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PetIQ, Inc. (NASDAQ:PETQ)
Q3 2019 Earnings Call
Nov 7, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon and welcome to the PetIQ Third Quarter 2019 Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask question. [Operator Instructions]

I would now like to turn the conference over to Jeff Sonnek. Please go ahead.

Jeff Sonnek -- Investor Relations

Good afternoon and thank you for joining us on PetIQ's third quarter 2019 earnings conference call. On today's call are Cord Christensen Chairman and Chief Executive Officer and John Newland Chief Financial Officer. Susan Sholtis will also be 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 Securities and Exchange Commission 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 on today's call management will refer to certain non-GAAP financial measures including adjusted gross profit adjusted G&A adjusted net income and 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 the financial information presented in accordance with GAAP. Please refer to today's release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. And in addition PetIQ has posted its third quarter 2019 supplemental presentation on its Website for reference.

Now I would 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 with an update on our business and the recent acquisition of Perrigo Animal Health then provide an overview of our financial highlights including the progress we have made in our Follow the Pets long-term growth plan. John will discuss our Q3 financial results and 2019 outlook in more detail. Finally Susan John and I will be available to answer your questions. PetIQ has executed on significant initiatives including three acquisitions to increasingly evolve our business model and our team since our IPO just two years ago. Our strong foundation combined with these acquisitions has made our competitive mode significantly deeper and wider. All of our accomplishments have been focused on our mission of becoming the leading pet health and wellness company delivering smarter options for pet parents to help their pets live their best lives through convenience and affordable access to veterinarian services and products. As a first mover in bringing low cost veterinarian products and services to over 60000 retail points of distribution and e-commerce sites PetIQ helps pet owners achieve quality veterinarian care and save money on all aspects of pet healthcare. Our most recent acquisition of Perrigo Animal Health provides PetIQ greater manufacturing scale with its state-of-the-art manufacturing and R&D facility located in Omaha Nebraska. It also provides a very important addition to the PetIQ business model with its pet health and wellness brands and over 700 pet health and wellness items it manufactures; all with accretive margins for the company.

We are ahead of schedule on our integration plan and already have visibility into sales growth in excess of 15% for 2020 for the acquired Perrigo business. Unlike any other companies in the industry PetIQ has a national footprint with convenient access to veterinarian services and veterinarian prescriptions on OTC medications at a value. Our differentiated business model and go-to-market approach has helped PetIQ generate incredible compounded growth and the third quarter is no exception. We generated record consolidated net sales of $183 million an increase of 42% or 29% excluding contribution from Perrigo Animal Health and adjusted EBITDA of $19.3 million an increase of 44% versus last year. Keep in mind our reported net income includes certain expenses associated with the acquisition and integration of Perrigo Animal Health that we completed earlier in the quarter which John will discuss in more detail. Focusing on our business segment our product business demonstrated continued momentum growing at a record 49% for the quarter and 34% excluding contribution from Perrigo Animal Health. We continue to benefit from the strength of our relationships with our animal health pharmaceutical partners. And acceleration in our manufactured brands and an increasing number of pet parents transitioning their pet healthcare needs to PetIQ is affordable and convenient offerings. Additionally through greater access and consumer visibility we are attracting new customers into the category which is helping grow the total market.

Our partners across sales channels and animal health pharmaceutical partners are growing with us. And all parties are motivated to continue to support the growth and wins together. We continued to experience strong broad-based growth at retail including mass grocery and club sales channels as well benefit form growth in consumer migration to e-commerce solutions for their pet wellness needs. We are providing access to the largest brands in pet health for our retail partners and supporting their various online strategies. For the third quarter and the 11th consecutive quarter e-commerce generated the highest sales channel growth rate and is 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 as pharmacies fill more pet prescriptions. Several of our large customers have increased their commitments to offering pet prescription drug programs. This is a strong tailwind for us. And an area of our business that is still in its infancy with a long runway of growth opportunity ahead. We remain very pleased with our 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. We also expect our expansion of our veterinarian clinics and growth in pets treated from 1.2 million pets a year to over six million pets a year will be a significant contributor to our prescription volume. To be clear the crossroads of our prescription drug program. And the adoption of e-commerce solutions is a very dynamic segment of the pet health and wellness industry today. We review them both as great strategic businesses for PetIQ. But keep in mind the success of our company is not beholden by these engagements. And is the least profitable component of our business today.

Our aim is to provide value to the entire pet medication ecosystems and the best example of PetIQ's value to the industry is delivering the more than one million prescriptions that our 1500 veterinarians write to all the industry participants. When you combine this with our wellness and our growth initiative PetIQ is one of the largest drivers of incremental category growth in the entire industry. Our ability to penetrate the underserved segment of the pet population is a key differentiator for our business. Understandably the rapidly shifting dynamics in the industry are causing participants to reassess their competitive position and create alignment with those providing true value to them and pet parents. PetIQ is a company that is relied upon as a trusted partner. And our contracts with the largest manufacturer in the country are representative of our alignment with them. With their support we are executing strategic sales initiatives by channel to meet the unique needs of all of our partners both in store and online. For the third quarter our flea and tick business performed well and with our recent acquisition PetIQ now has the second largest market share of any company reporting in the category. According to Nielsen measured channel data through September the flea and tick category was down 3.1% year-to-date and 3.7% for the third quarter.

PetIQ's results outpaced the category and our brands perform 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 the macro trends in a broader veterinarian market. Keep in mind for PetIQ only 26% of our third quarter sales were in Nielsen measured sales channels. The other 74% of our sales 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. Our service segment produced another great quarter. We increased net revenues by 7% to $24.5 million and adjusted EBITDA increased 37% to $7 million. Our continued progress in this area is coming from the same learning's that is allowing us to increase our pets per clinic and average ticket for pet. Both are allowing us to leverage our fixed cost and offer our customers a more consistent offering. Susan Sholtis President of PetIQ and her team are making continuous improvements and optimizing our model and performance in both our community clinics and our wellness center models. We remain on track with our growth initiatives and our team continues to execute on our plan to open 80 wellness centers in 2019. The company has opened 26 locations year-to-date for a total of 67 units in operation. There are 54 locations currently under construction or contracted to start construction with 34 locations opening in November and 20 in December.

We have strong visibility into our pipeline with our team already focusing on our 2020 new locations. The nine community clinics conversions to wellness centers we have completed thus far are producing results that are consistent with our stated target operating model on an accelerated basis with a faster ramp to profitability and lower costs. Every conversion we have completed in the past year are either already EBITDA positive or are annualizing to EBITDA positive with positive EBITDA margins in four to six months post completion. These results further reinforce our conviction in the services segment opportunity that will drive sustainable long-term growth. We believe converting community clinics into wellness centers supports this plan with a significantly lower risk and cost. These conversions are done by increasing their days of operation from one day per week to five and has significant operational advantages such as existing labor and engaged customer base and strong reseller host relationships. As a result our ramp to positive cash flow is significantly accelerate which we believe reduces complexity and drastically improves our visibility for success. In terms of our long-term target of 1000 units by 2023 we see an opportunity to convert approximately 60% of these locations or 600 of our community clinics while continuously backfilling the community clinic base to keep our base steady and mitigate any material cannibalization. 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. I'm extremely proud of the team we have in place that is executing on this initiative. To summarize in a very short period of time PetIQ has become the leading pet medication and veterinarian services company. We believe our operational and financial achievements for the quarter reflect the strengths 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 products and services PetIQ brings to pet parents. We believe we are well-positioned to deliver a strong finish to 2019 where we will continue to generate incremental sales from 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.

I would like to now turn the call over to John.

John Newland -- Chief Financial Officer

Thank you Cord and good afternoon, the consistency of our base products and services business was evident in our third quarter growth. Furthermore we realized expansion of adjusted gross margins in both segments on a year-to-date basis. Additionally the performance of our Perrigo Animal Health acquisition met all our expectations and our overall integration efforts are on plan. As Cord mentioned this is a business that creates a host of opportunities for us and we are focused on growing it over the long run. We are very pleased with our services-based business as well. We are seeing consumers respond to our message of smarter pet health with growth of our pet counts per clinic and average ticket. This dynamic is driving our community clinic financial performance demonstrated by topline growth continued gross margin expansion and leverage of our fixed cost infrastructure which is precisely what we aim to achieve. Our diversified business of products and services are performing very well and we are excited about what the future holds for PetIQ. Third quarter 2019 consolidated net sales were $186 million an increase of $54.6 million or 42% over the third quarter of 2018. Including contribution from Perrigo Animal Health net sales increased 29% for the quarter as well as the year-to-date period which speaks to the consistency of our growth this year. Our strong sales reflects growth in existing retail partners as a result of expanded item placement and marketing programs. Our services segment was driven by same-store growth within our community clinic-based business and growing contribution from our non-same-store wellness centers. In our third quarter segment reporting we are beginning to report same-store sales for our service business comp base which is comprised of our community clinics and wellness centers that have been in operation for at least 18 months.

Additionally, we added segment level disclosure of adjusted EBITDA that can be found at the end of our press release. This aligns our segment reporting to our methodology to utilize as the consolidated level and demonstrates the performance of our base business. This creates a new corporate reporting line which contains costs that are not allocated to the products and services segment and should be considered when analyzing the segment level profitability and absolute terms. With that I'll get into the performance of our business. Product segment net sales for the third quarter were $161.5 million an increase of 49% year-over-year. Excluding contribution from Perrigo Animal Health product segment net sales increased 34% for the quarter. This performance was consistent with the expectations we provided during the second quarter which called for greater seasonality in the third quarter versus the fourth this year that approximates a 60/40 split respectively. Segment adjusted EBITDA was $20.5 million an increase of 40% compared to the third quarter last year. We continue to have excellent traction in our distributed manufactured businesses that are focused on driving our prescription drug programs within the retail partner pharmacies both in-store and online as well as greater SKU penetration with existing accounts. Services segment net revenues increased 7.1% for the third quarter to $24.5 million. Excluding the contributions from our wellness center initiative third quarter 2019 adjusted service segment net revenue grew 2.4% versus the prior year to $21.9 million. Segment adjusted EBITDA was $7 million an increase of 37% compared to third quarter last year.

The service organization has done a great job to enhance the offering and further refine our community clinic model. As I mentioned at the outset these initiatives are driving a lift in total pet counts across our platform which will drive long-term segment sales growth as well as leverage the significant fixed infrastructure that is already in place. Excluding the non-same-store wellness center revenue services same-store revenue increased 2% and 12% for the three and nine-month ended September 30 2019 respectively. The lower same-store growth rate is a result of planned conversions of high pet count weekly community clinics into wellness centers. Non-same-store revenue increased 75.5% and 125.4% to $2.6 million and $6.3 million for the three and nine-month ended September 30 2019 respectively. Non-same-store growth is a result of opening additional wellness centers as well as wellness centers opened in the prior year maturing before moving into the same store sales space. Third quarter 2019 gross profit grew 13% to $27.3 million. However looking at our based business through the lens of gross profit we grew 47% of $39 million and realized an expansion of 80 basis points in adjusted gross margin versus the prior year to 21%. As we look ahead we expect gross margin improvement to continue given the higher margin of profile associated with the manufacturing business following the integration of Perrigo Animal Health. General and administrative expenses increased in the third quarter due to the integration of Perrigo Animal Health into our consolidated financials. Absent the step change in our product segment cost structure due to the acquisition we would have achieved G&A leverage for the quarter.

Third quarter adjusted G&A was $23.3 million an increase of approximately 22 basis points compared to the prior year period. We expect this rate of change to increase in the fourth quarter due to the seasonally softer sales. Importantly however the higher G&A run rate is more than offset by the creative gross margin profile associated with the Perrigo Animal Health business. Third quarter 2019 adjusted EBITDA increased 44% to $19.3 million and adjusted EBITDA margin was 10.5% which represents a 20 basis point increase from the prior year period. Interest expense was $5.7 million for the third quarter an increase of $3.6 million compared to the prior year period. While not a component of EBITDA its notable the interest expense was influenced by the financing of the Perrigo Animal Health acquisition in the third quarter. The higher interest expense coupled with $12 million of non-recurring costs related to the acquisition of Perrigo Animal Health such as integration expenses de-rationalization and inventory purchase accounting adjustment drove the third quarter net loss of $8.8 million as compared to net income of $3.9 million in the prior year period.

Adjusted net income which includes the additional interest expense was $9.3 million for the third quarter 2019 compared to $8.2 million in the prior year period. Turning now to the balance sheet. The company had cash and cash equivalence of approximately $10.5 million as of September 30 2019. In addition to our revolving credit facility which had $92.5 million available at quarter end our total liquidity was approximately $103 million. At the beginning of the third quarter on July 8 we closed $185 million acquisition of Perrigo Animal Health which is now reflected in the third quarter balance sheet. Including the acquisition the company has net debt of $255 million as of September 30 2019 which translates to a net leverage ratio of approximately 3.6 times when compared against our full year 2019 stand-alone adjusted EBITDA guidance of $56 million and including the $15.6 million un-synergized pro forma full year estimated 2019 EBITDA contribution of our Perrigo Animal Health asset. We're confident that we have a balanced capital structure in place that can support our rapidly growing product and service business to achieve our stated long-term growth objectives while simultaneously reducing leverage by one-half turn on an annualized basis. Now onto our outlook the first nine months of 2019 have been exceptional and provides us great confidence in our forecast for the balance of the year.

We are maintaining our 2019 guidance which calls for consolidated net sales in excess of $680 million with an adjusted EBITDA in excess of $62 million. This is supported by PetIQ's stand-alone guidance which calls for consolidated net sales to exceed $650 million representing growth of at least 23% and for adjusted EBITDA to exceed $56 million representing the growth of at least 35%. Consolidated guidance also continues to assume Perrigo Animal Health contribution of at least $30 million in net sales and at least $6 million of adjusted EBITDA. As Cord mentioned we remain confident in our plan to open more than 80 new wellness centers in 2019 and we would refer you to our website for details on these locations. We intend to update our full-year 2020 outlook which was provided in connection with the announcement of the Perrigo Animal Health acquisition in conjunction with our 2019 full year earnings release. We remain confident in our long-term 2023 growth objectives on a stand-alone basis including net sales of approximately $1 billion adjusted EBITDA margin greater than 15% and a thousand 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

Thank you, we will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Bill Chappell with SunTrust. Please go ahead.

Bill Chappell -- SunTrust -- Analyst

Thanks good afternoon.

Cord Christensen -- Chairman And Chief Executive Officer

Hi Bill.

Bill Chappell -- SunTrust -- Analyst

I certainly appreciate the breakout on EBITDA by division and I don't think I've seen that before. Is there something well I guess we have availability of going back maybe a year or two is there a make at some point?

Cord Christensen -- Chairman And Chief Executive Officer

John do you want to go ahead and answer that?

John Newland -- Chief Financial Officer

That's a good question Bill the prior year will be included in the queue so you will have visibility to that.

Bill Chappell -- SunTrust -- Analyst

Okay great, Thank you. And then Cord just on the rollout of wellness centers just trying to understand it seems you had always said it was going to be in the fall but even 20 stores in the key -- kind of holiday month seems a little tight. So just kind of help me understand how that plays out you know is there any risk to it carrying over to next year and then as I look to next year would you expect the rollout to be similar kind of second half weighted or should you have more doors opening in January and February and March?

Cord Christensen -- Chairman And Chief Executive Officer

Great question Bill We obviously knew when we made the decision to rollout that the time to get the deals ready to go was going to be backend weighted and we worked with all of our partners and put the schedule together. All of our retail partners signed off on the schedule. And at this point all the locations are under construction or getting ready to be started under construction and right now have no risk of all the locations being opened before the end of the year. And so we stand by the 80 locations that will be open in 2019.

We've also talked about it takes time to get the team up and running and the deal flow running on the construction side of the business and we now have that team running and expect that next year you'll see a normal rollout of locations opening evening across all four quarters of next year. So this is a component of just the timing of getting the program really ramped and running this first year and should see normal flow next year.

Bill Chappell -- SunTrust -- Analyst

Got it, and you don't want to tell me how many stores you're going to open next year do you?

Cord Christensen -- Chairman And Chief Executive Officer

We'll include the store count when we provide our full guidance in the -- when release full year earnings for the fourth quarter and full year.

Bill Chappell -- SunTrust -- Analyst

Okay I'll stay tuned. And then on the product side can you just -- has there been any changes to your contracts to your relationships with the online especially retailers just over the past two months?

Cord Christensen -- Chairman And Chief Executive Officer

We have not had any changes to our contracts and the numbers reflect -- you haven't seen any fall off. We're still doing business with all the customers and I think the bigger thing to appreciate is we talk about is just what an important role and how much value we're creating in the market with the script generation that we're doing with the wellness plans and wellness clinics expansion and the number of pets that we're treating. And so we're very confident that our relationships are in a very solid place and that we have a very protective model moving forward. And so as of right now we have no changes to those contracts.

Bill Chappell -- SunTrust -- Analyst

Got it, And then last one for me just as you look to kind of the spring reset if it is and that you closed Perrigo fairly early in the quarter or early on how does the setup look with especially your brand and PetArmor brand and shelf space and distribution. I mean is it incremental? Do you move more to one brand versus the other? Do you know what the plans look like at this point?

Cord Christensen -- Chairman And Chief Executive Officer

That's a great question and it allows us to address a couple of different points on it. I think the first one is we organize ourselves very quickly after the closing to get our sales strategy and how we manage our customers quickly in a place where all of the line reviews for the year were reviewed as us owning the whole business and presenting in a unified front and all retailers were able to consider their options for next year with them knowing we're running the business now. The good news is we're happy to report as I said in my script and in the release that we have visibility with the decisions that have been made that the business that we acquired will have growth next year greater than 15% because of that quick work. So we're very excited about the progress that we've made already through doing that.

The second part is is we met with all the retailers we looked at what we think the best thing is for us to support the brand and continue to accelerate growth into the future and we are going to a more unified brand strategy where we will consolidate into single brands for formulations and resellers. That has caused us to deal with some of the -- what you saw in our cost structure related to inventory that will be discontinued as we've dealt with that. But it's the right thing for the growth rate and it's the right thing for the long-term support and how we're going to be investing our marketing dollars and again we couldn't be more excited about already the progress we made and the visibility we see going into next year.

Bill Chappell -- SunTrust -- Analyst

Great, Thanks so much.

Operator

Our next question comes from Joe Altobello with Raymond James. Please go ahead.

Joe Altobello -- Raymond James -- Analyst

Hey guys. Good evening. This is actually Adam on for Joe. I had a couple of questions on the -- just a few more on the wellness center build-out. Obviously the jury seems to be out on where if Walmart fits into the wellness center build-out. So I was curious perhaps a tough question but when will we know kind of if the concept works and Walmart a little bit more broadly? And then separately I was kind of curious when we would get the first wellness centers in terms of rollout into like us receiving adjusted results?

Cord Christensen -- Chairman And Chief Executive Officer

Okay. A couple related questions. I think the first thing we would talk about is one we're extremely excited that we're literally opening up 35 location in Walmart as we speak with a bunch of them already opening in the last 30 days and these are the first locations that we've done the diligence and know that we've used our metrics for opening the locations. And so we're excited to get those results started and be able to start talking about the locations that we have; our past history and funnel having made those decisions. So we're extremely excited about that. There's another 15 locations that we'll open up right after the first of the year. So there will be 50 new Walmart locations essentially in a very condensed period of time with that same level of decision making and rolling those in. Our relationship with Walmart is extremely good. I think we'll start to get information immediately from those locations and then we'll build on that and as we get more confidence and understanding and clarity we'll share that information with you and the broader market on how they're working.

I know John you could take the question relative to when we start including the sales from the locations onto the normal reporting versus the same-store analysis.

John Newland -- Chief Financial Officer

Sure. Based off of our definition of maturity the first three stores that we opened last year will be included in our total sales base and earnings basing Q4 of this year. And the remaining 17 will come on in Q1 and Q2.

Joe Altobello -- Raymond James -- Analyst

Thanks guys. That's really helpful. And if I could just squeeze one more in I was curious if you could maybe remind us your expectations again for the wellness centers in terms of store economics in terms of average annual revenue per center margins just some more color on that would be great?

John Newland -- Chief Financial Officer

Yeah we -- we've actually -- like we said we're very excited about what our community clinics are doing and how they're performing as we've converted some of those locations and we've quickly seen them ramp to similar volume ranges that we've had at other stores. So we have discussed four different revenue ranges from $400000 $500000 and $600000 per year on annualized volume with EBITDA margins at 13% mid-20% at the $500000 range and up in the mid-30's when we're up at $600000. We are seeing those numbers flow through mature locations we already operate so we know they're real and we're running our P&L seeing that flow through in the community clinics and we'd expect that people can model their business in that mid to the high-end of that range of those two different store economics.

Joe Altobello -- Raymond James -- Analyst

Great that's helpful. Good luck with the rest of the year guys.

John Newland -- Chief Financial Officer

Thank you.

Operator

Our next question comes from Brian Nagel with Oppenheimer. Please go ahead.

Brian Nagel -- Oppenheimer -- Analyst

Hi good afternoon, Thanks for taking my questions. So I wanted to focus first just on the wellness business and Cord thanks for all the details here. But the one question I have and maybe simplistically but help me understand better just the rate of sales growth within division slowed pretty meaningfully from early this year to the third quarter. Understand there's a lot going on. What really explains that slowdown in total growth sales growth?

Cord Christensen -- Chairman And Chief Executive Officer

Brian I'll let Susan answer that question. She's so much closer to it. So Susan why don't you go ahead and take that question?

Susan Sholtis -- President

Yeah happy to. Hi Brian.

Brian Nagel -- Oppenheimer -- Analyst

Hi.

Susan Sholtis -- President

So the sales growth that you're seeing is really part of our going forward model. It's part of the conversion of the community clinic. So if you remember back in -- toward the end of 2018 that's when we started to initiate those -- that community clinic conversion into wellness centers. When we convert those clinics we increase pets and we increase revenue. So for example we go from basically seeing 100 pets per month to somewhere between 250 to 300 pets per month. So pets and revenue grow however because -- at the end of the day the revenue it is no longer a same-store comparison it goes into the non-same-store comparison bucket. So it moves out of that bucket that it currently resides in today. I think it's important to note though there are two items that we are very mindful of and we stay focused on. Number one is that we continue to fill that community clinic funnel because that really is I think Cord talked about it being our competitive mode. Nobody else has this. We take those community clinics we've got to continue to fill that funnel so that they mature and then as they mature we basically pull them off the top.

Our objective is to maintain our top-line. We want our top-line to be steady. And as we've converted those clinics from the end of last year into this year we're doing exactly that. I think net-net though this really is part of bringing our services side of the business to a $0.5 billion over the next five years.

Cord Christensen -- Chairman And Chief Executive Officer

And Brian I think that's the most important to really understand that we've consciously taken best locations put them in a model that we can accelerate the growth even faster and as those mature to that 18-month and we start consistently adding those month after month you'll see the sales hockey stick happen very quickly and you'll see that $80 plus million in service revenue start to ramp toward the $600 million plus number that we are messaging in our growth rate of the services in the company. So it's actually very exciting part of our business model. It's an investment we're making now to accelerate to that number we want in the future.

Brian Nagel -- Oppenheimer -- Analyst

Got it, that's helpful. The second question I want to ask and it's a good follow-up discussion there but the onset of this-the clinic business we talked a lot about the benefit or the potential benefit to product sales in stores where the clinic is operated. So now that we're shifting from opening clinics Greenfield to more of this conversion from community centers to wellness how is that dynamic taking -- how is that dynamic unfolding? Are you seeing better product sales in these stores as these wellness centers ramp or as this conversion is taking place?

Cord Christensen -- Chairman And Chief Executive Officer

I think Brian the ramp in treating more pets and giving advice for those pet owners to buy pet products whether its prescriptions or over-the-counter medications creates a tremendous amount of leverage for PetIQ and is part of the most that protects our business for the long-term. We are seeing our ability as people see us making investments to grow that number and to attract pets into every outlet that we do business with; whether it is in a pet specialty retailer or it's business we do with someone -- one of the online retailers or it's another brick and mortar Greenfield location. In every case that's part of the leverage and its part of the story. And we're not just a company selling an item to any of these retailers. We're bringing in an entire package of value and we talk about it in my script that people are looking for people that are providing more than just an item and a price.

And so that leverage we have is something that we are absolutely using everyday and it's why you're seeing some of the growth we're already capturing next year for the Perrigo business we acquired because that's the strength of our leverage on top of their business and why that growth is happening quickly. And so we're not afraid to ask for a favor in return when we're providing extra value. And I think you're seeing that leverage come through and why we continue to see sales numbers and earnings and things going in the direction they're going and it's going to continue to be a leverage we have that not only benefits the retailer but also benefits the partners we work with and distribute for. So we're very excited about seeing how it works. So hope that answers your question.

Brian Nagel -- Oppenheimer -- Analyst

Yes thanks Cord appreciate it.

Operator

Our next question comes from Kevin Grundy with Jefferies. Please go ahead.

Kevin Grundy -- Jefferies -- Analyst

Good afternoon guys. Cord I wanted to come back to the whole going direct conversation because it's coming up a lot in conversations with investors. I fully suspect it's coming up a lot when you're speaking with shareholders as well. Maybe delineate a bit between I guess the exclusivity that we sort of understood that PetIQ had with some big drug manufacturers versus what has sort of played out now in terms of what you're selling into online retailers on the Rx side versus what they're now selling direct? Maybe you could help us out with that a bit.

And then sort of longer-term how would you sort of characterize the risk to your Rx business; so said differently I mean if you're going direct now with some of these products what precludes them if anything what's the value proposition for PetIQ in order to maintain its value within the supply chain and then related to that what do you see is the risk to OTC outside of Rx?

Cord Christensen -- Chairman And Chief Executive Officer

Yeah thanks for the question Kevin I appreciate the opportunity to answer it. I'll take it backwards and if miss one of your questions let me know. The OTC part of our business we see no risk in that business and today the OTC is 50% of our distribution business. The reason I say that is we do value-added manufacturing in every case to help those items be ready for retail includes repackaging it includes security tagging it includes a number of different things and different case pack sizes to make the inventory dollars work for retailers. And what we charge for all that work is something that would be very difficult for someone to replicate. So we feel very safe. Our contracts are with plenty of term and with the work that we're doing and the quality job we're doing for our partners we see that not having an issue renewing as those contracts come to renewal time period. On the Rx side of the business we also have contracts that have terms in them that have retailers name by name and we see no risk of those through the length of those contracts and really have no reason to believe why they would not renew at the time because of the amount of value we're creating for those customers. And so when you look at our base business that you're seeing reporting and how it's working it's all in a very good place. Where you've seen some noise in the market is you have a couple of the major manufacturers that we do not make them a priority in our business in other areas and it's difficult to make them happy and they've chosen to be direct in some of those retail customers where we're not under contract. I don't know of anyone that's been able to keep all four of the major manufacturers happy to that level and so they have been in that way and so it creates a lot of noise out there.

I think the second component is people we do distribute for today have added map policies or minimum advertise pricing policies with our customers and through those policies they do have contracts with all of our customers where based on the retailers behavior they get additional marketing funds from those manufacturers and so some of the retailers have been out there talking about their direct relationships but today those direct relationships are marketing funds coming from the manufacturers but their purchase orders and their conversion of cash is running through our business and through our warehouses and through our trucks.

Kevin Grundy -- Jefferies -- Analyst

Okay, So Cord just to be very clear with that so Zoetis is exclusively selling through you you guys are in-turn selling to some of these online retailers; they are by no means selling directly to the online retailer is that correct?

Cord Christensen -- Chairman And Chief Executive Officer

Today there are no direct sales that are going to the online retailers around for Zoetis. We're handling all their business. They do have marketing contracts now where they are paying those retailers but today there's no change.

Kevin Grundy -- Jefferies -- Analyst

Okay, and then Cord just an update on how big the Rx business is broadly and then the online piece; can you frame that or John?

Cord Christensen -- Chairman And Chief Executive Officer

Yeah, we're not going to comment on that right now. We've been asked by some of our customers to not comment on that with the amount of concentrated volume we have with a couple of the retailers. So we won't comment on that today Kevin.

Kevin Grundy -- Jefferies -- Analyst

Okay. Fair enough couple more cleanups for me. John free cash flow now -- so cash flow through year-to-date is down and AR appears to be up quite a bit and some of this I suspect is from closing of the Perrigo deal. Can you help us with cash flow expectations now for the fourth quarter and then presumably based on your comments the expectation would be that free cash flow looking out to next year is -- this is levered free cash flow should be like in the circa of $35 million kind of range based on the comment that that leverage is going to decline by about half a turn a year. Can you just confirm both of those things?

John Newland -- Chief Financial Officer

Yeah Kevin great question. You are correct on all accounts. Our cash flow free cash flow we did invest in the changes in working capital specifically the accounts receivable that you called out through the first three quarters. If you noticed Q3 we actually had significant cash generation and that will continue into Q4 as well. You're also correct in your statement regarding next year and beyond and our cash generation of $35 million plus.

Kevin Grundy -- Jefferies -- Analyst

Okay, And one last one Cord probably for you. Flea and tick category; so looks pretty bad in the Nielsen data year-to-date down 3% but your growth is quite good ex-Perrigo up 29%. What do you think the flea and tick category is doing all channel? And then maybe you can kind of help us a little bit in terms of what the channel growth rates are just to sort of better understand what the industry is doing? What that looks like broadly by channel? And then maybe some context in terms of what your market share looks like? And I can stop there thank you guys.

Cord Christensen -- Chairman And Chief Executive Officer

Thanks Kevin. I think the big thing to understand obviously is what we always talk about is that a significant portion of our business is in unmeasured channels and those unmeasured channels are some of the things that happen in the club channel online to name a couple. The pharmacy business also is unmeasured and the flea and tick category obviously has had a ton of growth in chewable flea and tick that we participate in and those are all good sales drivers for the company and good diversification. The topical business has been down in the measured channels and it's been primarily because a lot of those topical businesses have been up significantly online.

And so our business and the Perrigo business is up significantly at the major online retailers and more than offsets the declines that we've seen in brick and mortar stores at this point and so it's fun to be at a place where we get to see the lens of the whole market and still see the products doing well but it's also fun to know that we have a great diversified position across all channels to where we are still seeing good growth in the category even though the part that's measured is down. That's why we tell people to be very cautious about how they use that because without knowing and seeing exactly what's happening at some of those major dot-coms you're going to be difficult to use that as a relevant piece of data for how a company is going to perform.

Kevin Grundy -- Jefferies -- Analyst

Okay. Thank you guys. Good luck.

Operator

[Operator Instructions] And our next question is from David Westenberg with Guggenheim Securities. Please go ahead.

David Westenberg -- Guggenheim Securities -- Analyst

Hi, thanks for taking the question. So factoring in the year commerce I think you've given data in the past about how in one year you can get to 375 is that tracking? And just in terms of -- is there a fixed -- seasonal component in terms of tracking to that one year. So you know if you open up the clinic say in the middle of the summer maybe you missed those months and you wouldn't track to that figure. Just any kind of early data and how you're thinking about these immature clinics and revenue components?

Cord Christensen -- Chairman And Chief Executive Officer

Susan would you like to take that?

Susan Sholtis -- President

Yeah sure David thank you. The beginning of your question you -- it cut out and I didn't hear the beginning of the question. You were talking about clinic ramp-up yes?

David Westenberg -- Guggenheim Securities -- Analyst

You've given data in the past that you expect $375000 in year one. Just wondering if that is going -- expectations and in addition to that if there's a seasonal component to getting that $375000 kind of figure in terms of when you open it up during the year because obviously that if you open up and get that firmer month it's probably better.

Susan Sholtis -- President

There definitely is. So and your question is a good one and it goes back to one of the questions that was asked earlier; really just about the timing of our opening of these wellness clinics. Because in the end it makes tons of sense for us to be opening these up right around the holiday season because as you can probably guess people aren't thinking about their pets in November and December a whole lot but when it comes spring you want to be open and you want to have those clinics up and running. So that is one of the reasons why we continued to push some of our clinic openings to the back half of this year so that we can take full advantage of flea and tick season at the beginning of the year. So I very similar if you take a look at flea and tick season I would say that the veterinarian services business follows along with that cadence because that's when people are thinking of their pets that's when they have issues and that's when they have problems. So it's going to be more heavily weighted to the beginning of the year; less heavily weighted to the back-half of the year.

Cord Christensen -- Chairman And Chief Executive Officer

Having said that what we are seeing with the conversion locations is we're up in those ranges within four to six months which means we're well below the 18 months we've messaged for prior locations. They will continue to mature and continue to grow and reach those two locations that are open you know multiple years and still attract new pets and pet owners and continue to grow beyond that. So the ramp to the $375000 $40000 and beyond that number happens very easily inside of that six to 12 months and we've seen it so far in that four to six months in the conversions. The Greenfield locations we're excited for these new Walmart locations to get another set of data points to see how fast that can happen when we're using our metrics in those locations and we'll report more on that as we get more data.

David Westenberg -- Guggenheim Securities -- Analyst

Got it, thank you very much. So then the animal health company that you distribute for announced that they are going to be getting 150 they think they can get $150 million in new market share gain how big of an opportunity do you think that is for you in terms of a pickup there? I don't know sensitivity with customers how much demand is on that but it seems like that would be a pretty interesting opportunity for you?

Cord Christensen -- Chairman And Chief Executive Officer

Yeah it's a great question David. We it's always hard for us to say how much is the number but I will tell you when you look back to the launch of like a NexGard and how the NexGard business contributed and ramped and our participation. Our channel gets its fair share we have the most and biggest net to catch that volume that comes over. That's an item that's going to take share but likely what is going to offset. We have stuff from something else because it is moving kind of the chips around on the table. But what's good is we have that item it's an item that we think has a lot of potential for new volume and we're going to be in a position to make sure that we get to participate in whatever incremental growth it drives. We still get more growth from pet parents moving their business away from the vet to our channel and that's a more -- that's a larger component of our growth rate and why we continue to have growth like we had this quarter where we had 29% organic growth and 42% total growth which is still a number that we continue to just see just how well people are looking for a way to save money on pet healthcare and PetIQ has been purpose built to provide that value.

David Westenberg -- Guggenheim Securities -- Analyst

Thank you very much.

Operator

And our next question comes from Jon Andresen with William Blair. Please go ahead.

Jon Andersen -- William Blair -- Analyst

Good afternoon everybody. I'd like to ask about conversions of community clinics. Could you talk a little bit more about the criteria that you used to decide whether to convert a clinic to a wellness center and how deep kind of the pipeline of community clinics that meet that criteria is today?

Cord Christensen -- Chairman And Chief Executive Officer

Thanks for the question Jon. I'll let Susan answer that question.

Susan Sholtis -- President

Yeah. Happy to do that. Hi Jon. So if the model basically follows the cadence of what we do with our community clinics. So if you remember what happens with our community clinics we basically open them up and we had a clinic once a month. We then when the pet growth basically gets to a certain level we then make it twice a month and then three times a month and then we go to weekly. Once we get to the point where we're at about a hundred pets per clinic that's when we tend to make the conversion into a wellness center. So we've got a pipeline of those community clinics that are already at that level but I would say that pets is number one. The second is going to be vets. So if I could develop a mantra it's all about pets and vets; seriously. So we get the number of pets that we need in order to be able to convert that clinic number one but then we also need to make sure that we've got the ability to recruit the vets in the area in order to be able to become full-time veterinarians in those wellness centers. So we've got a laser focus on those two things.

Another thing that I would want to highlight is what we put in place this year was we separated our teams. So we had an operational team but what we really needed was a grand opening team as well too. So we split the team for us in order to be able to really have a very well orchestrated model. So we have a grand opening team. They're responsible for the pre-launch the soft opening up to the point where we get to that launch. They then turn it over to the operational team. So it's all making sure that number one we've got the pets we've got the vets and that we've got the team basically on the ground in place to make sure that we can fully operate moving forward.

Jon Andersen -- William Blair -- Analyst

Okay. That's helpful. Is there anything -- are you doing anything different with the 50 or so new Walmart locations that will be opening you know this quarter and Q1? Is it just in your mind does it just come down to location to try and get a better outcome or are there other levers marketing levers that you might be pulling to or merchandising levers to build awareness and trial?

Susan Sholtis -- President

Yeah you know it's a good question but you're absolutely right. Location is number one. At the end of the day we have to have -- you have to have number one the population you have to have people that take care of their pets that want the service side of the business. And then number three you've got to have the vet. So again it comes back to pets and vets. So having a good location where you've got some -- where you've got a population base that's going to take care of their vet their pet is first and foremost. But back to your question on -- do we do -- are we doing anything different with the Walmart openings? We actually are working a partnership with Walmart for this next round of 50 openings that we have with them.

But again it comes back to we are not changing our model from the model that we developed and the team that we put in place at the beginning of this year which is having a grand opening team having an operational team making sure that we've got a very consistent and orchestrated cadence around pre-launch soft opening launch and then post-launch. And that literally pre-launch starts two months before the clinic opens. So we have events that happen in conjunction with our retailers to make sure that they're on board to make sure that we are all on the same page with the opening of these clinics and Walmart's been a great -- has been a great partner especially with these next 50 clinics coming up. They've been very helpful in us getting them up and running.

Jon Andersen -- William Blair -- Analyst

Okay. On the product business can you talk a little bit about the progress that you're making on your own manufactured items which are obviously critical to the overall margin mix of the business? And then the second part of that question is just Cord you mentioned a couple of times that you see the Perrigo Animal Health business growing at 15% or more next year. How about your own base or the legacy manufacture product business; will that -- do you expect that to keep a similar pace? Thanks.

Cord Christensen -- Chairman And Chief Executive Officer

Yeah thanks for the question and yeah right now we are seeing all of our manufactured product growing at that similar rate Jon and like I said if it's something that you always wonder when you close a transaction that late in the year and that close to line interviews [Phonetic] if you can get something implemented as fast and make the progress you're going to want to make. But yeah we definitely have been able to get out and see there was a business that wasn't being taken care of properly that we could support. We'd be able to see where investments were not made properly against the brand where dollars were wasted that if invested properly will drive the sales and so we definitely have the visibility that the Perrigo business will grow at that 15%.

And we absolutely have things in play that are working across our other manufactured products that are going to create similar type growth rates and expanded customer relationships as we talk about as we leverage the total model to get more things done it's working across all aspects of our business and so we still see plenty of room for growth across all of it.

Jon Andersen -- William Blair -- Analyst

That's great. Thanks so much good luck.

Operator

This concludes our question and answer session. I'd like to turn the conference back over to Cord Christensen for any closing remarks.

Cord Christensen -- Chairman And Chief Executive Officer

Thanks everybody for joining us today and for being part of our Q3 call and listening to the update on our company and our business. We appreciate everyone's attendance. We're super excited about our sales and our sales growth and our results again for this quarter. As we continue to work hard to deliver our stated mission to deliver a smarter way for pet parents to help their pets live the best lives through convened access to affordable products and services and we know it's working as we continue to see the numbers flow the right direction and look forward to interacting with all of you through the next quarter and reporting a full year results. Thanks again for your time and we'll be in touch soon. Have a good night.

Operator

[Operator Closing Remarks]

Duration: 57 minutes

Call participants:

Jeff Sonnek -- Investor Relations

Cord Christensen -- Chairman And Chief Executive Officer

John Newland -- Chief Financial Officer

Susan Sholtis -- President

Bill Chappell -- SunTrust -- Analyst

Joe Altobello -- Raymond James -- Analyst

Brian Nagel -- Oppenheimer -- Analyst

Kevin Grundy -- Jefferies -- Analyst

David Westenberg -- Guggenheim Securities -- Analyst

Jon Andersen -- William Blair -- Analyst

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