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," "intend," "may," "plan," "potential," "predict," "project," "should," "will," "future," 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 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 vaccine mandates which may be required in certain jurisdictions where we operate and increased turnover rates and absenteeism of our labor force resulting from those mandates which may impact our ability to continue operations at our distribution centers and pharmacies •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 achieve performance targets, including managing our growth effectively •the ability to manage relationships with our supplier and distributor 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 •access to financial markets along with changes in interest rates and foreign currency exchange rates •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 onMarch 1, 2021 , 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. 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 we may make. The results of operations for the three and nine months endedSeptember 30, 2021 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 consolidated financial statements and the related notes and other financial information included in our Form 10-K.Covetrus, Inc. 2021 Q3 Form 10-Q 22 -------------------------------------------------------------------------------- Table of Contents 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 the best 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. In
We are currently in the second 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 2021. 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) software services, and (iii) prescription management. See Note 3 - Segment Data and Note 4 - Revenue from Contracts with Customers. Across our segments and major product groups, the willingness of Animal Owners to seek care and 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 seek to strengthen the relationship between Customers and Animal Owners and provide our Customers with the necessary products, including our proprietary brands and compounded medications, and technology solutions, including our recent acquisition of VCP in the wellness space, for them to deliver care for pets.
Key Factors and Trends Affecting our Results
Growth continues following the onset of the COVID-19 pandemic
During 2020, the animal-health market largely benefited from the lockdowns instituted in response to the COVID-19 pandemic, including the benefit to veterinary practices, including our Customers, from an increase in visits driven by people adopting more pets during 2020 as well as companion Animal Owners increasing their per-visit spend with their veterinarians. This is expected to be a multi-year effect as these Animal Owners seek care from veterinary practices for their newly adopted pets. Additionally, the required responses to mitigate the spread of the COVID-19 pandemic shifted Customer and Animal-owner demand to our prescription management and online pharmacy services. However, we did not experience this COVID-19 driven growth on a straight-line basis: there was a spike in supply chain services sales inMarch 2020 that we consider a pull-forward effect, followed by a significant weakening of sales inApril 2020 as that pull-forward effect balanced out; our growth in supply chain services and prescription management then accelerated for the remainder of the second quarter of 2020 before normalizing in the third and fourth quarters of 2020. The net sales growth for the nine months endedSeptember 30, 2021 reflects the continued strength of the companion-animal market, our improved sales execution which was furthered by our commercial organization realignment inNorth America as ofJanuary 1, 2021 , and elevated purchasing patterns from our prescription management and online pharmacy service users. Our prescription management and online pharmacy service are currently available inNorth America and as the economy re-opens, which remains unpredictable due to the volatility of COVID-19 variant infection rates, users' behavior may change. However, 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.Covetrus, Inc. 2021 Q3 Form 10-Q 23
-------------------------------------------------------------------------------- Table of Contents 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. For example, in theU.S. , we are closely following guidelines fromOSHA on vaccine mandates and will institute policies to comply with applicable federal mandates. 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.
Foreign Currency Effects
Our performance was positively affected by the appreciation of other currencies as compared to USD during the nine months endedSeptember 30, 2021 as compared to the same period of 2020. However, this effect may be temporary.
Investing in Innovation and Corporate Infrastructure
During 2020, we undertook certain temporary cost-containment measures to help us manage the uncertainty created by the COVID-19 pandemic, which are no longer present in the third quarter of 2021. Additionally, we experienced a beneficial effect on SG&A in 2020 from decreased travel and in-person trade shows and conferences as a result of the COVID-19 pandemic and the return of in-person commercial activity beginning in the second quarter of 2021 has resulted in an increase in our expenses related to these meetings and events. We also continue to spend on our corporate functions to build out the infrastructure necessary to support our business today and in the future. Our strategic initiatives in the near and long-term are focused on transforming our offerings into an all-in solution. Our current priorities focus 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 andCovetrus -branded products and proprietary brands like Kruuse, Vi, andCalibra are included within our supply chain services major product category. Our prescription management platform and compounding services are included within our prescription management major product category. To support these strategic initiatives, our spending will likely further increase to support our continued acquisitive and organic growth in the animal-health market. We also expect to invest in internal initiatives to develop technology to be used across our business to drive greater efficiency as well as coordination of our global employee base. However, we 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.
Cost Inflation and Labor Availability
We are also closely tracking macroeconomic factors that could lead to increased 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 transportation rate increases.
We may experience a further increase in labor turnover in our
Terms with Key Suppliers, Customers, and Partners
Each year, suppliers in the veterinary channel 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. EffectiveJanuary 1, 2021 , we no longer are partnered with Merck & Co., in theU.K. , which contributed to a decrease in our U.K. Net sales for the nine months endedSeptember 30, 2021 , and which we expect will also result in decreases for the remainder of this fiscal year. We also are no longer partnered with one of our customers in theU.K. , which further depressed our U.K. Net sales, which we expect to continue throughout 2021. We are taking action to mitigate the effects of the supplier and customer loss in theU.K. ; however, for the nine months endedSeptember 30, 2021 as compared to the nine months endedSeptember 30, 2020 , we experienced a 4%, decline, or$129 million excluding foreign exchange gains, in our consolidated net sales attributable to theCovetrus, Inc. 2021 Q3 Form 10-Q 24 -------------------------------------------------------------------------------- Table of Contents decreasing net sales in theU.K. On gross profit, theU.K.'s contribution declined to 2% for the nine months endedSeptember 30, 2021 as compared to 5% for the nine months endedSeptember 30, 2020 . The transition of our supply chain operations inGermany to a third-party logistics provider in late 2020 has resulted in disruption to our supply chain and a reduction in customer sales volumes. Although we are making progress on stabilizing our customer base and improving service levels in this market, we continue to experience lower sales volumes following the transition. For the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 there was a 24% reduction in Net sales inGermany . However, these customer losses are not expected to have a significant effect on us as our German operations represent 2% of our consolidated net sales for both the nine months endedSeptember 30, 2021 and 2020. Our supplier relationships are concentrated with five suppliers accounting for approximately 49% and 50% of our purchases for the nine months endedSeptember 30, 2021 and for the year endedDecember 31, 2020 , respectively. If we were to lose one of these five major manufacturing relationships, our global financial performance could be materially affected. As these contracts are largely country-specific, annual relationships are separated between supply chain and prescription management, our ability to exercise influence over the terms is currently limited and negatively impacting our gross profit margin. We expect our future success necessitates achieving better terms and stronger relationships with our manufacturers and suppliers as we work with these partners on global initiatives. We expect to utilize our strategic growth initiatives to influence Customer and Animal-Owner brand loyalty in our efforts to drive value for our manufacturers and 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.
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 September 30, Nine Months Ended September 30,
Location 2021 2020 2021 2020
Cost of sales $ 2 $ 1 $ 4 $ 3
Selling, general and administrative 32 33 99 98
Total amortization expense $ 34 $ 34 $ 103 $ 101
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, which correlates with our
second and third quarters given that most of our business is in the northern
hemisphere. 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. The sales of animal
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 although the increasing
effects of climate change around the world may affect both the timing and
magnitude of these seasonal impacts.
Covetrus, Inc. 2021 Q3 Form 10-Q 25
-------------------------------------------------------------------------------- Table of Contents 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 consolidated statements of operations. Adjusted EBITDA excludes share-based compensation, strategic consulting, transaction costs, formation ofCovetrus expenses, separation programs and executive severance, carve-out operating expenses, certain IT infrastructure expenses necessary to establish ourselves as a newly public company, goodwill impairment charges, capital structure-related fees, operating lease right-of-use asset impairments, the proportionate share of the adjustments to EBITDA of consolidated and non-consolidated affiliates whereCovetrus ownership is less than 100%, managed exits from businesses we are exiting or closing, 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 3 - Segment Data as required by ASC 280.
Results of Operations
Three Months Ended September 30, Nine Months Ended September 30,
$ Change % Change $ Change % Change
(In millions) 2021 2020 B/(W) B(W) 2021 2020 B(W) B(W)
Net sales $ 1,162 $ 1,126 $ 36 3 % $ 3,453 $ 3,217 $ 236 7 %
Cost of sales 946 929 (17) (2) 2,807 2,625 (182) (7)
Gross profit 216 197 19 10 646 592 54 9
Operating expenses:
Selling, general and
administrative 220 224 4 2 662 642 (20) (3)
Operating income (loss)
85 %$ (16) $ (50) $ 34 68 % Interest expense, net$ (8) $ (10) $ 2 20 %$ (26) $ (37) $ 11 30 % Other, net (a)$ (2) $ 5 $ (7) NM $ (2)$ 79 $ (81) NM Net income (loss)$ (4) $ (35) $ 31 89 %$ (51) $ (14) $ (37) (264) % Net income (loss) attributable to Covetrus$ (4) $ (35) $ 31 89 %$ (51) $ (15) $ (36) (240) %
(a) For the nine months ended
Year-Over-Year Period Comparisons
Net Sales Three Months Ended September 30, (In millions) 2021 2020 $ Change % Change North America $ 697$ 618 $ 79 13 % Europe 353 403 (50) (12) APAC & Emerging Markets 116 108 8 7 Eliminations (4) (3) (1) (33) Total Net sales$ 1,162 $ 1,126 $ 36 3 % Covetrus, Inc. 2021 Q3 Form 10-Q 26 -------------------------------------------------------------------------------- Table of ContentsNorth America net sales+$79 million I +13% 3 months Q3 2021 v Q3 2020
? Primarily due to
Europe net sales -$(50) million I -(12)% 3 months Q3 2021 v Q3 2020 ? Largely due to$61 million driven by the loss of Merck & Co. as a supply partner as well as a loss of a customer, both in theU.K. , and customer losses due to the previous disruption in our supply chain operations resulting from our transition to a third-party logistics provider inGermany and$14 million from the managed exit of our French distribution business which contributed net sales for all of the third quarter of 2020 ? Primarily due to$18 million in organic growth including the strong performance inthe Netherlands ,Ireland ,Czech Republic and in our proprietary brands, Kruuse and Vi and a favorable foreign exchange impact of$7 million
APAC & Emerging Markets net sales
? Primarily due to
Consolidated net sales+$36 million I +3% 3 months Q3 2021 v Q3 2020 ? Primarily due to net supply chain organic growth inNorth America *, prescription management growth, favorable foreign exchange, net supply chain organic growth in APAC & Emerging markets* and certain markets withinEurope *, as well as growth in proprietary brands* ? Largely driven by decreases inEurope's supply chain services driven by the loss of Merck & Co. as a supply partner as well as a loss of a customer, both in theU.K. , and customer losses due to the previous disruption in our supply chain operations resulting from our transition to a third-party logistics provider inGermany * as well as net sales that are no longer being contributed following the managed exit of our French distribution business in the fourth quarter of 2020 *indicates supply chain drivers across our segments are mostly offset on a consolidated basis Net Sales Nine Months Ended September 30, (In millions) 2021 2020 $ Change % Change North America$ 2,045 $ 1,771 $ 274 15 % Europe 1,080 1,166 (86) (7) APAC & Emerging Markets 342 288 54 19 Eliminations (14) (8) (6) (75) Total Net sales$ 3,453 $ 3,217 $ 236 7 %North America net sales+$274 million I +15% 9 months Q3 2021 v Q3 2020 ? Primarily due to$199 million in net supply chain organic growth driven by total animal-health market demand and gains in our market share in the companion-animal market, which is our largest market, particularly during the peak parasiticides season and$74 million from prescription management growth ? Largely due to$3 million from net sales that are no longer being contributed following our disposition of scil in the second quarter of 2020Europe net sales -$(86) million I -(7)% 9 months Q3 2021 v Q3 2020 ? Largely due to$149 million driven by the loss of Merck & Co. as a supply partner as well as a loss of a customer, both in theU.K. , and disruption in our supply chain operations resulting from our transition to a third-party logistics provider inGermany and$68 million from the disposition of scil, the deconsolidation of a subsidiary inSpain and the managed exit of our French distribution business that occurred in 2020 as the divested businesses contributed net sales for all or part of the first three quarters of 2020 Covetrus, Inc. 2021 Q3 Form 10-Q 27 -------------------------------------------------------------------------------- Table of Contents ? Primarily due to$69 million in favorable foreign exchange and$67 million in organic growth including the strong performance inthe Netherlands ,Ireland ,Belgium and in our proprietary brands, Kruuse and Vi
APAC & Emerging Markets net sales
? Primarily due to
Consolidated net sales+$236 million I +7% 9 months Q3 2021 v Q3 2020 ? Primarily due to net supply chain organic growth inNorth America *, favorable foreign exchange, prescription management growth, net supply chain organic growth in APAC & Emerging markets* and certain markets withinEurope *, as well as growth in proprietary brands* ? Largely driven by the loss of Merck & Co. as a supply partner as well as a loss of a customer, both in theU.K. , and disruption in our supply chain operations resulting from our transition to a third-party logistics provider inGermany *, our disposition of scil and the deconsolidation of a subsidiary inSpain in the second quarter of 2020, and the managed exit of our French distribution business in the fourth quarter of 2020
*indicates supply chain drivers across our segments are mostly offset on a consolidated basis
Gross Profit and Gross Profit Margin
Three Months Ended September 30,
Gross Margin Gross Margin Gross Profit %
(In millions) 2021 % 2020 % $ Change Change
North America $ 143 20.5 % $ 123 19.9 % $ 20 16 %
Europe 50 14.2 53 13.2 (3) (6)
APAC & Emerging Markets 23 19.8 21 19.4 2 10
Total Gross profit $ 216 18.6 % $ 197 17.5 % $ 19 10 %
North America gross profit +$20 million I +16%
3 months Q3 2021 v Q3 2020
? Primarily due to $11 million from prescription management growth, $5 million
from supply chain organic growth, and $2 million from acquisitions that were not
present in our results in the prior year period
Europe gross profit -$(3) million I -(6)%
3 months Q3 2021 v Q3 2020
? Largely due to $7 million decrease in supply chain gross profit driven by the
loss of Merck & Co. as a supply partner as well as a loss of a customer, both in
the U.K. , and customer losses due to the previous disruption in our supply chain
operations resulting from our transition to a third-party logistics provider in
Germany
? Primarily due to $2 million from supply chain organic growth in several
markets, including the Netherlands , $1 million from the increased contribution
from higher margin proprietary brands, and $1 million from favorable foreign
exchange
APAC & Emerging Markets gross profit
? Primarily due to$1 million from organic growth, primarily related to supply chain, and$1 million from favorable foreign exchange Consolidated gross profit+$19 million I +10% 3 months Q3 2021 v Q3 2020 ? Primarily due to prescription management growth, supply chain organic growth inNorth America *, acquisitions that were not present in our results in the prior year period, net supply chain organic growth within certain markets inEurope * as well as growth in proprietary brands*, favorable foreign exchange, and net supply chain organic growth in APAC & Emerging markets*Covetrus, Inc. 2021 Q3 Form 10-Q 28 -------------------------------------------------------------------------------- Table of Contents ? Largely driven by decreases inEurope's supply chain services driven by the loss of Merck & Co. as a supply partner as well as a loss of a customer, both in theU.K. , and customer losses due to the previous disruption in our supply chain operations resulting from our transition to a third-party logistics provider inGermany *
*indicates supply chain drivers across our segments are mostly offset on a consolidated basis
Gross Profit and Gross Profit Margin
Nine Months Ended
Gross Margin Gross Margin Gross Profit %
(In millions) 2021 % 2020 % $ Change Change
North America $ 418 20.4 % $ 371 20.9 % $ 47 13 %
Europe 159 14.7 164 14.1 (5) (3)
APAC & Emerging Markets 69 20.2 57 19.8 12 21
Total Gross profit $ 646 18.7 % $ 592 18.4 % $ 54 9 %
North America gross profit +$47 million I +13%
9 months Q3 2021 v Q3 2020
? Primarily due to $21 million from prescription management growth, $20 million
from supply chain organic growth and $6 million from acquisitions that were not
present in our results in the prior year period
Europe gross profit -$(5) million I -(3)%
9 months Q3 2021 v Q3 2020
? Largely due to $20 million from a decrease in supply chain gross profit driven
by the loss of Merck & Co. as a supply partner as well as a loss of a customer,
both in the U.K. , and disruption in our supply chain operations resulting from
our transition to a third-party logistics provider in Germany and $10 million
from our disposition of scil, the deconsolidation of a subsidiary in Spain , and
the managed exit of our French distribution business that occurred in 2020 as
the businesses contributed gross profit for all or part of the three quarters of
2020
? Primarily due to $10 million from favorable foreign exchange, $8 million in
strong performance in our proprietary brands Kruuse and Vi, and $7 million from
organic growth in several markets, including the Czech Republic , the
Netherlands , Poland , and Romania APAC & Emerging Markets gross profit
? Primarily due to
Consolidated gross profit+$54 million I +9% 9 months Q3 2021 v Q3 2020 ? Primarily due to prescription management growth, supply chain organic growth inNorth America *, favorable foreign exchange, net supply chain organic growth within certain markets inEurope * as well as growth in proprietary brands*, APAC & Emerging markets net supply chain organic growth*, and acquisitions ? Largely driven by the loss of Merck & Co. as a supply partner as well as a loss of a customer, both in theU.K. , and disruption in our supply chain operations resulting from our transition to a third-party logistics provider inGermany *, our disposition of scil and the deconsolidation of a subsidiary inSpain in the second quarter of 2020, and the managed exit of our French distribution business in the fourth quarter of 2020 *indicates supply chain drivers across our segments are mostly offset on a consolidated basis SG&A Three Months Ended September 30, (In millions) 2021 2020 $ Change % Change North America$ 130 $ 129 $ 1 1 % Europe 43 51 (8) (16) APAC & Emerging Markets 18 14 4 29 Corporate 29 30 (1) (3) Total SG&A$ 220 $ 224 $ (4) (2) % Covetrus, Inc. 2021 Q3 Form 10-Q 29 -------------------------------------------------------------------------------- Table of Contents North America SG&A+$1 million I +1% 3 months Q3 2021 v Q3 2020 ? Largely due to$4 million of increased costs to support the growth in our prescription management and software services businesses,$3 million of expenses associated with acquisitions in the fourth quarter of 2020 and the third quarter of 2021 and$2 million in increased travel and advertising expense primarily related to supply chain ? Primarily due an$8 million operating lease right-of-use asset impairment in the prior year
Acquisition-related intangible amortization was 23% of North America SG&A in 2021 and 2020
Europe SG&A -$(8) million I -(16)% 3 months Q3 2021 v Q3 2020 ? Primarily due to a decrease of$9 million in expenses that are no longer being incurred following the managed exit of our French distribution business, and a$1 million decrease in expenses related to the formation ofCovetrus ? Largely due to$2 million in increased share-based compensation, a$1 million increase in separation programs and executive severance, and a$1 million impact from unfavorable foreign exchange APAC & Emerging Markets SG&A+$4 million I +29% 3 months Q3 2021 v Q3 2020
? Largely due to
Corporate SG&A -$(1) million I -(3)% 3 months Q3 2021 v Q3 2020
? Primarily due to
Consolidated SG&A -$(4) million I -(2)% 3 months Q3 2021 v Q3 2020 ? Primarily due to a decrease in expenses that are no longer being incurred following the managed exit of our French distribution business, operating lease right-of-use asset impairment in the prior year, decreased expenses related to the formation ofCovetrus , and decreased strategic consulting fees and IT infrastructure costs ? Largely due to increased legal costs related to on-going litigation, expenses that are now being contributed following acquisitions in the fourth quarter of 2020 and the third quarter of 2021, increased costs to support growth in ourNorth America prescription management and software services businesses, increased share-based compensation expense, increased travel and advertising expense, and unfavorable foreign exchange SG&A Nine Months Ended September 30, (In millions) 2021 2020 $ Change % Change North America$ 381 $ 364 $ 17 5 % Europe 127 142 (15) (11) APAC & Emerging Markets 48 41 7 17 Corporate 106 95 11 12 Total SG&A$ 662 $ 642 $ 20 3 % Covetrus, Inc. 2021 Q3 Form 10-Q 30 -------------------------------------------------------------------------------- Table of Contents North America SG&A+$17 million I +5% 9 months Q3 2021 v Q3 2020 ? Largely due to increased costs to support the growth in our prescription management services and supply chain businesses of$11 million and$5 million , respectively,$8 million of expenses that are now being contributed following acquisitions in the fourth quarter of 2020 and the third quarter of 2021, and$1 million in increased travel and advertising expense ? Primarily due to$8 million operating lease right-of-use asset impairment in the prior year
Acquisition-related intangible amortization was 24% of North America SG&A in 2021 and 2020
Europe SG&A -$(15) million I -(11)% 9 months Q3 2021 v Q3 2020 ? Primarily due to a decrease of$20 million in expenses that are no longer being incurred following our disposition of scil, the deconsolidation of a subsidiary inSpain , and the managed exit of our French distribution business that occurred in 2020,$5 million decrease in expenses related to the formation ofCovetrus ,$3 million in reduced transaction costs, and$1 million decrease in travel and advertising expense driven by pre-COVID-19 travel and advertising expense present in the first quarter of 2020 ? Largely due to a$8 million unfavorable foreign exchange effect and$6 million of increased costs, including costs stemming from COVID-19 cost containment measures in 2020 that are no longer in place in 2021,$2 million from increased share-based compensation expense, and a$1 million increase in separation programs and executive severance APAC & Emerging Markets SG&A+$7 million I +17% 9 months Q3 2021 v Q3 2020
? Largely due to
Corporate SG&A+$11 million I +12% 9 months Q3 2021 v Q3 2020 ? Largely due to$10 million in increased costs incurred as we continue to invest in innovation and our corporate infrastructure to enable our growth,$6 million in increased legal costs related to on-going litigation,$5 million from increased share-based compensation driven by performance stock unit incentive programs, and$3 million in increased strategic consulting fees ? Primarily due to$9 million in decreased expenses related to the formation ofCovetrus ,$2 million in decreased IT infrastructure costs, a$2 million decrease in transaction costs, and a$1 million decrease in capital structure related costs Consolidated SG&A+$20 million I +3% 9 months Q3 2021 v Q3 2020 ? Largely due to increased costs incurred as we continue to invest in innovation and corporate infrastructure to enable our growth*, increased costs to support growth in ourNorth America supply chain and prescription management services*, unfavorable foreign exchange effects, expenses that are now being contributed following acquisitions in the fourth quarter of 2020 and the third quarter of 2021, increased share-based compensation, increased legal costs related to on-going litigation, increased strategic consulting fees, and increase in separation programs and executive severance ? Primarily due to a decrease in expenses that are no longer being incurred following our disposition of scil, the deconsolidation of a subsidiary inSpain , and the managed exit of our French distribution business, decreased expense related to the formation ofCovetrus , operating lease right-of-use asset impairment in the prior year, and decreased transaction costs *Increases from the year-over-year effect of COVID-19 related cost containment measures that were undertaken in 2020 and those specific actions no longer being in place in 2021 are captured in our increased costs to support our growth
Income Taxes
3 months Q3 2021
Income tax benefit 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. deferred tax assets.Covetrus, Inc. 2021 Q3 Form 10-Q 31
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3 months Q3 2020
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 the sale of our scil business and change in valuation allowance due to uncertainty regarding the realization of future tax benefits from certainU.S. deferred taxes.
9 months Q3 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 relates to valuation allowances due to uncertainty regarding the realization of future tax benefits from certainU.S. and non-U.S. deferred tax assets.
9 months Q3 2020
Income tax expense of
The difference between our effective tax rate and the federal statutory tax
rates for the jurisdictions in which we operate, for this period, primarily
relates to the sale of our scil business and non-deductible stock compensation
expense.
Adjusted EBITDA
Three Months Ended September 30,
(In millions) 2021 2020 $ Change % Change
North America $ 55 $ 45 $ 10 22 %
Europe 16 19 (3) (16)
APAC & Emerging Markets 10 8 2 25
Corporate (23) (13) (10) NM
Total Non-GAAP Adjusted EBITDA $ 58 $ 59 $ (1) (2) %
North America Adjusted EBITDA +$10 million I +22%
3 months Q3 2021 v Q3 2020
? Primarily due to prescription management growth of
Europe Adjusted EBITDA -$(3) million I -(16)% 3 months Q3 2021 v Q3 2020 ? Largely due to a$6 million decrease comprised of the loss of Merck & Co. as a supply partner and a loss of a customer, both in theU.K. , and customer losses due to the previous disruption in our supply chain operations resulting from our transition to a third-party logistics provider inGermany ? Primarily due to$3 million of positive organic growth in several markets and an increased contribution from higher margin products and services
APAC & Emerging Markets Adjusted EBITDA
? Primarily due to organic growth mainly related to supply chain
Corporate Non-GAAP Adjusted EBITDA -$(10) million 3 months Q3 2021 v Q3 2020 ? Largely due to$5 million from a foreign exchange transaction loss related to intercompany notes and$3 million in increased legal costs related to on-going litigationCovetrus, Inc. 2021 Q3 Form 10-Q 32
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Consolidated Non-GAAP Adjusted EBITDA -
? Largely due to the loss of Merck & Co. as a supply partner and a loss of a customer, both in theU.K. , and the customer losses due to the previous disruption in our supply chain operations resulting from our transition to a third-party logistics provider inGermany , increased legal costs related to on-going litigation and a foreign exchange transaction loss related to intercompany notes ? Primarily due to prescription management growth and improved performance across certain of our markets, including an increased contribution from higher margin products and services Adjusted EBITDA Nine Months Ended September 30, (In millions) 2021 2020 $ Change % Change North America$ 166 $ 141 $ 25 18 % Europe 57 53 4 8 APAC & Emerging Markets 29 20 9 45 Corporate (71) (44) (27) NM Total Non-GAAP Adjusted EBITDA$ 181 $ 170 $ 11 6 % North America Adjusted EBITDA+$25 million I +18% 9 months Q3 2021 v Q3 2020
? Primarily due to an
Europe Adjusted EBITDA+$4 million I +8% 9 months Q3 2021 v Q3 2020 ? Primarily due to an$8 million increase in contribution from our higher margin proprietary brands,$6 million of positive organic growth in several markets, includingthe Netherlands ,Czech Republic ,Belgium , and$3 million from favorable foreign exchange ? Largely due to a$15 million decrease composed of the loss of Merck & Co. as a supply partner and a loss of a customer, both in theU.K. , and the disruption from our transition to a third-party logistics provider inGermany
APAC & Emerging Markets Adjusted EBITDA
? Primarily due to a
Corporate Non-GAAP Adjusted EBITDA -$(27) million 9 months Q3 2021 v Q3 2020 ? Largely due to$10 million in increased expenses incurred as we continue to invest in innovation and our corporate infrastructure to enable our growth,$8 million from an unfavorable foreign exchange transaction loss related to intercompany notes and$6 million in increased legal costs related to on-going litigation
Consolidated Non-GAAP Adjusted EBITDA
? Primarily due to improved performance across certain of our markets, including
an increased contribution from higher margin products and services and a
favorable foreign exchange impact
? Largely due to increased costs incurred as we continue to invest in innovation
and our corporate infrastructure to enable our growth
Covetrus, Inc. 2021 Q3 Form 10-Q 33
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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 Credit
Facility. There were no borrowings from the Revolving Credit Facility as of
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 also operate on a disciplined, global approach to inventory management, including replenishing stock as sales deplete inventory to lower holding levels, executing inventory buy-ins only when price discounts make economic sense with no outsized working capital effect, or when vendor rebate targets are within reasonable reach with incremental purchases and no meaningful impact on cash forecasts. Planned investments 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, including investments like our warehouse management system •Implementing a European enterprise resource planning system to reduce complexity in our global 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 Acquisitions In connection with our acquisition of VCP onJuly 9, 2021 , we paid$65 million in total consideration of which$61 million were cash payments. We believe this acquisition gives us greater access to the animal-health wellness market, which is experiencing rapid adoption by Animal Owners, and better positions us to help veterinarians deliver proactive healthcare via membership programs integrated with our practice management and prescription management solutions. We repatriated$68 million inJune 2021 to provide for greater flexibility in how we fund our planned investments, including our acquisition of VCP as well as toward certain of our planned investments listed above. AtDecember 31, 2020 , we determined certain unremitted earnings existing in foreign subsidiaries located in various jurisdictions were no longer indefinitely reinvested. Accordingly, our tax liability associated with the repatriation of the undistributed earnings from the applicable subsidiaries located in these tax jurisdictions was recorded as ofDecember 31, 2020 .Covetrus, Inc. 2021 Q3 Form 10-Q 34
-------------------------------------------------------------------------------- Table of Contents Trends Our operational plans to manage our liquidity continue to involve seeking opportunities to reduce non-critical capital expenditures, sharpening our focus on collecting supplier rebates and amounts owed to us by customers, managing opportunistic inventory purchases as we carefully monitor sales forecasts and timing of projected price increases, quickly 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. InDecember 2020 , we fully prepaid the Term Loan Facility's$60 million mandatory amortization payments for 2021, which reduced our outstanding balance and lowered 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 onMarch 31, 2022 . Our interest rate swap contracts, which effectively fixed the borrowing rates on a portion of our floating rate debt, matured onJuly 31, 2021 . Based on the current floating interest rate environment, we anticipate that we will incur lower interest expense, at least for a period of time, following the maturity of our interest rate swap contracts. We were in compliance with the covenants in our Credit Facilities as ofSeptember 30, 2021 . Based on our expected Credit Facilities-defined leverage as ofSeptember 30, 2021 , once the quarterly compliance filing is made, the current applicable margin on our borrowings outstanding will remain unchanged at least until the next compliance filing is made for the three months endingDecember 31, 2021 . Based on 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 is currently set at 5.00x but will decrease by 0.5x as ofDecember 31, 2021 , and finally to 3.75x as ofJune 30, 2022 through maturity of the Credit Facilities inFebruary 2024 . The decrease in this particular financial covenant and our required compliance may influence our investment decisions. The duration of the COVID-19 pandemic continues to be unknown. Should the pandemic extend beyond 2021, or the severity of variant strains increase that reduces the effectiveness of vaccines and negatively impacts global economic conditions, then we may experience a negative impact on our liquidity position. Therefore, we continuously assess steps we can take to improve working capital and increase cash on our balance sheet, investigate government sponsored financing or tax holiday programs that may be available to us or to our customers, 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 development of presence, product, and service offerings
•Term Loan Facility amortization payments
•Ongoing operating lease payments
•Capital investments in current and future facilities
•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 Credit Facility
•Availability of financing through the capital markets
•Sales of businesses or assets if those actions align with our strategic
objectives
Our Term Loan Facility and Revolving Credit Facility bear interest on a floating
rate basis, which are referenced to LIBOR. The banking syndicate associated with
our Credit Facilities intends to cease using the 1-week and 2-month USD LIBOR at
the end of
Covetrus, Inc. 2021 Q3 Form 10-Q 35
-------------------------------------------------------------------------------- Table of Contents 2021, with the other USD Tenors to ceaseJune 30, 2023 . Our Credit Facilities, with which we primarily elect to reference 1-month USD LIBOR for our borrowings, will be amended to reflect the replacement basis rate accordingly, when identified. Longer term, if we desire to access alternative sources of funding through the capital and credit markets, challenging global economic conditions, such as a long-lasting COVID-19 pandemic or an economic downturn, could adversely impact our ability to do so. Cash and Cash Equivalents As ofSeptember 30, 2021 , we had Cash and cash equivalents of$187 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.
Cash Flows
The following table summarizes our cash flows from operating, investing, and
financing activities:
Nine Months Ended September 30,
(In millions) 2021 2020 $ Change
Net cash provided by (used for) operating
activities $ 58 $ 11 $ 47
Net cash provided by (used for) investing
activities (119) 55 (174)
Net cash provided by (used for) financing
activities (37) 160 (197)
Total net cash flows $ (98) $ 226 $ (324) Cash inflows and outflows from changes in operating activities for the 9 months ended Q3 2021 v Q3 2020
Net cash provided by operating activities of$58 million as compared to net cash provided by operating activities of$11 million was: ? Primarily driven by a decrease in accounts receivable related to the loss of Merck & Co. in theU.K. as a partner effectiveJanuary 1, 2021 and the subsequent loss of a customer in theU.K. discussed in "Terms with Key Suppliers, Customers, and Partners" within the "Overview" as well as the effect from our improved collection efforts, increasing accounts payable related to inventory purchases (discussed below), and the effect from our improved profitability from certain markets, in particular the increasing contribution from higher margin products ? Largely driven by inventory increases in 2021 due to increased demand, while maintaining our disciplined, global approach to inventory management as compared to our purposeful reduction in inventory in 2020, which was instituted to manage the COVID-19 uncertainty
Cash inflows and outflows from changes in investing activities for the 9 months ended Q3 2021 v Q3 2020
In 2021, net cash used for investing activities of
In 2020, net cash provided by investing activities of$55 million was: ? Primarily due to$104 million in net proceeds from the divestiture of scil and$4 million in proceeds from the sale of property and equipment ? Largely due$40 million in purchases of property and equipment and$13 million in payments related to our deconsolidation of a subsidiary inSpain and contribution to our equity method investment inSpain , called Distrivet, aCovetrus company
Cash inflows and outflows from changes in financing activities for the 9 months ended Q3 2021 v Q3 2020
In 2021, net cash used for financing activities of
Covetrus, Inc. 2021 Q3 Form 10-Q 36 -------------------------------------------------------------------------------- Table of Contents ? Due to$4 million in proceeds from share-based awards
In 2020, net cash provided by financing activities of
Contractual Obligations
During the first quarter of 2021, we had a material change in our contractual obligations since the end of fiscal year 2020 due to an amendment inApril 2021 to a third-party consulting agreement. See Note 3 - Segment Data. There have been no material changes in our contractual obligations for the three months endedSeptember 30, 2021 . 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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