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PetIQ, Inc.  (NASDAQ:PETQ)
Q2 2019 Earnings Call
Aug. 07, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

This is the conference operator. Welcome to the PetIQ Second Quarter 2019 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Jeff Sonnek, Investor Relations for opening remarks. Please go ahead.

Jeff Sonnek -- Investor Relations

Thank you. Good afternoon and thank you for joining us on PetIQ's second quarter 2019 earnings conference call. On today's call, Cord Christensen, Chairman and Chief Executive Officer; John Newland, Chief Financial Officer; Susan Sholtis is also present and will be available for Q&A.

Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could differ materially from actual events and those described in these forward-looking statements. Please refer to the Company's annual report on Form 10-K and other reports filed from time to time with the SEC, and the Company's press release issued today for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

Finally, please note that on today's call, management will refer to certain non-GAAP financial measures, including adjusted gross profit, adjusted G&A, adjusted net income, adjusted EBITDA among others. While the Company believes these non-GAAP financial measures will provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. In addition, PetIQ has posted a second quarter 2019 supplemental presentation on its website for reference.

Now, I'd like to turn the call over to Cord Christensen, Chairman and Chief Executive Officer.

Cord Christensen -- Chairman and Chief Executive Officer

Thank you, Jeff. Good afternoon, everyone. I will start by providing an overview of our financial highlights and discuss the progress we have made on our Follow the Pets long-term growth plan. John will then review our second quarter financial results in more detail and our revised outlook for 2019, which we've raised on a stand-alone basis as well as provide a detail related to the contribution to 2019 from our recent Perrigo Animal Health acquisition. Finally, Susan, John and I will be available to answer your questions.

We had an exceptional second quarter. We generated record consolidated net sales of $221 million, an increase of 29% and adjusted EBITDA of $20.8 million, an increase of 30% over second quarter last year. Our record net sales reflects broad-based growth across sales channels in both our pet products and veterinarian services segments. PetIQ remains uniquely positioned for continued growth, as pet parents increasingly seek savings on their pets' healthcare through our complimentary veterinarian product and service offerings. We believe our recent acquisition of Perrigo Animal Health further solidifies our leadership position in the industry, as we deliver on our mission to make pets' lives better through improved access to affordable pet healthcare.

Going forward, our combined teams are stronger and more strategically positioned to continue to execute on our Follow the Pets long-term growth strategy. Focusing on our business segments in a little more detail, our product business demonstrated continued momentum, growing 31% for the quarter, which is being driven by a variety of powerful forces, which include favorable secular trends as well as greater accessibility. Our position in the marketplace is ideally suited to meet the growing demand from consumers that are seeking greater value and convenience within our retail partners.

Additionally, through greater access and consumer visibility, we are attracting new consumers to the category, which is helping grow the total market. This is all made possible by the strength of our manufacturer relationships, which are the strongest they've ever been. We continue to see strength in our prescription drug programs within retail partner pharmacies and increased velocity of all our pet health and wellness SKUs within existing accounts. The consistent results within our product segment reflect our direct engagement with the animal health manufacturing community. And with their support, we are executing thoughtful sales channel strategies to meet the unique needs of all our partners both in-store and online.

With the growth that we are experiencing, we recently brought on Michael Smith to lead our Products Division. Michael is a pet and consumer packaged goods industry veteran and has been appointed Executive Vice President of our Products Division. With responsibility for managing all aspects of PetIQ's product revenue, product strategy, retailer relationships and strategic product partnerships, he will be reporting directly to me. Michael joined us from the world's largest retailer, where he has held various leadership roles within the pet and personal care categories. In addition to Michael's retail experience, he brings a strong consumer background, having worked at leading consumer packaged goods companies, including Colgate-Palmolive, Procter & Gamble and Energizer. Michael, has already delivered significant contributions to the team in only a month on the job, and we look forward to his leadership as we continue our integration of the Perrigo Animal Health and grow our existing pet products business over the next several years.

For the second quarter, our flea and tick business performed well and outpaced category growth. According to Nielsen measured channel data through June 30, the flea and tick category was down 3.4%, and on a quarter-to-date basis it was down 4.6% through June. PetIQ's result outpaced this result in the Nielsen measured channel over the same period.

Our brands performed better than the overall market. Non-measured channels were up meaningfully and our prescription drug flea and tick was up significantly and in line with macro trends in a broader veterinarian market. Keep in mind, for PetIQ, only 26% of our second quarter sales were in Nielsen-measured sales channels. The other 74% of our sales that were in unmeasured sales channels, which dramatically outpaced the measured flea and tick sales channels, particularly in the e-commerce and Rx sales channel. We continue to generate solid increases in both SKU velocity and distribution. We continue to benefit from growth and consumer migration to e-commerce solutions for their pets wellness needs. We're providing access to the biggest brands in pet health for our retail partners, various online strategies.

For the second quarter, e-commerce generated the highest channel growth rate for the 10th consecutive quarter, growing at a much faster rate than the overall Company growth rate. Our prescription drug program also performed well, producing the highest growth rate among all of our product categories. In addition to our pharmacies filling more pet prescriptions, the commitment that several of our large customers have made to the pet prescription drug program continues to be a tailwind for us, but still only in its infancy. We remain very pleased with the strong results of this Pet Rx rollout and believe this further reinforces our optimism for this category over time, as more of our partners look to expand online with animal health and wellness using PetIQ as the preferred vendor of choice.

At the beginning of July, we closed on our acquisition of Perrigo Animal Health. This transaction provides us with greater manufacturing scale with their state-of-the-art manufacturing facility located in Omaha, Nebraska and complimentary high margin brands such as PetArmor and Sentry, that can help continue to accelerate PetIQ's long-term growth plan.

We're excited to have their team integrated into the PetIQ family and capitalize on our opportunities to increase our manufacturing scale, expand product and brand diversity, and improve our customer reach all while we capture significant cost savings and synergies to fuel greater net sales and profitability.

I would like to highlight a few of the key strategic and financial benefits we expect as a result of this transaction. First, their branded product business has a stronger margin profile than PetIQ's existing business, enabling the potential for significant margin expansion for the combined company. PetIQ will now have even more meaningful product category, brand and sales channel diversity with a focus on accessible and affordable, high-quality preventative and wellness veterinarian products.

Second, this acquisition allows us to more rapidly realize the opportunity provided by the macro trends in the pet industry, where there's rising pet ownership, a heightened sensitivity to the rising healthcare costs associated with pet ownership, pet humanization and increased aging of pets that depend on better healthcare. We believe that our complimentary distribution channels and sales teams provide actionable white-space opportunities in new and existing customers, representing the potential to accelerate net sales growth for both PetIQ and Perrigo Animal Health's current product portfolios.

Third, in addition to benefiting from greater operating scale and increased procurement savings, Perrigo Animal Health will add outstanding manufacturing expertise and marketing capabilities. We expect these to provide meaningful future costs benefits to PetIQ. Together, we expect the combined organization to provide meaningful future costs benefits to PetIQ and are reaffirming our expectation to generate more than $3 million in run rate cost synergies by 2020, and growing to more than $5 million by 2021.

Our service segment produced another great quarter. We achieved 12% growth of the base community clinic business and realize disproportionate operating income growth of 125% due to the implementation of the key learnings to drive greater leverage of our fixed costs and offer our customers more consistency across our platform. Our President, Susan Sholtis and her team have been implementing continuous improvements since acquiring VIP last January, and as a result, the business is beginning to see greater operating leverage.

We are accelerating our community clinic service business model and extrapolating these incremental refinements to our emerging wellness center operating model to position our service segment for long-term profitable growth, as we accelerate unit openings in the coming quarters and years and optimize our returns on those capital investments. The wellness center growth initiative is going extremely well. We opened an additional seven units in the second quarter, which was consistent with our plan and are poised to meet our 2019 plan of opening 80 units by year-end. We have updated our website to highlight our open units and the 80 locations that will be opening soon.

As we spoke about last quarter, we are beginning to convert some of our mature community clinics to wellness centers. The incremental performance is consistent with our prototype model by increasing their days of operation from one day per week to five, but as significant operational advantages such as existing labor, an engaged customer base and stronger retailer host relationships. As a result, our ramp to positive cash flow is significantly accelerated, which we believe reduces complexity and drastically improves our ability to succeed. In terms of our long-term target of 1,000 units by 2023, we see an opportunity to convert approximately 45% of these locations or 450 from our community clinics. Our greenfield opportunities remain extremely robust, and new partnerships continue to emerge as we fill our development pipeline with optimal locations that fit our criteria. Today, our wellness centers are spread across six different retail banners and we are the only veterinarian service provider in the country with the infrastructure to support a national rollout like this in an organized fashion. I'm extremely proud of the team we have in place that is executing this initiative.

In summary, our second quarter results demonstrate the strength of our well-diversified animal health and wellness products and services business. We believe our operational and financial achievements for the quarter reflect the strength of PetIQ's mission to make pets lives better through improved access to affordable pet healthcare. We are targeting a large, underserved segment of the pet population and consumer demand continues to grow for the value and convenience PetIQ brings to pet parents. We believe we are well positioned to deliver a strong second half in 2019, where we will generate incremental distribution and velocity gains across our brands in both new and existing sales channels. We remain committed to executing against our growth strategy and look forward to continued sales and profit growth.

With that, I would now like to turn the call now over to John.

John Newland -- Chief Financial Officer

Thank you, Cord, and good afternoon to everyone on the call. Our results clearly speak to the strength of our diversified portfolio of products and services. Our message is smarter pet health resonates with the unserved and the underserved pets and pet parents. As a result, the overall market has grown and our pet counts are significantly up over prior-year. Also, the message of convenient access to affordable prescription pet meds has been well received. And we continue to see exponential growth in that category. These two things are the key drivers to our continued growth and success.

Second quarter 2019 consolidated net sales were $220.6 million, an increase of $49.5 million or 29% over the second quarter of 2018. Our strong sales continue to be driven primarily by product segment growth, particularly within existing accounts, as well as the operational improvements within the service segment, which is driving greater pet counts. Product segment net sales for the second quarter were $194.6 million, an increase of 31% year-over-year. Segment operating income was $20.2 million, an increase of 25.2% compared to second quarter last year. We continue to have excellent traction on our distributed business, and are focusing our efforts on increasing the penetration of existing accounts with additional SKUs, as well as establishing new customer relationships.

We continue to see significant growth from both an increasing number of consumers choosing our channel over traditional channels and greater SKU distribution as our partners broaden their assortments in the pet category. This is a trend that we believe will serve as a robust tailwind for PetIQ, driven by growing consumer awareness of the retail channel as a convenient and cost-effective solution for their pet wellness needs, and more doors carrying full assortments of veterinarian-recommended products.

We are benefiting from a growing industry adoption of pet medication fulfillment in the e-commerce retail channel and our traditional prescription drug program, which supports the retailer brick-and-mortar pharmacies located across the country. Both of these channels performed well and we expect this to be an ongoing source of growth, as consumer awareness expands and the animal health manufacturers further innovate within key categories.

These industry tailwinds are driving more pet prescriptions toward retail, which our customers are filling. In addition to the channel shift with the broader market, we're able to drive incremental traffic in prescription volume through their pharmacy network with our growing service platform staffed by our 1,500 veterinarians who wrote over 1.1 million prescriptions in 2018. PetIQ is a trusted partner for both brick-and-mortar and click-and-pick go-to-market strategies, with a strong runway for future growth across all sales channels.

Services segment net revenues increased 14% for the second quarter to $26 million. Excluding the contributions from our wellness center initiative, second quarter 2019 adjusted service segment net revenue grew 12% versus the prior year to $23.9 million. Segment operating income was $4.4 million, an increase of $2.4 million or 125% compared to the second quarter last year where we generated operating income of $2 million. As Cord discussed in his remarks, the service organization has done a great job to enhance the offering and further refine our community clinic model. These initiatives are driving a lift in total pet across our platform, which will be instrumental in our ability to drive long-term segment sales growth as well as leverage the significant fixed infrastructure that is already in place.

Second quarter 2019 gross profit was $34.9 million or 15.8% as a percentage of net sales, compared to $26.3 million or 15.4% as a percentage of net sales in the same period last year. Adjusted gross profit was $36.2 million and adjusted gross margin for the quarter was 16.5%. Consolidated gross margin was positively influenced by our service segment sales growth and further supported by improving service segment margin.

First quarter 2019, general and administrative expenses were $24.5 million. Adjusted G&A was $18.2 million or 8.3% of sales, which is down approximately 90 basis points compared to 9.2% in the prior-year period. As we have stated previously, the scale-related efficiencies that we are generating within our product segment will be similarly apparent as we grow our service platform. While we continue to strategically make disciplined investments in our business to support our future product and services growth, we believe the service business is at a tipping point of becoming considerably more profitable after decades of investment by the VIP team, and we believe that our performance through the first half of 2019 demonstrates this dynamic. Second quarter 2019 adjusted EBITDA increased 30% to $20.8 million and adjusted EBITDA margin was 9.5%, which is an increase from 9.4% margin in the prior-year period.

Turning now to the balance sheet. The Company had cash and cash equivalents of approximately $36.6 million, as of June 30, 2019. In addition to our revolving $75 million credit facility, which had $69.8 million available at quarter-end, our total liquidity was approximately $106.4 million. Following second quarter end on July 8, we closed the $185 million acquisition at Perrigo Animal Health. PetIQ financed the transaction with $25 million of existing cash on hand and $145 million of new term loans financing and the remaining balance through the existing revolving credit facility. As part of that transaction, PetIQ was able to manage both its term loan and revolver for total savings of 75 basis points, which we believe demonstrates the improving quality of our cash flows as our business evolves.

After giving effect to the Perrigo Animal Health acquisition, the Company would have had an estimated net debt of $262 million as of June 30, 2019, which translates to a net leverage ratio of approximately 4.3 times, when compared to our full-year 2019 adjusted EBITDA guidance. Due to the strong cash generative nature of Perrigo Animal Health business, we believe that we should be able to reduce leverage by 0.5 turns on an annualized basis. We feel confident that we have the balanced capital structure in place that can support our rapidly growing products and services business to achieve our stated long-term growth objective.

Now on to our outlook. The first half of 2019 outperformed our expectations, due in part to our continued adoption of the retail channels with convenient and cost effective alternative through traditional channels. We continue to have great confidence in the business and as such, we are raising our PetIQ stand-alone 2019 guidance and providing a forecast for the Perrigo Animal Health contribution for the balance of the year.

Our updated 2019 PetIQ stand-alone guidance calls for consolidated net sales to exceed $650 million, which represents an increase of at least 23% and compares to full-year 2018 results which grew by 98%. Our updated guidance for adjusted EBITDA is to exceed $56 million, an increase of at least 35% versus full-year 2018 results which increased 86%. Consistent with our long-term strategy and updated guidance, we expect PetIQ's stand-alone second half 2019 net sales to well exceed our 15% growth target. However, given the seasonality of our product business, we estimate 60% of the second half net sales will occur in third quarter and 40% in the fourth. As we've spoken about in the past, we anticipate that our full-year 2019 adjusted gross margin will be approximately flat versus full-year 2018, and approximately 17.5%.

In addition to our pet PetIQ stand-alone forecast, we expect contribution from our Perrigo Animal Health acquisition as follows for the balance of 2019. Net sales contribution of at least $30 million and adjusted EBITDA contribution of at least $6 million. When combined with our stand-alone guidance, PetIQ have consolidated net sales in excess of $680 million with adjusted EBITDA in excess of $62 million.

As Cord mentioned, we remain confident in our ability to open more than 80 new wellness centers in 2019 and we've updated our website to communicate the timing of these locations. The Company intends to update its full-year 2020 outlook, which was provided in connection with the announcement of the Perrigo Animal Health acquisition at the end of 2019. The Company remains confident in its long-term 2023 growth objectives on a stand-alone basis, including net sales of approximately $1 billion, adjusted EBITDA margin greater than 15% and 1,000 wellness center locations. In closing, we are very pleased with our year-to-date performance and remain excited about our future growth prospects.

With that overview, Susan, Cord and I are available for your questions. Operator?

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Bill Chappell with SunTrust. Please proceed with your question.

Bill Chappell -- SunTrust -- Analyst

Thanks. Good afternoon.

Cord Christensen -- Chairman and Chief Executive Officer

Good afternoon, Bill.

Bill Chappell -- SunTrust -- Analyst

Before digging into the results, I wanted to just -- there has been a lot of noise I guess in the market over the past 1 month, 1.5 months, about some of the online pharmacies talking about going direct to the animal health companies. And that would imply that they are may be cutting you out or that they no longer need you to get those Rx or any other products to their stores, and what that will do to your margins and what to your revenue base? So, if you could kind of help us understand the situation and how that plays out, and then also how much -- how big online pharmacies are of your product base right now anyways?

Cord Christensen -- Chairman and Chief Executive Officer

Yes. Thanks, Bill. I appreciate the question, and yes, there has been a lot of noise and we've looked forward to getting through this quiet period to be able to address that question and talk about it directly. As a Company, we are very close and in great partnerships with all of the major animal health manufacturers and have very close partnerships with the two largest manufacturers in the space. Those two large manufacturers right now, we estimate across the total retail channel are representing in excess to 75% of all the volume that's done in the space with the other two sharing the other roughly 25% or just under 25%.

Excluding the online pharmacies, we are still maintaining in excess of 95% share, where the large -- the two large ones we do 100%, then we're handling the majority of it due to all the efficiency through our 24-hour delivery and other things that we do as a business. As it relates to the online pharmacy business, the two large manufacturers that I represented with in excess of 75%, we are handling 100% of what they're doing in the online pharmacy space and believe there's been a mischaracterization of the nature of the direct relationships.

We've been heavily involved with both the online retailers and the manufacturers in developing our strategic alignment on how the category is supported across all retail, which included online. This led to various MAP policy implementation and incremental marketing funding that's being paid into the channels to support the business in total. And the order to cash as far as carrying inventory receivables and delivering the product to them and the nature of the flow through still is going through PetIQ. And with the length of our contracts, the value that we're providing to both sides of that, we see no change of that happening anytime soon.

As far as the percentage of the online business, we do not break out or speak specifically to how much business they're doing. They would ask us not to do that. I will confirm for the market that, we've seen a significant increase in our prescription drug program across the total company. And if you remember, I've commented in the past that, at our IPO on a $267 million business, we're in the low teens as the percentage of sales from an Rx perspective. At the end of 2018, that number had grown against a base over $500 million -- I believe $530 million, up into the low-20% range. And our run rate in 2019, that percentage of our total sales is now over 30%.

And so, we have seen both the macro trends of the change in flea and tick going to prescription, the general growth of consumer desire to transfer to our channel and their general aggregation that PetIQ has by being such a key player in helping facilitate the capture of those sales and I hope that that dispels any misunderstanding about the direct nature of our relationships with the manufacturer or our participation with the major online pharmacies that have put out, what I would call, conflicting information. And all of us are doing very well together and are moving things forward in a way that obviously shows such a significant increase in our overall sales in business.

Bill Chappell -- SunTrust -- Analyst

Just to be clear, you don't expect the revenue -- your revenue to online pharmacies or the margin in which you're generating from transacting that to meaningfully change or at least to the negative side it in the perceivable future?

Cord Christensen -- Chairman and Chief Executive Officer

No, just the opposite. We're seeing continued growth rates and have dedicated teams trying to keep up with the daily changes in the volume, so we can anticipate the weeks of supply we need to support what's happening.

Bill Chappell -- SunTrust -- Analyst

Got it. And then just quickly on the wellness centers. You may have said this, but are you still in the plan on, I guess, 40% of the new wellness centers being conversions and maybe an update on how those converted stores you've talked about from November that have turned profitable faster than expected, how they're doing?

Susan Sholtis -- President

Hi, Bill, this is Susan. Thank you for the question. The first thing I want to say is that we are absolutely on track to building the 80 wellness centers. And I think to that point, if everybody hasn't had a chance to go to the website, I would recommend that you visit petiq.com, where we posted the locations for our 2019 wellness centers.

I want to just take a step backwards real quickly to say that, when I started back in October, if you remember, my Number 1 objective was to learn and understand how to really optimize that wellness clinic model. One of the most obvious learnings out of the gate was that location matters. So we developed a predictive model here in Windsor, California that would drive locations that had a higher likelihood of success. Once we put that model into place, it was important for us to have discussions with our retail partners, because at the end of the day, building large clinics have to be a win-win for both ourselves and for our retail partners, so blindly we spent time learning and adjusting course.

So that's the Number 1 learning. But the Number 2 learning, I'm starting to call my secret weapon, which is the community clinics. They are absolutely critical to our success. You heard both Cord and John mentioned their importance, as it relates to our model. And it's absolutely true, because unlike any of our competitors out there in the market space, we learned a tremendous amount from our community clinics. We learned how to leverage those learnings and build them into fantastic wellness centers. So we will continue to stay on track, be close to 40%, 45% of all of our clinics coming from that community clinic model.

John Newland -- Chief Financial Officer

Now the 80 locations, Bill, 45% this year are conversions of those community clinics. As far as the locations we opened up in fourth quarter, we crossed over a positive EBITDA position with those locations in about four months. We did a lot around those and we think that something that sounds like six months is probably a normal course. And as the sample size gets bigger, we'll continue to share the progress and how those are performing. But a very bright spot to see the pet counts ramp, because ultimately 1,000 clinics is important, but the number of pets we treat is more important. And what we want to see is how fast can we run from treating over 1 million pets to treating over 6 million pets. And the conversion of the community clinics just accelerates at the speed at which we will do that and will ultimately reduce our investment risk, our capital exposed and drive to a faster position to get to that 15% targeted EBITDA margins by 2023.

Bill Chappell -- SunTrust -- Analyst

Great. Thanks for color.

Operator

Our next question comes from the line of Joe Altobello with Raymond James. Please proceed with your question.

Joe Altobello -- Raymond James -- Analyst

Thanks. Hi, guys. Good afternoon.

Cord Christensen -- Chairman and Chief Executive Officer

Hey, Joe.

Joe Altobello -- Raymond James -- Analyst

So a couple questions. I guess, first, I understand you're not ready to talk 2020 yet, but is there any reason why your base business ex-Perrigo wouldn't deliver your typical 15% sales growth next year?

Cord Christensen -- Chairman and Chief Executive Officer

Hey, Joe. I don't -- we see no reason why it shouldn't. And again, we have the dirtiest job of predicting that the rate that consumers are going to continue to come into the channel. And so far, we continue to be conservative and more people keep coming over at a pace that's faster than normal. The base gets bigger and which means 15% is more meaningful, but we've seen nothing that indicated that isn't the case. And us not updating our 2020 guidance is not us shying away from it. We're in the middle of the line review season. It's going extremely well. We're getting more information about what we can expect for next year. And I think what we'd really want to message is, the news we'll give it on 2019 will be -- at the end of 2019 for 2020 will be a improvement and better than what we have already messaged. And people should expect that it's positive, not negative that waiting, so we can be more accurate when we deliver the news.

Joe Altobello -- Raymond James -- Analyst

All right. And then, the Perrigo business has not been growing at 15%. It's been declining. And part of the reason for that or a big part of the reason for that has been PetIQ. So how quickly do you think you can get the Perrigo business to growing at that 15% rate?

Cord Christensen -- Chairman and Chief Executive Officer

Yes. The base Perrigo business we believe will deliver 15% growth or better next year. One of the good surprises has been is the last 30 days, how quickly the teams have aligned, how culturally we've been able to match. We closed on the transaction. The entire leadership team was there at the day of close. We had a great kickoff meeting with them and then we went straight into three days of strategic planning across account assignment item gaps. And since those meetings, we've had meetings with all of our best customers, allying on significant opportunities and we're very confident that our business is going to have a very quick return trend on that sales decline it had in the past.

And, yes, part of their problem was us, but now we're the advantage, they have going back out to the market and I would say I'll be very surprised if we don't have a growth rate there that's consistent with what we've had in the Company in total, which for us is extremely exciting because of the margin profile of that business.

Joe Altobello -- Raymond James -- Analyst

Got you. Okay, thank you, guys.

Operator

Our next question comes from the line of Kevin Grundy with Jefferies. Please proceed with your question.

Kevin Grundy -- Jefferies -- Analyst

Hey, guys. Good evening and congrats on the quarter.

Cord Christensen -- Chairman and Chief Executive Officer

Thanks, Kevin.

Kevin Grundy -- Jefferies -- Analyst

Hey, Cord, just a point of clarification on the upward revision to the guidance, it seems like on the services side, relatively in line with expectations, no big change there, at least as you see fiscal 2019 playing out. Can you break down sort of where the upside was in the quarter, and then both with respect to the guidance on the Rx, and then sort of general product side of the business for us?

Cord Christensen -- Chairman and Chief Executive Officer

Yes, it's good catch. Sure, Kevin, I think the services segment has been doing better than what we expected at the start of the year, where pet counts are up, but the base number of clinics that are reporting is actually down as we've talked about in past quarters. So the fact that we're maintaining and doing better than we thought with the clinic, kind of optimization we did earlier in the acquisition has been a significant surprise and a good contributor to the business and obviously, the community clinics and wellness centers that are new will start coming into our numbers next year, so we'll be able to have that number, have a larger base to report from. So that's good news for the future.

The Company in total, Kevin, the 50% growth that we anticipated across all categories except Rx has been right in line with our expectations. Literally budgets and numbers and accuracy of those budgets have been virtually perfect and we've been excited to see those numbers flow free in the accuracy we've been able to project the business with that space. The upside has been in the prescription drug program and the incremental increased from 15% to the 29% can almost all be attributed to slight contributions from the service business, and the remaining balance being from the prescription drug increase. And so I think what we're seeing is the product business in total is still performing in line with our expectations and the prescription drug business has definitely accelerated beyond what we had anticipated and more consumers have traded over into our channel than what we had expected for 2019. It's been a nice surprise for the business and for the results.

Kevin Grundy -- Jefferies -- Analyst

Okay, thanks, Cord. And just one quick follow-up for John, the free cash flow guidance. John, did I hear you correctly? So what we should be modeling from a free cash flow perspective is roughly 0.5 turn of EBITDA. Is that the way we should be thinking about that? Because that should ramp pretty significantly, given the accelerated pace here with which EBITDA will be growing here for the business over the next several years.

John Newland -- Chief Financial Officer

Yes. So the net leverage is 0.5 turn based on the EBITDA growth that we should expect to see. There is a free cash flow component associated with it as well, Kevin, that we didn't message in all of it. That could be upwards of 0.2 turns to 0.3 turns per year. It's unallocated this time based on our current modeling, but there is a potential for upside on top of that, yes.

Kevin Grundy -- Jefferies -- Analyst

Okay. I will leave it there and then I guess we'll take that offline. Okay, thank you, guys.

John Newland -- Chief Financial Officer

Thanks.

Operator

Our next question comes from the line of Jon Andersen with William Blair. Please proceed with your question.

Jon Andersen -- William Blair -- Analyst

Hi. Good afternoon, everybody.

Cord Christensen -- Chairman and Chief Executive Officer

Hey, Jon.

Jon Andersen -- William Blair -- Analyst

I was just wondering if you could talk a little bit more about the growth in the e-commerce business, and more specifically the mix of that business relative to the brick-and-mortar business. Does it SKU right now more distribution, more prescription? And are there opportunities that you can pursue to mix that business maybe more toward sort of your own or manufactured brands to kind of bring the overall profitability of that segment up? Because it is, as you pointed out, I think the fastest growing portion of your business going on 10 quarters now.

Cord Christensen -- Chairman and Chief Executive Officer

Yes, great question, Jon. So I hope I'll answer it all properly. I think I understand the question. The online business has ramped significantly with the introduction of the Rx programs that we're supporting across all those online retailers. And that business as you know is virtually a 100% distribution based. And so the mix that we have online currently is not at our normal balance across the Company as you mix up manufacture to the online business. We've had very open dialogue with our partners in the online space about where the gaps are. And even recently, one of the large online retailers had over 40 items that had been organized in place to start that mix heading the right direction with other negotiations going on. I've personally been in top-to-top meetings with a number of the online retailers addressing that exact subject and we're very excited about our prospects and there'll be one of the things we believe that will contribute to realign some of the growth that should be coming back into the Perrigo business that's been lost.

Not to mention the other things that we already do well, that we can now have a bigger seat at the table due to all the things that we're doing together and how well the businesses are running and the relationships that are being built there. So, yes, we do see that as a place where the mix will improve. It will drive significant margin expansion for the Company as we get to participate in the other parts of our business. And we're very hopeful over time that we can get it mixed out to our normal mix across distribution and manufactured goods.

Jon Andersen -- William Blair -- Analyst

Great, that's helpful. And on the Omaha plant that you acquired with Perrigo, could you just talk a little bit about the capabilities of that facility, the current capacity utilization, how much opportunity you have to grow within that facility? Thanks.

Cord Christensen -- Chairman and Chief Executive Officer

Yes. It's actually one of the most significant parts of the acquisition. The plant has the capabilities to produce virtually everything that would be considered an over-the-counter health and wellness item that has a chemical or liquid component to it. We also do some caplets and tablets and chewable tablets as well in that location. So, today they're producing over 250 SKUs across all of those different form factors. The plant is one of the nicest plants I've been in my career as far as the amount of automation and just cleanliness, the certifications, the ability to do both EPA and FDA related products. So we're extremely proud of what they have there.

The distribution side of the business there as well as is one of the most advanced I've seen as well with the amount of automation it has and its pick in pallet build and then just how the efficiencies are there as well. So we're extremely excited about those assets that came over as part of the acquisition. From a capacity standpoint, Jon, and if you go back, there's public information out there that the business at its peak, had excess capacity when it was upwards of $160 million, $180 million of volume. And at closing, when you really got to true run rate, the business was roughly doing $76 million, $77 million of business. So there's in excess of 50% or we can more than double the business with virtually no additional investment. And so we're hopeful and we're out being in The Streets and doing the things we do well to get the plant back up to needing to run more shifts and run more days. So I'm very excited about our opportunity at that plant and what that team is going to be able to contribute to the overall Company's future.

Jon Andersen -- William Blair -- Analyst

Okay. And then the prescription business has been the primary product category driver. Is there anything -- are there any new products or form factors coming that you think have the potential to accumulate lot of market share over the next 12 months to 24 months and are you well positioned? If that's the case, are you well positioned in terms of your relationships with those -- that manufacturer or manufacturers?

Cord Christensen -- Chairman and Chief Executive Officer

Yes. So there is significant new items that will be launched the next year and the year after. Obviously, we're not going to be disclosing what those are on an open forum like this, because that's part of the fun part is being able to launch things that will surprise the market, but there is significant items coming out of our manufacturer partners that have been organized for launch the next couple of years. We also have significant items that we've had in our pipeline development. That is there.

And I would want to clarify, Jon, we've had significant growth in more than just the prescription drug program. It's just been an overshadowing effect to just how far the over -- the prescription program has overperformed our expectations. And so, like we said, the 15% growth across the normal base businesses happened and we've been excited about all the distribution gains, new items, contributions. It's just the prescription drug program really did just take off and start to run and create incremental value for everybody that has been incremental to what we expected.

Jon Andersen -- William Blair -- Analyst

Okay. And just last one for me. So the consumption trends in flea and tick in brick-and-mortar retail kind of whole home it sounds like, from a category standpoint, you're outperforming in the measured channels. And I know, it's not a big part of the business anymore, but, what are the brick-and-mortar retail customers -- what are they doing to try and combat that? I mean, does that treatment incentive for them to get more involved in your service program to try and continue to drive traffic and capture more prescription volume over time? I'm just trying to think a little bit about that dynamic.

Cord Christensen -- Chairman and Chief Executive Officer

Yes. We've definitely seen a heightened awareness that the category has had some pressure in the topical space due to the amount of consumer shift to the chewable and consumable side of the flea and tick category. Hence we've always talked about the strength of our model that we're positioned to participate where the innovation is, no matter when it happens. And so it's been played out exactly as we communicated it would.

I think separately, the category overall is down roughly 4% year-to-date. If you look at our brands, and the brands we support topically, we're nowhere near that kind of decline in the data and feel great about how we've been able to be out there and actively working with our partners to make sure we're doing the best we can with topicals. As you said, it's a small part of our business. They're getting smarter. They're leaning in with us on services. They're leaning into their prescription programs to be an acceptable place for people to redeem their prescription. Everybody is doing more than they've ever talked about. So the support we're getting on that side in its own is fantastic.

I think large brick-and-mortar retailers are getting much more sophisticated on how to compete with online retailers and they're being very strategic about how they market, how they brand and how they price product, which I think is slowing down some of the leakage that's taken place. And so again, we're agnostic. We have to support the channels in total and we're positioned to benefit from what happens across any form factor or any part of the store or any type of retailer, Jon. So I think PetIQ is right now perfectly positioned to really continue to do well and deliver the kind of results we've been delivering.

Jon Andersen -- William Blair -- Analyst

Okay. Thanks so much. Congrats on the quarter.

Cord Christensen -- Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question.

Brian Nagel -- Oppenheimer -- Analyst

Hi, good afternoon.

Cord Christensen -- Chairman and Chief Executive Officer

Good afternoon, Brian.

Brian Nagel -- Oppenheimer -- Analyst

Nice quarter. So the first question and I think it's a bit of a follow-up of your prior question. But I just want to understand better. You started to now rollout more aggressively the wellness centers. The overall commentary on the wellness center sounds quite good. How -- as you are looking at the data, how should we think about, and I know it's early, but the initial performance of these centers, particularly as you've made the shift now to more stringently evaluate the location.

And then the second question on that question would be any initial read on the product sales occurring in these stores, or the uptick in product sales occur in the stores as these wellness centers open?

Cord Christensen -- Chairman and Chief Executive Officer

Yes. Brian, I appreciate the question. I mean obviously, we've talked about this in the last few quarters, and the learnings that we're applying and the things that we're seeing and obviously we're pushing to open up more with all that knowledge base. As Susan said location matters, the funnel we built to make those decisions matters. The locations that we started opening at the end of last year, which were our first conversions, would have been the first locations where we applied the initial learnings from those first locations we opened up with Walmart. So we're seeing very positive results from that. The sample size is going to start getting significantly bigger with our decision making. So we'll be providing more information as those mature, but we are confident that we're continuing to see consistently when we opened up in a community clinic and change it to wellness center, that the ramp is much faster.

Again, excited that we have 45% of the 80 that are going to be in that segment, because I think it'll give us another bigger sample size that the next locations we have in the greenfield space. We've had a few locations now open. That we selected and have come out of the gates at almost two [Phonetic] what we did on the first locations and are seeing the type of things we want to see out of it. But again, the sample size is small, but that we are in a really good spot, I think.

Susan Sholtis -- President

I just want to -- I can add something into that as well too. Thank you, Brian. We probably, some of the most exciting data that we're seeing is from the most recent wellness centers that we've opened. We had an additional, you heard Cord talk previously about the three that we opened in fourth quarter of 2018, and they basically exceeded budget by 73%. So they're doing incredibly well and continue to do incredibly well. But we open an additional four wellness centers in second quarter of this year 2019. All four of those clinics have basically busted through the same set of metrics. We really look closely at pets per clinic and dollars per pet and all four of the centers that we ordered -- opened in second quarter, as Cord said before, based on our criteria, based on where the locations that we knew we're going to work, those clinics are performing very well.

Cord Christensen -- Chairman and Chief Executive Officer

The last thing to your question, our product sales ramp, obviously any places in the clinic, whether it's a veterinarian, we're seeing significant trajectory change in the prescription drug program versus when there's not. We've talked about in the past where stores that don't have a veterinarian in the past had been in the hundreds of dollars a month in sales and immediately moving up into the $4,000, $5,000, $10,000, $15,000 a month in sales for prescription drugs and the ancillary over the counter medications, we're also seeing significant increases.

So the traffic and the focus on health with the veterinary involved in those stores is a significant contributor. As Susan and I are in Windsor, California today, we've been working with the strategic plan through the back half of this year. But more importantly today was about what's happening in the first half of next year. And we're well in front of what's going to be coming in. And I think what you'll see as we talked about the website gives you clearer clarity on where the locations are going to be when they're going to open. There's a banner, if you go to petIq.com, that you'll be able to see that information. But you should also know that we now have a cadence that probably, we're caught up from a cadence to where the quarters will now be balanced on how we open locations going into next year. And we feel great about the learnings and what's going to be coming, for Brian. And I think we should be able to start getting even more and more metrics that we can share to give people the confidence they can track the results and see their contribution coming. So it's a great time in our service business.

Brian Nagel -- Oppenheimer -- Analyst

Well, I appreciate all the color, good. So the follow-up question I have, as the call's been going on, I just looked at your website and it does lay out those locations extraordinarily well. As we think about 80 locations now, which I guess over the balance of the year, so the next four months or so, how risky is that? I recognize here about half of these are coming from locations you've technically already operated, but how much risk is there into opening 80 locations through the balance of '19?

Susan Sholtis -- President

Yes. I'll take that Brian. Zero. There is no risk. Those centers are already well under way. I think that one of the things that we did in the last several months as well too is we split the team and we've got one team that's completely focused on 2019 build out. And then as Cord said, before we've got another team that's focused on 2020. So we're already deep into planning for 2020. The clinics that we've already committed to and our retail partners have already committed to, are out there, and they're going to happen this year.

Brian Nagel -- Oppenheimer -- Analyst

Got it. And then just a final question for me, and then switching gears, but looking at the growth and I recognize that you haven't given 2020 guidance yet. But as we think about the gross margin, it was stable here in Q2, but choppy in the quarters before. How should we consider, think about the puts and takes on gross margins, we look beyond '19 into '20?

John Newland -- Chief Financial Officer

Yes. I think, Brian, the best way to think about it is our margins are actually extremely stable at this point. And the only thing that we've continued to messages the mix of the business. And so we've never had more levers that allow us to have the ability to have accretive margins in the business. As you think about the margin profile of our manufacturer business and the improvements there, our service business which we now have two quarters in a row of delivering the stated kind of margin objectives and earnings and as those expand, you'll see the margin mix go the other direction. And we know we're going to always be chasing the distribution business, because it is $10 billion of product that we get to participate in all that.

And so at the end of the day, what you need to know is G&A stayed extremely stable. We're doing a ton more business with the same amount of people, so the leverage is off the chart and all businesses at this point is good and accretive, and I think you'll see the mix will be there going forward that we're very well positioned to continue to see expanded margin, which is why we have the confidence of ton we can grow EBITDA margin from the 7.9% we had back in 2017 to where we're on track to be with a significant improvement there and going into the 10% and then grow into where it's 15% or plus or above in the future. So we're feeling really good about how the model is building out, how it's coming together, Brian.

Brian Nagel -- Oppenheimer -- Analyst

Okay. Thank you very much. Congrats and good luck going forward.

Cord Christensen -- Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of David Westenberg with Guggenheim Securities. Please proceed with your question.

David Westenberg -- Guggenheim Securities -- Analyst

Hi. Thanks for taking the questions and congrats on a good quarter. So with respect to the Company's privacy, can you at least maybe describe that the two companies that you have 100% of the volume in the retail, would you describe maybe one of them known for -- either known for kind of maybe big product innovation?

Cord Christensen -- Chairman and Chief Executive Officer

Are you talking about from a retail perspective -- oh, from the manufacturer side?

David Westenberg -- Guggenheim Securities -- Analyst

Yes. Exactly.

John Newland -- Chief Financial Officer

Yes, I mean, Dave, it's not hard to say who they are. I mean, they definitely are -- the one is the Number 1 share in chewable flea and tick and Number 1 share in Heartgard, our heartworm medicine. The other one is a well known Company as well that's been incredibly strong from an innovation standpoint in a number of areas in the derm space. So, yes, they are both known high-performers, but their product base performs extremely well in maintenance and preventative maintenance type products, which is the strength of what comes to retail.

David Westenberg -- Guggenheim Securities -- Analyst

Yes, all right. Thank you. Thank you very much. And something that they kind of hit the tape from Bloomberg today was Baird being rumored into being conversations with the Elanco. Now the justification around that, might possibly be, one's really good at Rx, one's good at OTC. From a relationship with retailers and online retailers, you might maybe have the kind of the same kind of, say, market power. So what's your thought now that you have for Perrigo asset and that kind of having OTC and having prescription might be pretty valuable. And what's the change in conversations like maybe you have right now?

Cord Christensen -- Chairman and Chief Executive Officer

I'm not sure I follow the question, David, because you talk about acquisition targets and then you talk about strength in the market.

David Westenberg -- Guggenheim Securities -- Analyst

Sorry. Well, let me rephrase that. So, I just rumored right now, but maybe -- can you maybe talk about the impact of maybe Bayer, Elanco kind of the way they might be thinking in the market and having OTC and prescription products on the kind of the same company. You have a similar kind of thing and maybe that would be a justification. What kind of strengths have you guys had that -- thinking about that, just market dynamics, just maybe -- just discuss that, the changing landscape in animal health and with regards to that?

Cord Christensen -- Chairman and Chief Executive Officer

Yes. Well, I think, obviously we're at a point that the work that we've done and others have done with us has gotten to where we've gotten from a place where all anyone talked about in gray market to where there virtually is no gray market left and no diversion, which means you have a clean business with real data to go run and run the business smarter, which has allowed people to now everybody working harder to make sure it's done right. So I think in general, the focus on the future of how animal health is going to be received into our channel, the hard days are behind us and as far as the acceptance and I think it's heading in the right direction.

PetIQ, today, is positioned extremely well, because we're one of the few companies that not only does a fantastic job of supporting how product gets delivered and handled, but we're rewarding the retailers with a significant participation. That is not normal to the vet channel. The margins they get to participate in sales is a significant that part of the glue we have in this space. Us building clinics that drive foot traffic means we're one of the few companies that do that work that's actually reinvesting significant dollars to bringing new pets into the category, driving incremental growth, which means we're also feeding back to the manufacturing partners, significant increases in their business and profit to where everybody involved should be very well balanced about how they're going to participate in this space. I think the leverage that creates for PetIQ is that nobody really has the ability to do all the things that we're doing in this space right now. And I think we're smart enough to know how to go in and create value that allows us to continue to grow and compete.

And I mean, I'm not surprised that other people are rumored to be thinking about how they become more strategic in the space and do a better job of being a participant, but we're just excited to see that the acceptance is driving the growth and we still believe it's very early innings, because as big as we are and as much progress as we've made in the last couple of years, we're almost 4 times being the size of the business, both sales and earnings, there's so much more to go from a percentage share standpoint and we believe there are still significant gains to be had and the future is still where the brightest days are still to come, David.

David Westenberg -- Guggenheim Securities -- Analyst

I appreciate you being able to answer that without having to necessarily comment on the rumor, because that's the difficulty I had in asking that question. So anyway, the last question I guess for Susan, the competitor thrive is doing very well in this space. And just kind of thinking about how you're thinking about competition in the wellness clinic sector, do you see competitions may be good because it's expanding pie, expanding awareness? And if you do think of it as competitive, do you see it as more of being competitive and in terms of competition for customers or maybe competition for labor, knowing that, your business model is unique and it offers veterinarians kind of a different way to practice that might be appeal to a certain demographic? Thank you, that's the last question.

Susan Sholtis -- President

Yes. Thank you, David. I honestly, I see the benefit in growing the pie and I am really, that's what we're focused on here as an organization. One of the projects that we just kicked off, which I'm excited to get the results back on, is really a good segmentation of our consumers, understanding our pet owners a lot better. Right now, our most recent data shows that, about 45% of our customers haven't seen a veterinarian for the past three years. So honestly, I think that the more that we all focus on growing the pie, the better that we're all going to be at providing better healthcare for pets and also for the pet owners as well too.

David Westenberg -- Guggenheim Securities -- Analyst

Thank you everybody.

Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Cord Christensen for closing remarks.

Cord Christensen -- Chairman and Chief Executive Officer

In closing, we are very proud of our year-to-date results. We believe they demonstrate the differentiated products, services and solutions that PetIQ provides to help our partners grow and increasingly connect with underserved pet parents. The success we've had thus far would not be possible without PetIQ's dedicated team, who are always executing on our mission to make pets lives better through improved access to affordable pet healthcare. The alignment and support of the animal health manufacturing community, which enables PetIQ to execute smart strategic plans across all sales channels, and our shareholders as well as key business partners that support and challenge us every day to consistently raise the bar on what we can achieve.

We appreciate your participation today. We look forward to speaking with you again when we report our third quarter results and thank everyone for their attendance. Have a great rest of your day.

Operator

[Operator Closing Remarks]

Duration: 60 minutes

Call participants:

Jeff Sonnek -- Investor Relations

Cord Christensen -- Chairman and Chief Executive Officer

John Newland -- Chief Financial Officer

Bill Chappell -- SunTrust -- Analyst

Susan Sholtis -- President

Joe Altobello -- Raymond James -- Analyst

Kevin Grundy -- Jefferies -- Analyst

Jon Andersen -- William Blair -- Analyst

Brian Nagel -- Oppenheimer -- Analyst

David Westenberg -- Guggenheim Securities -- Analyst

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