to acquire the remaining minority interests, held by our former partners in certain of our Brazilian entities, and$(1) million in distributions to non-controlling shareholders ? Due to$3 million in proceeds from share-based awardsCovetrus, Inc. 2022 Q2 Form 10-Q 33 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Estimates Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts in our condensed consolidated financial statements. There have been no material changes in our critical accounting estimates from those disclosed in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations of our Form 10-K. For a discussion of critical accounting policies and estimates as well as accounting policies adopted, see Note 1 - Business Overview and Significant Accounting Policies of our Form 10-K.
Recent Accounting Pronouncements
For information on recent accounting pronouncements, see Note 1 - Business Overview and Significant Accounting Policies.
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