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Covetrus, Inc. (NASDAQ:CVET)
Q3 2019 Earnings Call
Nov 12, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, my name is Jimmy and I will be your conference call operator today. At this time, I would like to welcome everyone to the Covetrus Third Quarter 2019 Earnings Conference Call.

I would now like to turn the call over to Mr. Nicholas Jansen, Vice President of Investor Relations. Please go ahead.

Nicholas Jansen -- Vice President of Investor Relations

Thank you. Good morning and thank you for joining us for Covetrus's Q3 2019 Earnings Call. I am Nicholas Jansen, Vice President, Investor Relation. Joining me on today's call are Benjamin Wolin, our Acting President and CEO and Christine Komola, our Executive Vice President and CFO. Ben and Christine will begin with prepared remarks and then we will be happy to take your questions.

During this conference call, we anticipate making projections and forward-looking statements based on our current expectations. All statements other than statements of historical fact made during this conference call are forward-looking including statements regarding management's expectations for future financial business, operational performance and operating expenditures.

Forward-looking statements may be identified with words such as will, may, expect, plan, anticipate, upcoming, believe, estimate or similar terminology and the negative of these terms. Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those contemplated in these forward-looking statements. These risks and uncertainties include those under the heading Risk Factors in our most recent annual report on Form 10-K, quarterly report on Form 10-Q, earnings press release on Form 8-K and other periodic reports filed with the Securities and Exchange Commission which are available on the Investors section of our website at ir.covetrus.com and on the SEC's website at www.sec.gov.

Forward-looking statements speak only as of the date hereof, and except as required by law, we undertake no obligation to update or revise these forward-looking statements. During this presentation, we will also provide certain pro forma results for the three and nine months ended September 30, 2019 and 2018 to help investors understand the underlying trends in the business as if the merger of the animal health business of Henry Schein and Vet's First Choice closed on December 31, 2017.

Note, however, the historical combined financial statements do not necessarily reflect what the results of operations would have been had we operated as a combined company during this period as those results would depend on a number of factors including the chosen organizational structure, what functions were outsourced and performed by employees and strategic decisions made in areas such as information technology and infrastructure.

You can find this morning's press release announcing our third quarter 2019 results on this call on ir.covetrus.com. We will continue to use our site to distribute important and time-critical company information. The press release also contains further information about the non-GAAP financial measures that we will discuss during this call.

These non-GAAP financial measures exclude from our GAAP financial results, certain non-cash or non-recurring items such as costs directly associated with the spin-off and merger and the ongoing integration process, including certain infrastructure investment expenses, restructuring charges and goodwill impairment charges. We believe that in order to properly understand our short-term and long-term financial trends, investors may wish to consider the impact of these items as a supplement to financial performance measures determined in accordance with GAAP. Please refer to this morning's press release announcing our third quarter 2019 results for a reconciliation of these non-GAAP measures to our GAAP financial results.

With that, I will now turn it over to Ben to provide the highlights.

Benjamin Wolin -- President and Chief Executive Officer

Thanks, Nick and good morning everyone. It has been three weeks since I assumed my current role at Covetrus, and during that time I have spent as much time as possible, speaking with shareholders, employees, customers, partners and clients to better understand our company and how to build success for every one of our essential stakeholders going forward.

While it's been a brief period of time and there is much more work to do, I'd like to take the early parts of this call to talk with you about four core themes that I am focused on moving forward. First, all of us here need to acknowledge and take responsibility for the very difficult and challenging entry and early life we have had as a public company. We underestimated the sheer complexity of the transaction and the many competing priorities, which drove increased spending and added an additional set of challenges to an already complex process. Clearly, some of these difficulties are self-inflicted missteps and as a result, there is plenty of responsibility to share for our performance as a public company this year.

With that said I want to make a clear statement that the Board, the Executive leadership team and the many employees across the globe with whom I visited since becoming CEO remain unified and fully committed to the promise and value to Covetrus model can and will deliver to our customers, manufacturers, partners, employees and shareholders.

For our customers, that value means using our unique and integrated supply chain software and technology capabilities to deliver clinical and financial success. For their clients, we can provide an improved experience and access. And for our manufacturers, this means unlocking new demand throughout the market. I'm confident that the global opportunity remains and we expect to deliver on that opportunity.

Second, before we discuss results, I want to make it clear that we will be changing how we analyze and discuss the company and its progress going forward, focusing internally and externally on simplicity and openness for our business. While the initial merger and early integration has been challenging, it is becoming clear to our team what the most critical financial drivers and metrics of our performance are, and we will work very hard to be open and clear in describing and discussing those metrics with you. By focusing on these drivers and providing greater clarity on the specific levers we have, we will promote increased accountability throughout the organization, enhance our execution and in time, we expect that we will deliver more consistent financial performance that meets our high standards and expectations.

Third, we will identify and focus on the core drivers of our business and eliminate activities that are not central to our value proposition. There are too many projects, initiatives and distractions and frankly, too many non-core assets from legacy acquisitions. This will change. By concentrating on our key initiatives and our core businesses, we will drive more focus within our organization, free up resource capacity for innovations and accelerate our balance sheet initiatives.

To fast track this process, we have already brought in outside expertise to partner with us and emphasize the importance of moving quickly and executing, but in a way that delivers meaningful value to the organization.

Fourth, for Covetrus to succeed, we need to focus on execution and innovation. Execution and innovation starts with a simple understanding that everything we do much both improve our customers' practice health and clinical success. This can only happen by ensuring that we are retaining and recruiting the best talent for our organization and ensuring that our incentives are appropriately aligned, my fifth and final theme. Focusing on culture and talent will be part of everything we do. We will build a culture focused on customer-centricity, collaboration, trust, transparency, a shared vision and a pursuit of clearly defined winning outcomes.

We will promote and recruit the best talent that aligns with our culture and we will work collaboratively to succeed. I will now hand it off to Christine to provide a detailed review of our third quarter 2019 results.

Christine T. Komola -- Executive Vice President and Chief Financial Officer

Thanks, Ben. Good morning everyone and thank you for joining us today. I will focus most of my third quarter result comments on our pro forma non-GAAP measures as these items provide the most insight into the underlying trends impacting our businesses. Please refer to today's press release for a more detailed description of our third quarter results in accordance with GAAP.

Covetrus GAAP net sales were just over $1 billion in Q3 or a 10% year-over-year increase. Non-GAAP pro forma organic net sales increased 5% year-over-year in Q3. As a reminder, pro forma net organic sales growth includes a full quarter of Vets First Choice in both periods, excludes the impact of foreign exchange fluctuations and M&A and normalizes for net sales adjustments for manufacturer switches from direct to agency sales in the United States, which can impact year-over-year comparisons. These results include the impact from the previously announced customer loss in North America and the impact within APAC tied to a manufacturer moving to a direct sales model in Q4 2018.

Normalizing for those two events, underlying pro forma organic net sales growth would have been nearly 8% in Q3, a little bit more than 4% year-to-date. Moving to our operating segment net sales performance, North America pro forma organic net sales increased 4% year-over-year in Q3. The previously announced loss of a supply chain customer earlier this year negatively impacted organic growth in Q3 by 4%.

Our supply chain pro forma organic net sales growth increased 1% year-over-year in Q3 or 5% when the previously announced customer loss is excluded. Total Vets First Choice net sales increased 36% to $72 million in Q3 versus 30% year-over-year growth last quarter and we ended Q3 with approximately 9,700 practices on the platform.

Turning to Europe, pro forma organic net sales increased 6% year-over-year in Q3. Our UK pro forma organic net sales, which is our largest market in Europe, increased 5% year-over-year. Our UK business is beginning to benefit from the expansion of our relationship with the largest corporate group in Europe, which we announced on our Q2 call.

We also experienced healthy pro forma organic net sales growth in most of our European markets, including solid performance from our businesses operating in Ireland, Czech Republic and Belgium. Moving on to APAC and Emerging Markets, our team delivered a 3% year-over-year increase in pro forma organic net sales in Q3, which is a further acceleration relative to our first half of the year results.

I think it's important to note that this growth more than compensated for the negative 8% year-over-year sales impact resulting from a manufacturer [Indecipherable] to direct sales model in this market in Q4 last year. Normalizing for that event, APAC and Emerging Markets segment grew double-digits year-over-year driven by continued growth in the number of customers served. Turning to consolidated gross margin. Our GAAP gross margin was 19.4% in Q3 versus 18% in the prior period. If Vets First Choice is included in the prior period, gross margin as a percentage of net sales would have been relatively flat year-over-year. Growth in our higher gross margin technology businesses offset the impact from customer consolidation, changes in manufacturer margins and the negative mix of sales both from a product and a geographic perspective.

Our GAAP selling, general and administration expenses were $216 million during Q3. This includes our one-time costs as well as the additional ramping of reoccurring operating expenses tied to our infrastructure investments. We implemented certain cost saving measures in Q3 to help offset some of the higher-than-expected SG&A tied to being a new public company. Longer term, we will continue to look for ways to further reduce cost and complexity and simplify our organization.

As you are probably aware, during our Q2 earnings call, we revised our full-year adjusted EBITDA guidance, which in turn contributed to a sustained decline in our share price and market capitalization. These events triggered an interim goodwill impairment review based on GAAP. Based on our analysis, we determined that the carrying value of our reporting units, some of which were based on the initial valuations at the time of the spin-off, an acquisition in early February exceeded their fair market value.

As a result, we recorded a non-cash goodwill impairment charge, totaling $939 million in Q3 that is included in our GAAP operating results. Pro forma adjusted EBITDA which excludes items like goodwill impairment, spin off and merger-related expenses and share-based compensation, among other things, was $49 million in Q3 versus $51 million in the prior-year. Changes in foreign exchange rates negatively impacted adjusted EBITDA by $1 million year-over-year.

Q3 adjusted EBITDA, excluding the impact of foreign exchange, declined modestly year-over-year on a pro forma basis as a result of higher SG&A expense, which offset growth in gross profit. Adjusted EBITDA declined versus Q2, which is consistent with the typical seasonality of our businesses but also reflects the incremental spending on infrastructure related to the first half of the year. While our pro forma year-over-year results benefited from the scaling of legacy Vets First Choice and was aided by the year-over-year value capture benefit that I will discuss in a minute, we continue to see gross margin pressure across many of our supply chain businesses despite the improved sales performance during the quarter, a trend that might continue in the near term.

Turning to value capture. We exited Q3 at a $10 million run rate in incremental EBITDA with sequential progress aided by the procurement benefits and the initial savings from our new shipping contract, early contributions from our prescription management divisions year-to-date and newly launched initiatives to increase engagement with strategic customer accounts.

In total, we remain on track to exit 2019 at our expected $20 million run rate EBITDA benefit based on efficiency gains realized from recent business unit integrations in late Q3. That said, we acknowledge this run rate benefit has more -- been more challenging to achieve than initially anticipated and has been more dependent on cost saving measures and less so on the originally planned revenue synergies.

The global opportunity remains and we are committed to delivering against the $100 million target. That said, we acknowledge the target may take longer than anticipated to achieve. Looking at the rest of the income statement, we had approximately $15 million in net interest expense in Q3.

Our GAAP net loss was $906 million or a loss of $8.09 per diluted earnings per share as a result of the aforementioned non-cash goodwill impairment charge booked during the quarter. Our pro forma adjusted net income, as seen on our non-GAAP reconciliation was $19 million versus $21 million in the prior year.

Please note that our pro forma adjusted net income for all periods now add back amortization of acquired intangibles for all legacy acquisitions versus our previous disclosure of only adding back amortization of acquired intangibles for the Vets First Choice acquisition. This decision was made to align our external reporting with the way we look and manage the business.

Turning to the balance sheet and cash flow metrics. Covetrus generated $33 million in cash flow from operations during the first nine months of 2019 and $3 million in non-GAAP free cash flow then [Phonetic] when subtracting net purchases of property and equipment of $30 million. For the full year, we now expect $50 million in capital expenditures, including our infrastructure investments versus the prior forecast of $50 million to $60 million as we have prioritized spending on our highest-return projects to reduce our capital commitments. We ended Q3 with $68 million in cash and cash equivalents on the balance sheet, $1.2 billion in long-term debt and no borrowings against our $300 million revolver credit facility.

Our cash on the balance sheet increased $13 million sequentially despite paying in the last $40 million owed to Henry Schein during the merger agreement, during -- which occurred during this quarter. We remain focused on cash flow generation as we prepare for fiscal 2020.

Our net leverage ratio is defined by our credit agreement, stood at approximately 4.3 times for the trailing 12 months ended September 30, 2019 inside the 5.5 times covenant. The net leverage covenant drops to 5.0 times next year and will be in effect for the trailing 12-month period ending June 30, 2020.

As you are aware, our credit agreement permits adjustments to EBITDA for certain items including consideration for our run rate value capture, as we expect to realize over the next 12 months. We remain committed to deleveraging and we will look for opportunities to do so beyond the mandatory $15 million quarterly term loan amortization payments that begin in the first quarter of 2020. As Ben mentioned earlier, by streamlining our organizational focus, we look to enhance our financial flexibility moving forward, including deleveraging as appropriate.

Finally, turning to our full year guidance. We continue to forecast non-GAAP pro forma organic net sales growth of low single-digits, which is consistent with our 2% growth achieved year-to-date and our prior forecast. Note the expected negative impact from the previously disclosed customer in North America and the impact of our one-time manufacturer moving to a direct sales model in APAC in October 2018 remains unchanged at about 2% in 2019.

As we embark on our path forward and access -- and access current trends and where we stand through the first nine months of the year, we believe it's appropriate to update our 2019 non-GAAP pro forma adjusted EBITDA outlook. We are now forecasting 2019 non-GAAP pro forma organic EBITDA in the range of $190 million to $196 million. As we are currently in the process of our bottom-ups planning for 2020, we will not be discussing our 2020 outlook at this time and expect to provide our guidance for the next year on our Q4 conference call. Our team is focused on executing against our core pillars in order to put us in a better position for a stronger sustained earnings growth in the year ahead.

Lastly, as more fully disclosed in our Form 10-Q that we will file later today, management has identified efficiencies [Phonetic] in our internal control over financial reporting relating to the operation of information technology general controls in the area of logistical surgery -- security and change management.

The aggregate impact of these is the risk of failure of automated controls and other controls that rely on data from these applications, primarily in change management and logical security functions. The material weakness did not result in any identified misstatements in the current period consolidated financial statements nor in any restatements of consolidated financial statements previously reported and there were no changes in previously reported financial results. We have begun to develop a remediation plan for this material weakness, which will be remediated and disclosed in our annual report of 2019.

Now, I'll turn it back over to Ben for some brief closing remarks.

Benjamin Wolin -- President and Chief Executive Officer

Thank you, Christine. Before opening the call for questions, I just want to say one more thing. I've only been here for three weeks and obviously there is a tremendous amount of work to be done to fulfill our promise. But, I also feel that there is a tremendous amount of opportunity here. It's a large and growing market. We have the assets and a powerful platform with a large user base and some real significant opportunities to innovate.

I'm excited about this opportunity. I'm excited about working with the people here and I look forward to continuing to speak with all of you as we chart this new path forward. This concludes our prepared remarks and now I will turn it over to Nick to moderate the Q&A session.

Nicholas Jansen -- Vice President of Investor Relations

Thanks, Ben. We want to take as many questions as possible. So we ask that you limit to two and then reenter the queue should you have additional ones. So Jimmy, please provide instructions for the Q&A session and we are then ready to take the first question.

Questions and Answers:

Operator

[Operator Instructions]

Our first question comes from John Kreger with William Blair. Your line is now open.

John Kreger -- William Blair & Company -- Analyst

Hi, thanks very much. Ben, thanks for those initial comments. Can you maybe just review the gross margin pressures that I think you guys touched on briefly in the call. Just elaborate, are you seeing that globally or is it in a particular region? Just give us some more detail. Thanks.

Benjamin Wolin -- President and Chief Executive Officer

Sure thing John, you're welcome. Good to meet you. So just in terms of gross margin, the end market for us continue to remain healthy. But as you know, over the last year, we've continued to see consolidation of -- both on the manufacturer side as well as on the end customer front and that has been where we're seeing the gross margin pressure. I don't think it's been any different from a -- sequentially from quarter-to-quarter. And in terms of moving forward, we're acutely aware that if -- that we need to have a great unified platform that will allow us to address those type of pressures and bring real value to our customers and our manufacturers.

John Kreger -- William Blair & Company -- Analyst

Great, thanks. And then I know you don't want to talk about 2020. But can you give us an update on when you think you can take the prescription management platform outside the US? Thanks.

Benjamin Wolin -- President and Chief Executive Officer

Sure thing. So it's a little bit premature for me to give specific plans around the expansion of the platform, but we are laser focused on driving value for our customers through the expansion of that platform both in the US and abroad. In terms of a specific timetable, we're -- it's a little bit early for me to set any markers out there.

John Kreger -- William Blair & Company -- Analyst

Okay, thank you.

Operator

Thank you. Our next question comes from Jon Block with Stifel. Your line is now open.

Jon Block -- Stifel Nicolaus and Company, Incorporated -- Analyst

Thanks, good morning. Just a couple from me. I think -- to start in remarks, you talked about the complexities in the business and the $100 million in value capture that may take longer than that three-year window. I think you also Ben, alluded to some potential sales or divestitures that could occur in non-core assets. So, just taking a step back, what do these variables mean for the original goals of call that long-term double-digit growth in adjusted EBITDA for the company. Do those two variables weigh on those long-term targets? And then I've got a follow-up. Thanks.

Benjamin Wolin -- President and Chief Executive Officer

Sure thing. So thanks for the question. In terms of the long-term goals of the business, both strategically as well as financially, I think all of that remains intact. Obviously we're behind schedule in our first year, and I think really the complexity of the transaction, the amount that we tried to do in year one clearly slowed us down. So I don't think anything has changed in terms of looking at different ways to delever on the balance sheet, obviously makes sense given the position that we're in, but we would only do that in areas where we think it is non-core and wouldn't take away from our future opportunity.

Jon Block -- Stifel Nicolaus and Company, Incorporated -- Analyst

Got it. Very helpful. And then just a pivot, in the past couple of quarters, you gave some very helpful metrics on sort of the purchases that were occurring in the veterinary practice and highlighting some of the moves that we saw out of the practice into the alternative channels, that was accelerating, I think from 1Q to 2Q. Do you have those metrics for 3Q or maybe just at a high level, taking a step back that it sort of stabilized this particular quarter, your revenue growth seem to just certainly strengthening and coming above expectations. Thanks guys.

Benjamin Wolin -- President and Chief Executive Officer

Yeah. So without getting into detail, I'd say at a high level, the market was slightly better in Q3. And as you pointed out from the results, we saw stability in the quarter and that was reflected in the financial performance.

Jon Block -- Stifel Nicolaus and Company, Incorporated -- Analyst

Thank you.

Operator

Thank you. Our next question comes from John Ransom with Raymond James, your line is now open.

John Ransom -- Raymond James & Associates -- Analyst

Hi, good morning. Christine, maybe could you take us through the 3Q $49 million of adjusted EBITDA to the implied 4Q and -- 4Q EBITDA, it's a pretty big sequential step down and it's not clear what is driving that? Thanks.

Christine T. Komola -- Executive Vice President and Chief Financial Officer

Hi, John. Sure. I would say as we looked at our guidance, we do have a stable Q3. But having said that, we've just been talking about the pressures that we're seeing in margin, particularly around our customer segments, our infrastructure, the buildup of some of the overhead expenses that we've got. So when we combine it altogether, we just felt it was prudent to adjust our guidance accordingly.

Benjamin Wolin -- President and Chief Executive Officer

John, this is Ben. I'd also just add that, obviously we're here in a moment where it's critical for the management team and the company to rebuild trust with our investors and the analyst community. And so we wanted to make sure that going forward we could have numbers that we could meet and exceed and felt like this was the appropriate expectation to set given where we are right now.

John Ransom -- Raymond James & Associates -- Analyst

Okay. So as a follow-up to that, I mean, to be clear, should we model in an increase in sequential G&A? Is there some other seasonality in the business around costs that we're not thinking of or is this -- are margins really going to fall off a cliff between 3Q and 4Q? It's just not clear where the -- exactly where the pressures are. Thanks.

Christine T. Komola -- Executive Vice President and Chief Financial Officer

Yes, So I would say, as we've been talking about the increase in our overhead as we built out our infrastructure both on the IT perspective as well as just the corporate overhead gets built out, that is where I would focus. Gross margin hasn't changed dramatically, but those are the types of pressures that we're seeing .

John Ransom -- Raymond James & Associates -- Analyst

Okay, thank you.

Christine T. Komola -- Executive Vice President and Chief Financial Officer

You're welcome.

Operator

Thank you. And our next question comes from Erin Wright with Credit Suisse. Your line is now open.

Erin Wright -- Credit Suisse -- Analyst

Great, thanks. I guess, can you go into a little bit more detail on what you're seeing in the North American companion business? Last quarter there was pressure, you mentioned some stabilization now, but what changed from the second quarter experience?

Benjamin Wolin -- President and Chief Executive Officer

Sure thing. So I think really two things, one, we saw stability in that segment growth at the end market -- from an end market perspective. And then just increased focus by our team and our organization about executing against our plan. And as a result, I think you saw improved financials from Q2 to Q3.

Erin Wright -- Credit Suisse -- Analyst

Okay, great. And then this is kind of a two-part question, but on the distribution side of your business, I guess, can you give us an update on your corporate relationships, particularly heading into 2020? Do you anticipate I guess any sort of changes in your corporate relationships next year? And then the second part of my question is on the vendor side. How are those conversations going? We're heading into another round of annual recontracting here. Are the conversations different kind of with your new team in place and how should we think about that heading into next year, any sort of meaningful changes in rebate terms, agency shifts, anything like that we should be thinking about heading into next year? Thanks.

Benjamin Wolin -- President and Chief Executive Officer

Yeah, so in terms of both the first and the second questions, we are having very positive dialogs with both our corporate customers as well as our manufacturers. There is no specific news to report at this time, but we as a business are pretty focused on having a unified approach out there that combines distribution, software and technology to both drive the P&L of our customers and increase market share for our manufacturer. So we feel good about where we're positioned but obviously know that we have to execute in order to continue to drive the business.

Erin Wright -- Credit Suisse -- Analyst

Okay, thanks.

Operator

Thank you. And our next question comes from David Westenberg with Guggenheim Securities. Your line is now open.

David Westenberg -- Guggenheim Securities, LLC -- Analyst

Hi, thanks for taking the question. I realize you're still drinking out of the fire hose. So we'll go kind of easy. So you kind of mentioned in your prepared remarks, changes in language. Can you talk about maybe some key performance indicators that you might be looking at? Help us kind of track the business. I realize it's brand new. But just what kind of figures should we be looking at in the next couple of quarters and say now it's on track.

Benjamin Wolin -- President and Chief Executive Officer

Yeah, sure thing. First of all, thank you for going easy on me David. I think that for us that statement was really -- to reflect a new approach where we are both being as transparent as possible with both our employees, our customers and our investors and we want to create a paradigm where everybody understands what direction that we're -- what we're driving in. As it comes to specific metrics, I'm not ready to roll out anything quite new, but obviously I think some of those areas we're going to be around are organic sales growth, our ability to engage our core customers, not just enroll them as well as the health and growth of the distribution business.

David Westenberg -- Guggenheim Securities, LLC -- Analyst

Got it. All right. And then just maybe early on, do you -- have you identified kind of maybe product lines that would be a core versus non-core? I realize it's very early, and anything that might help there would be good. Thank you.

Benjamin Wolin -- President and Chief Executive Officer

Sure thing. So, yeah, it's premature to specifically identify different assets or specific areas of business, but I would say at the highest level, it's pretty clear that we need to continue to invest and innovate around the platform and by platform, I'm really talking about the combination of supply chain prescription management and Tim's [Phonetic] to drive the P&L of our reflective -- of our customers as well as to increase market share and create market gains for our manufacturers. And anything that falls outside of that is really something that we're not interested in focusing on.

David Westenberg -- Guggenheim Securities, LLC -- Analyst

Thank you so much.

Operator

Thank you. Our next question comes from Nathan Rich with Goldman Sachs. Your line is now open.

Nathan Rich -- Goldman Sachs -- Analyst

Thanks. And, Ben, thanks for your comments to start the call. You mentioned, revenue synergies coming in a little bit below expectations. Could you maybe just dive into a little bit further detail in terms of what specifically has kind of underperformed relative to what you expected at the beginning of the year? Is it kind of sales on the Vets First Choice platform or the profitability of those sales? Any details you could share would be great.

Benjamin Wolin -- President and Chief Executive Officer

Sure thing. Thanks for the question Nathan. So I think in general, if we just kind of go back to our entry into the public markets, we expected to see a very accelerated adoption of the platform as well as not just from an enrollment standpoint but -- an engagement standpoint, and we are behind our original expectation. I think that doesn't take away from the real quality results that we're seeing here in the near term and we're pretty pleased with where we ended up in totality from an enrollment standpoint. But at the end of the day we need to focus on that engagement and get customers to ramp. And I think you're starting to see a little bit of that, the VSC business as Christine pointed out in her remarks grew 36% on a year-over-year basis versus 30% in Q2. So we're starting to see some progress there, but obviously, significantly lower than our original expectation.

Nathan Rich -- Goldman Sachs -- Analyst

Okay, great. Thanks for that color. Christine, I just had a quick follow-up for you on your earlier comments on the implied 4Q guidance and kind of what you expect to see on the margin side. It sounded like you were pointing to some additional overhead costs, so those are additional investments that you're having to make in the business. And just could you share kind of any detail on kind of where you're seeing those additional costs?

Christine T. Komola -- Executive Vice President and Chief Financial Officer

Sure. They are additional investments to set up the company as we continue to set up the company that anniversarying those costs and building that is a big part of it. Seasonality also takes into effect. Our Q4 results are typically the lowest just because of seasonality, year-over-year. And then the other piece that I would add as we think about our corporate overhead and we continue to build out those funds, the first half was just a slower ramp up compared to the second half as people are more fully employed. I think [Technical Issues] the gross margins are not dramatically different, sales trends seem to be stabilized as well, as you saw, we kind of built back back up to where we have previously been which is why we didn't change our sales guidance.

Nathan Rich -- Goldman Sachs -- Analyst

Okay, thanks for the questions.

Operator

Thank you. And our next question comes from Kevin Kedra with G. Research. Your line is now open.

Kevin Kedra -- Gabelli & Company -- Analyst

Great, thanks for taking the questions. Maybe to build on that last one. As we think about, I know you said you don't want to give 2020 outlook at this point. But as we think about some of the drivers on that SG&A line for Q4, is that the way we should really be thinking about SG&A going forward, what we're going to see in Q4? Are there certain elements that we should think is being either temporary or not fully placed in at this point?

Benjamin Wolin -- President and Chief Executive Officer

Thanks, Kevin. Yeah. So we're obviously not giving a 2020 number, but we are aggressively reevaluating our spend across our corporate function as well as within the various business units. So it is not safe to model that forward.

Kevin Kedra -- Gabelli & Company -- Analyst

Okay. And then you mentioned covenants and those are going to drop down from 5.5 times to 5 times EBITDA. You guys seem to be at this point safely under that. But how comfortable are you with where those covenants are, and have you had any discussions about maybe having this adjusted?

Christine T. Komola -- Executive Vice President and Chief Financial Officer

At this point, we are still very comfortable with those. Our thinking and our planning allows us to both pay off the amortization that we've got on a quarterly basis and covenant is in good spot. So we don't expect any changes to happen. Bank relationships continue to remain strong and as we said in our remarks, we are looking at all opportunities, including non-core asset sales as potential ways to further sure up our ability to hit the covenant requirements.

Kevin Kedra -- Gabelli & Company -- Analyst

Thanks.

Christine T. Komola -- Executive Vice President and Chief Financial Officer

You're welcome.

Operator

Thank you. And I'm showing no further questions in the queue at this time, I'd like to turn the call back to Ben Wolin for any closing remarks.

Benjamin Wolin -- President and Chief Executive Officer

Thank you everyone for the questions and the time today. I just wanted to reiterate that the Board, the management team and all of the employees across the globe are very excited about the future opportunity and know that if we are focused and prioritized that we can achieve the long-term goals that we had set out to achieve when we initially went public. So thank you everybody for your time and look forward to speaking with you in person.

Operator

[Operator Closing Remarks]

Duration: 40 minutes

Call participants:

Nicholas Jansen -- Vice President of Investor Relations

Benjamin Wolin -- President and Chief Executive Officer

Christine T. Komola -- Executive Vice President and Chief Financial Officer

John Kreger -- William Blair & Company -- Analyst

Jon Block -- Stifel Nicolaus and Company, Incorporated -- Analyst

John Ransom -- Raymond James & Associates -- Analyst

Erin Wright -- Credit Suisse -- Analyst

David Westenberg -- Guggenheim Securities, LLC -- Analyst

Nathan Rich -- Goldman Sachs -- Analyst

Kevin Kedra -- Gabelli & Company -- Analyst

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