Covetrus, Inc.
Q4 2021 Earnings Call Transcript

Published: 24 Feb 2022

[Operator:]

Good day and thank you for standing by. At this time, I would now like to welcome everyone to Covetrus Fourth Quarter and Full Year 2021 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers presentations there will be a question and answer session. . I would now like to turn the call over to your speaker today, Mr. Nicholas Jansen, Vice President of Investor Relations. Please go ahead.

[Nicholas Jansen:]

Thank you, Ann, and good afternoon. Thank you for joining us for Covetrus' Q4 and full year 2021 earnings conference call. Joining me on this afternoon's call are Ben Wolin, our President and Chief Executive Officer, and Matthew Foulston, our Executive Vice President and Chief Financial Officer. Ben and Matthew will begin with prepared remarks, and then we will be happy to take your questions. During today's conference call, we anticipate making projections and other 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 expectations for future financial business, operational performance and operating expenditures. Forward-looking statements may be identified with words such as will, expect, believe, should or similar terminology in 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 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 or 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. You can find this afternoon's press release announcing our fourth quarter 2021 and full year 2021 results in the accompanying slide decks for this call on ir.covetrus.com. The release and presentation also contain further information about the non-GAAP financial measures that we will discuss today. Please refer to those documents for a reconciliation of non-GAAP measures to our GAAP financial results. With that, I will turn it over to Ben to provide highlights, beginning on Slide three.

[Ben Wolin:]

Thanks, Nick. Good afternoon everyone and thank you for joining us. I hope everyone is safe given the turbulent times that we live in. We have a lot of ground to cover. So I'll dive right into my prepared remarks starting on slide three. Next week marks my second anniversary as the company's permanent CEO. And while there is still much to be done to deliver Covetrus' full potential within the attractive and growing animal health market, I am proud of all the progress the team has made over the last two years. In 2021, we accelerated our pace of innovation. We strengthened our value proposition to our veterinary practice customers, head owners and manufacturer, partners. We continue to steadily push forward towards our end goal of becoming the leading global technology-enabled veterinary health care solutions company. Financially, 2021 was also a successful year where we delivered 5% year-over-year non-GAAP organic net sales growth. We increased non-GAAP adjusted EBITDA by 8% year-over-year, which was faster than net sales growth, and we continue to scale our technology solutions and proprietary brands. On the latter front, I would highlight another year of success in our North American prescription management business, where we grew net sales 24% year-over-year or 28% when normalized for an accounting change and we increased non-GAAP adjusted EBITDA by more than 90% year-over-year to $44 million, a rather impressive outcome on top of what was a phenomenal 2020 for the business during the peak of the pandemic. The financial success came despite some unanticipated headwinds in our UK and German markets and higher than planned corporate costs during the year, including the negative impact from FX on our intercompany loans and elevated costs tied to certain legal developments. Importantly, with many of these challenges now in the rearview mirror, we are in a healthy position to accelerate net sales and non-GAAP adjusted EBITDA growth in 2022 as we build upon our underlying financial momentum and monetize our innovation coming to market. Turning to slide four. As many of you have heard me say in the past, at Covetrus everything we do is centered on helping veterinarians drive better health and business outcomes, we exist to help our customers thrive. As we have emphasized on these calls, we have the tools needed for a veterinarian to address their primary day-to-day challenges, improve their practice workflow and continue to grow their business. And our platform only got stronger in 2021. We invested significantly in our practice management solutions. We acquired new capabilities to further strengthen the vet to pet relationship. We built and opened two new pharmacies and invested in consumer marketing to better position the veterinarian for success, amidst the increased competition from online retailers. We also launched new proprietary products to support better clinical care and enhance our operational infrastructure to reduce our cost to serve while delivering added value to our veterinary practice customers. Lastly, we transformed our commercial sales model to make it easier for our customers to partner with Covetrus. Turning to slide five now. Now our enhanced value proposition in North America where our platform is the most advanced is clearly resonating in the market. North American net sales reached $2.7 billion in 2021 and have grown at a compound annual growth rate of 14% over the last two years, which is faster than the overall market growth during this corresponding time frame. And while, the sales growth has been broad-based, we have delivered strong growth in the higher margin parts of the business, including prescription management and proprietary brands which has led to a 21% CAGR in North America segment adjusted EBITDA. In fact, prescription management non-GAAP adjusted EBITDA has gone from a roughly breakeven business two years ago to $44 million in 2021 accounting for almost 60% of the growth of North America's segment profitability during the same time period. What really excites me however is what we show on slide six in the presentation, which highlights how early we are in the process in driving our comprehensive all-in solution for veterinarians in North America. At the end of 2021, slightly more than 10% of our customers were quote all-in customers using our overall services for supply chain, practice management, prescription management and compounding. This increased by approximately 100 basis points year-over-year in 2021 and we have significant momentum entering 2022 with our new commercial go-to-market model for both independently operated and corporately owned veterinarian practices. All-in customers in North America generate more than six times in sales and our distribution only customers with transactional growth margins more than 250 basis points higher. As we continue to invest in innovation we see our penetration rate with all-in customers moving higher and providing a strong foundation for above average market growth in the years ahead. Importantly. In our Europe and APAC and emerging market segment, we have a growing portfolio proprietary brands, a burgeoning software business and a newly aligned global commercial strategy that bodes well for us replicating our U.S. success overseas in the future. Our recent financial success in our APAC and emerging markets segment provides a glimpse of the opportunity as our Australian market is the furthest along outside the U.S. on their comprehensive all-in journey. Another way to look at the progress we are making in driving our higher margin solutions can be seen on slide seven, where 44% of our 2021 gross profit is now coming from the company's technology, e-commerce and proprietary products and services across our segments. This is an improvement of 300 basis points year-over-year as gross profit of these solutions increase 16% year-over-year, which is five times faster than the growth in our third party product distribution. As more and more of our supply chain customers expand, they're buying to these higher margin solutions and adopt other new innovative offerings we are bringing to market in 2022 and beyond, which I will detail shortly. We should continue to see consolidated gross margin expansion consistent with the 50 basis point improvement delivered in 2021. Moving to slide eight. I'm very excited about our upcoming launch of Covetrus Pulse in North America, a new innovative cloud-based veterinary operating system or VOS as we call it. That has united a comprehensive suite of Covetrus applications relied on daily by veterinary practices in the U.S. into one secure easy-to-use cloud platform, driving improved efficiencies in business operations, animal health and client experiences. With Covetrus Pulse, veterinarians will be able to create, renew and approve prescriptions, communicate with clients and co-workers, personalize business dashboards, manage pet care plans and customize with preferred third-party apps, all from one central operating system to fit their practices needs. This product launch is a culmination of almost two years of significant investment along with great partnerships with the veterinary community to bring a best-in-class platform to market which drives increased efficiencies and delivers a new standard of care for practice management. Best of all, we now have more than 1,000 beta customers using the new platform and expect more than 2,000 customers by the end of Q2 of this year, assuming no significant disruption to the productivity of our software teams based in the Ukraine. While the financial impact from the launch of Pulse is modest in the very short term. We estimate Pulse customers that leverage the full suite of applications could deliver a 3x increase in sales to Covetrus versus a legacy software customer. While we are enthusiastic about the pending launch of the Pulse VOS in the U.S., I would be remiss not to highlight a number of the other new innovations planned for 2022. These include first, our first international cloud-based practice management solution ascend offered in the UK, Australia and New Zealand. Second, new features added to along with deeper integration of VCP and Rapport into our leading on-prem software solutions AVImark and ImproMed. And third our next generation e-commerce storefront for prescription management customers that will be rolling out in late Q4 of this year. This Next Generation Storefront will significantly improve the consumer experience while enhancing our ability to drive increased revenue for our veterinary practice customers through consumer engagement optimization. More to come on the significant opportunity as we approach launch later this year. This provides a good segue to our other strategic priorities for 2022 as outlined on slide nine. These priorities include, one, continuing to optimize our integrated go-to-market strategy to secure new business and grow our net sales faster than the overall market. Second, driving significant adoption of our tech platform in 2022, which will translate into accelerated software net sales growth and another year of 20 plus percent net sales growth in prescription management in North America. Third, increasing our investment in consumer marketing and technology capabilities to further strengthen the vet to pet relationship. Fourth, restoring profitable growth in Europe with the recent cost actions taken in the UK and in Germany. Fifth, enhancing our proprietary brand strategy through the additions of new and proven talent including our recent hire, César França and new product development launches. And sixth and lastly, leveraging our corporate infrastructure for growth, as we have reached the necessary base without further investment to support the business moving forward. By bringing these six strategic priorities together not only do we expect to help our veterinarians drive better outcomes, but we believe their success will accelerate our business and market opportunities. Driving increased adoption and usage of our platform, owning more margin and delivering innovation to our customers and their clients positions Covetrus for another great year in 2022. I will now turn the call over to Matthew to discuss our financials in more detail.

[Matthew Foulston:]

Thanks Ben. Good afternoon everyone, and thanks for joining us today. I will now review our fourth quarter and full year 2021 financial results and provide additional commentary on our initial 2022 expectations. The focus of my comments will be on our non-GAAP results where applicable. Please refer to today's press release for a more detailed description of our fourth quarter on full year 2021 GAAP financial results and reconciliations of non-GAAP measures through the GAAP results. Starting on slide 11, some brief financial highlights for the fourth quarter. Q4 non-GAAP organic net sales increased 2% year-over-year and non-GAAP adjusted EBITDA increased 13% year-over-year to $63 million. Strong performance in our North America and APAC and emerging markets segments led the way and more than offset the $4 million collective headwind in Europe from the previously disclosed challenges in the UK and in Germany. We deliver 50 basis points of year-over-year gross margin improvement during Q4 and another 10 basis points of adjusted operating sense leverage resulting in 60 basis points of euro-the-year non-GAAP adjusted EBITDA margin expansion to 5.6%. Additionally, our net leverage improved modestly during the fourth quarter of 2021 and we generated another $22 million in free cash flow, which enabled us to pre-pay $30 million of our required 2022 term loan principal amortization payments in December. Now turning to the consolidated details on slide 12. Covetrus's net sales for $1.12 billion in Q4 relatively flat versus the prior year and an increase of 2% year-over-year on a non-GAAP organic basis against the challenging 12% growth comparison from the prior year period. The previously disclosed items in our UK and German markets continue to impact year-over-year comparisons with non-GAAP organic net sales growth negatively impacted by approximately 700 basis points. Encouragingly, Germany operations have started to stabilize and actually come back to positive euros a year net sales growth in Q4. North America continues to deliver exceptional results with another quarter of double-digit year-over-year growth in non-GAAP organic net sales. Turning to slide 13. Consolidated non-GAAP adjusted EBITDA was $63 million for the fourth quarter of 2021 compared to $56 million in the prior year period. The 13% year-over-year growth was driven by strong double-digit growth in our North America and APAC and emerging markets segments, which more than offset the moderate decline in Europe driven by our UK and Germany challenges. FX losses on inter-company loans and higher legal costs also were a drag on year-over-year growth, but much lower than we experienced during the third quarter. Non-GAAP adjusted EBITDA margins were 5.6% during Q4, a 60 basis point year-over-year improvement driven by the strength in North America and APAC and emerging markets. We were pleased with the margin expansion delivered during the fourth quarter particularly considering increased supply chain disruption and cost pressures experienced in the quarter across many of our global businesses driven by primarily the omicron variant. The full year 2021 on slide 14, consolidated non-GAAP adjusted EBITDA increased 8% year-over-year to $244 million, led by 43% growth in APAC and emerging markets and 19% growth in North America. Europe was flattish year-over-year despite a $19 million collective headwind from the challenges in our UK and German markets, which highlights the strength of the rest of the European operations, particularly that about proprietary brands. While corporate expense increased $29 million year-over-year, approximately 50% of that increase was an unanticipated negative foreign exchange impact on intercompany loans, which is not expected to repeat in 2022. Now that we have put in place hedges to reduce our economic exposure to FX volatility on these loans. Encouragingly, we were still able to deliver 10 basis points of non-GAAP adjusted EBITDA margin expansion in 2021, despite these unanticipated headwinds. Our underlying financial momentum, the recent cost actions taken in Europe and the flattening of corporate expenses provide increased visibility into our outlook for accelerating non-GAAP adjusted EBITDA growth in 2022. Moving to our operating segments beginning on slide 15. North American net sales increased 11% year-over-year and Q4 on both the reported and non-GAAP organic basis. Segment adjusted EBITDA increased 27% year-over-year and Q4 with segment-adjusted EBITDA margins expanding 110 basis points versus the prior year period, reflecting the increased contribution from higher margin areas of the business including prescription management and Covetrus branded products. We were pleased with the margin expansion delivered during the fourth quarter, particularly considering higher than expected Omicron driven supply chain disruption experienced in the quarter, including increased trade expense. Encouragingly, we delivered another quarter of market share gains in our supply chain business and 22% year-over-year net sales growth in prescription management. Excluding the accounting change that we have previously discussed, prescription management net sales increased 25% year-over-year during the fourth quarter and 28 for the full year. Importantly, we delivered significant operating leverage in prescription management during q4. With non-GAAP adjusted EBITDA increasing $12 million year-over-year to $14 million. And for the full year 2021, prescription management non-GAAP adjusted EBITDA was $44 million or nearly double 2021 levels of $23 million. This equates to a 22% flow-through of incremental net sales into incremental non-GAAP adjusted EBITDA in 2021, representing the second consecutive year of meeting or exceeding our 15% to 20% conversion aspiration. Encouragingly 2022 is off to a strong start in prescription management where sales increase by 30 plus percent year-over-year in January and are trending well in February. Turning to our Europe segment on slide 13. Non-GAAP organic net sales decreased 13% year-over-year in Q4, reflecting the previously disclosed challenges we are experiencing in the UK and German markets, which negatively impacted organic growth by 17%, more than offset healthy veterinary demand fundamentals and strong execution across the rest of our European markets. Our businesses operating in Ireland, Poland, Switzerland and Romania were notable contributors that helped offset these headwinds during the quarter. On a positive note, Germany returned to year-over-year net sales growth during the fourth quarter, a good sign entering 2022 particularly with our recent cost cutting measures now in place. Turning to profitability. Our Europe segment adjusted EBITDA in Q4 increased 22% year-over-year to $14 million with margins declining 30 basis points year-over-year to 4.2%. The combined UK and German markets accounted for the entire decline in profitability in Q4. A typical year-over-year comparison in proprietary brands also impacted growth metrics during the quarter. Moving on to our APAC and emerging markets segment on slide 17, our team delivered 5% year-over-year growth in non-GAAP organic net sales in Q4, reflecting another quarter of strong sales execution, despite challenging comparisons and some incremental COVID-19 pandemic restrictions in several of these markets. Australia delivered healthy 7% year non-GAAP organic net sales growth during Q4. Alongside more modest growth in our New Zealand and Brazilian markets in the quarter. Segment adjusted EBITDA increased 22% year-over-year during Q4 and segment adjusted EBITDA margins expanded by 130 basis points year over year driven by ongoing operating leverage from healthy net sales growth. Now turning to the balance sheet on slide 18, we generated $22 million in free cash flow in Q4 and $42 million for the full year 2021. We executed strategic inventory purchases during the quarter ahead of anticipated price increases, which impacted our cash flow generation during the fourth quarter, but should provide incremental margin during the first half of 2022. We ended the year with more than $480 million in available liquidity, which is comprised of cash and cash equivalents and availability under our revolving credit facility. And approximately 1.6 turns of headroom under our net leverage covenant as defined in our credit agreement. And as I mentioned earlier, we prepaid $30 million of our required 2022 term loan principal amortization payments in December, which combined with our lower bank leverage will reduce interest costs this upcoming year. Now turning to our detailed 2022 guidance as outlined on slide 19. We forecast non-GAAP organic net sales growth of 7% to 8%. The outlook includes 10% to 11% growth in North America alongside the continued adoption of our all-in platform, 3% to 4% growth in Europe as we anniversary the 2021 challenges in the UK and Germany and 6% to 7% growth in APAC and emerging markets. Our global outlook assumes market growth rates above pre-COVID-19 levels, but below the robust growth seen in both 2020 and 2021 as then market conditions normalized. Looking at non-GAAP adjusted EBITDA, our outlook of $270 million to $280 million remains unchanged versus our preliminary outlook released at the JPMorgan Healthcare Conference earlier this year and reflects 11% to 15% year-over-year growth, an acceleration versus the compound annual growth rate delivered over the last two years. This is driven by the lapping of the specific challenges in our UK and German markets and the non-repeat of certain headwinds in corporate costs. We anticipate over 20% growth in net sales and continued growth in profitability and prescription management and an improvement in our software growth outlook with multiple new products coming to market in 2022. We also anticipate general stability in our supply chain businesses around the globe with continued focus on growing our higher margin proprietary brands. Some of this growth will be offset by higher freight costs continued labor market tightness and the return of discretionary spending as global economies reopen. We also continue to monitor the Russian, Ukraine situation and the downstream impact that might have on the global supply chain and some of our European markets, but have not factored anything explicit into our outlook at this time given the current state of affairs. Finally, while we do not provide specific quarterly guidance, given the timing of our Europe cost cutting actions and the fact that some of the global supply chain challenges emerged in the second half of 2021, we do expect year-over-year non-GAAP adjusted EBITDA growth rates to be stronger in the second half of 2022 with Q1, 2022 growth rates expected to be flattish year-over-year. With that, I'll now turn the call back over to Ben for some brief closing remarks.

[Ben Wolin:]

Thanks Matthew. In closing and outline on slide 20, we have a solid foundation in place, a clear plan and visibility looking forward to deliver accelerated growth in 2022. Our end market is attractive and durable and we are aggressively investing in our platform to enhance our value propositions, secure new business and to accelerate our in-market opportunities. We are also focused on driving our Covetrus-branded and proprietary product portfolio and streamlining operations to deliver increased efficiencies while reinvesting back into our tech platform. I'm confident in our strategy and encouraged by the momentum we have in the core drivers of our business. We're still in the early innings of the journey towards the company's long-term goals of above market net sales growth and annual non-GAAP adjusted EBITDA margin expansion, but I believe we have solid blueprint and a team to execute it as we drive sustainable shareholder value creation. This concludes our prepared remarks, and I will now turn the call back over to Nicholas Jansen to moderate the Q&A session.

[Nicholas Jansen:]

Thanks Ben. We will begin our Q&A now. So we want to take as many questions as possible. So we ask you to limit them to two and then reenter the queue should you have additional ones. Saline , can you please provide instructions and we are ready to take the first question.

[Operator:]

Your first question comes from the line of Jon Block from Stefil. Your line is open.

[Jon Block:]

Thanks guys. Good afternoon. First question, the fourth quarter 2021 the North American supply chain revenue was up, I think roughly $40 million year-over-year. But EBITDA for North American supply chain was down about a $1 million year-over-year. So Matthew, I think you lose a freight, you called that out. Maybe just the thought for 2022. Can North American supply chain EBITDA grow with some of these increased cost pressures that you're calling out. When we think about North America for 2022, do we think about EBITDA predominantly driven by the prescription management business?

[Matthew Foulston:]

That's a great question. Clearly the prescription management business will be a big contributor in 2022. I would say the situation we and everyone else faced in Q4 was pretty unique in terms of having not just increased rate pricing pressure, but also massive absenteeism driven by the omicron variant. And when we have absenteeism, we have a smart intent labor, our productivity drops. And we just struggled to get the shipments out and we ended up missing a couple of rebates. So I think Q4, a little bit of a perfect storm and a little bit worse than you ought to expect flowing forward.

[Jon Block:]

Fair enough. Thanks. That's helpful. And then, second question, Ben or Matthew, the gross ads for prescription management have been, I think, it might be fair to say somewhat modest over the past couple quarters. To be clear that the sales growth has still been tremendous and I know that the same-store growth has been tremendous. But please talk to how we should think about new store growth versus same-store sales growth in 2022 here in North America? And maybe that's a decent segue into sort of the timing for international prescription management. Your thoughts there? And could that be a 2023 event? Thanks guys.

[Ben Wolin:]

Yes. Thanks Jon. I'll take that Matthew. Look, I think if you look backwards two years ago, we were very deliberate and vocal about our focus on driving utilization of the platform. We had reached a pretty significant market penetration almost a third of the customers in the U.S. But as we only had about 4% of clinics consumers transacting on the platform. And so that 4% has now grown almost 50% and with some customer cohorts even higher than that, and that's what really has fueled the growth from say, $200 plus million of revenue to north of $500 million of revenue in 2021. I think some of that same mentality and focus will exist in 2022. When you think about a lot of our focus on things like Pulse, so much of that is about driving better workflow and as a result more vet initiated prescriptions on the platform. So the lion share of the volume increase in 2022 is going to come from greater and greater utilization. And Matthew mentioned that 30% growth number in January. So obviously, it's well ahead of the overall 20% plus number that we gave as part of guidance. So that's where the majority of the growth is going to come. We still will pick up new accounts. Would expect that be to be in the 5% to 10% range over the next 12 months or so. But in terms of really propelling the business forward and where the market opportunity is, it's again just all mostly focused on driving greater and greater utilization.

[Jon Block:]

Any comments on an international, Ben, from a timing perspective?

[Ben Wolin:]

Yes. No new updates there on international. We are making a lot of progress on our cloud-based solution in the UK, Australia and New Zealand, which lays a foundation for being able to do that. But no new news on that front, Jon.

[Jon Block:]

Very helpful. Thanks.

[Operator:]

Your next question comes from the line of John Kreger from William Blair. Your line is open.

[John Kreger:]

Hey guys. Thanks. I was hoping you might be able to give us a little bit more perspective on where you see sort of market trends going. I know some of your claims data and sales data, probably gives you good insight. Just curious, from your perspective trends like patient traffic, spending per visit are kind of still in a sort of post COVID sort of normalization phase or we stable? And what kind of assumptions are you making for 2022?

[Ben Wolin:]

Yes, John. Thanks for the question. It has been fairly stable on the end market side of things now for a couple of quarters in the deck that we provided. You get a good sense of some of the growth rates that we're anticipating. So in the U.S. still high single digit growth, a little bit more modulated internationally. I think the biggest issue honestly is capacity with our customers. And I'm sure you see this from covering other companies and just being out in the market. But wait times to get into a hospital driven by staffing limitations is still driving the huge -- a huge part of the business dynamic. So I think if you just look at the back half of 2021, we anticipate similar growth rates for 2022 with the biggest gaining factor honestly being customer capacity.

[John Kreger:]

Okay, great. Thank you. That's helpful. And then the other, you gave us some intriguing stats on the sort of all-in customers and what you think Pulse can do. Can you just -- how are you going to drive that better integration and adoption across your customer base? Is it -- is there a financial incentive? Is it sort of the way you're going to motivate your own sales force? Just elaborate on what the plan is to sort of drive that adoption beyond the 10%?

[Ben Wolin:]

Yes. Two thing. There's really two main levers to drive that adoption rate. The first is just ease of doing business with us through the integration of the various platforms. So when you think about whether it be Pulse or greater integration into AVImark and ImproMed, so much of the adoption of additional solutions comes from data interoperability, enhanced workflows. And so, whether that be compounding or prescription management or appointment management, any of those add-on solutions, they just get a lot better and easier to use when they're integrated. So I think there's just kind of a overall ease of ease of using the platform which drives adoption. The second which you alluded to is really on the sales and marketing front. And so, we're now one year into our unified sales approach as we ripped off a band-aid at the end of Q4 of last year and went to an account manager specialist model, one face the customer. And so that is like any large-scale salesforce change always a work in progress, but really pleased with the results. And I think you see that in the prepared remarks if you just look at North America's top line growth three-year CAGR of almost 14% ahead of where the market is. Not, that would not have been possible if it weren't for the combined efforts or the efforts of going or through our combined sales force. So a lot of optimization left to go there getting incentive right, getting packaging right, but we feel like there's just a ton of running room and obviously the data is pretty compelling when you get it right.

[John Kreger:]

Great. Thank you very much.

[Operator:]

Your next question comes from the line of Nathan Rich from Goldman Sachs. Your line is open.

[Nathan Rich:]

Hi, good afternoon. Thanks for the questions. I wanted to start with the prescription management margins and how we should think about that going forward. I think you had previously talked about targeting kind of incremental margins in the high teens. I think the last two quarters though looking at 3Q and 4Q we're well above that at about 30%. So could you maybe just talk about what drove the margins that you saw in Rx management in the back half of this year. And how you're thinking about that playing out for 2022?

[Ben Wolin:]

So, Matthew, would you like to fill that?

[Matthew Foulston:]

Yes, absolutely. We've consistently said that we've been targeting drop down from incremental revenue to adjusted EBITDA to 20% range. And as you rightly pointed, the back half of the year was really strong. I think that we got a big tailwind in Q4 from a non-repeat of that legal settlement we had the year before which was about $4 million. So I think that's artificially strong. Although we're pleased with it and we'll take it to the bank, but I do think going forward that 15 to 20 is the right way to model it. And as long as we're in that range or at a minimum close to that 15, we'll be very happy.

[Nathan Rich:]

Okay, great. And then, I wanted to go back to the or organic growth guidance. Obviously, a lot of focus on inflation in the market. So I was wondering if you could maybe comment on how much price increases you're seeing from suppliers? And how much of that might be reflected in the organic growth guidance? And Matthew, if you can maybe just talk about in a little more detail how what freight and wage costs have trended relative to your expectations now that we're a couple of months into the year.

[Ben Wolin:]

Yes. Let me let me start with freight we continue to see upward pressure on freight and by and large as you can see from the margin performance we're managing to get it covered with price. But I would tell you the pace of those changes feels like we're always catching up. So we do suffer a bit of a lag issue there. So we really have a little bit of timing problem, but essentially we're pushing the pricing through to get that covered. Labor very tight labor market as we said fourth quarter was very difficult without the crown and all that, but we're continuing to manage through it. Attrition rates remain high and inflation in the low to mid single digits on labor. I don't know if you want to talk a bit about pricing., Ben?

[Ben Wolin:]

Yes Nathan. I think we have seen -- we expect kind of mid to high single digits price increases from suppliers as that gets largely passed through or almost entirely passed through on to customers and then on to consumers. We don't have perfect insight to the number of price increases that occur during the year. But we would expect it to be similar to previous years where it's somewhere between one two or three price increases depending on the manufacturer and the product line, but cumulatively I would expect mid to high single digits on a price increase basis.

[Nathan Rich:]

Thanks. That's really helpful.

[Operator:]

Next question from the line of Erin Wright from Morgan Stanley. Your line is open.

[Erin Wright:]

Great. Just to follow-up to that that question, but on the price increases the mid to high single digit price increases that you're seeing that compares to kind of what historically have you seen there. And then, does your guidance reflect, I guess, any major changes to your vendor relationships are access to products, for instance, the expanded terrestrial relationship with the Lanco. Are there any major changes in buy sell versus agency relationships that are influencing top line or margin trends?

[Matthew Foulston:]

Yes. So Erin, I think the price increases are largely in line with previous years. Again as manufacturers are in different places in their own portfolios and have different opportunities there. So it's not always the same from a manufacturer to manufacturing product, but I think on average it's a pretty --a year consistent with previous years. In terms of our relationships with suppliers, I think we're in a much different place than we were a year or two years ago both in terms of when we have visibility to that and the nature of our relationships with those suppliers. So, we are basically done with all of our suppliers and have come to terms with everybody a year ago. There was still a lack of visibility on that front. Second the economics are basically the same again, puts and takes across the different parts of the portfolio, but very similar to 2021 economics. And in some cases we have suppliers and you mentioned some of them who are really leaning in to our capabilities. A lot of that comes from having an omnichannel solution. We are clearly the only player in the market that is both global as well as can reach veterinarians in clinic and consumers online all under the same umbrella. So we feel very differentiated versus the other players out there in the market and I think that's starting to show up in how we work with suppliers not just the top four but really the top 10 or 15 our relationships have really I think have evolved and are excited about where we're heading -- headed on that front.

[Erin Wright:]

Okay, great. And then, how should we be thinking about the Europe business. The 3% to 4% growth that you talk about in 2022, is that the right way to think about growth across that segment longer term? Or what are some of those lingering headwinds embedded in the 2022 guidance? And how should we be thinking about the reorganization strategy and profitability across that segment? And kind of your overall commitment kind of to the Europe market at this point?

[Ben Wolin:]

Yes. Matthew, I'll start with just kind of end market dynamics and then you can talk about bridging that to the guide and how kind of the lapping of Germany and UK play into the numbers. So in terms of the end market Erin, we expect kind of mid single digit growth rates. Again, emerging markets within Europe growing faster than some of the more traditional markets. And so, that should be pretty similar to end market growth in the past. Of course, don't have a lot of visibility into what's going to happen here in the Ukraine and whether that's going to create any short-term instability in some of these markets, but absent that we expect to see mid single-digit growth rates. And Matt, you can talk about how you translate that into the guide for the full year.

[Matthew Foulston:]

Yes. And just to give you a little bit of history on what we've actually done physically. We have new leadership in both of those markets. We took a modest restructuring charge in Q4 to downsize the cost structure and better align it with revenue. And as we said in the prepared remarks, Germany did return to in the fourth quarter. From a go forward perspective, the UK still has Q1 to lap. So UK is going to be a drag on top and bottom line in Q1. But once we get into the second half, the UK will stop being a drag. We talked about both of those markets being a drag. We talked about both of those markets being about a $19 million year-over-year drag in 2021. Our hope is we get at least half of that back in 2022 in terms of year-over-year improvement.

[Erin Wright:]

Okay. All right. Thank you so much.

[Operator:]

Your next question comes from the line of Elliot Wilbur from Raymond James. Your Line is open.

[Elliot Wilbur:]

Thanks. Good afternoon. Maybe just some additional questions around some of the performance trends you referred to with respect to 2022. Specifically thinking about the strong start to the year in terms of Rx management, any particular dynamic that you might call out there that, believe may have led to the better than expected or strong performance kind of in light of what's been a relatively slow start to the year at least in terms of the growth rate and overall vet clinic visits. And I think you previously talked about some supply issues particularly with respect to dietary products that may have negatively impacted growth in the Rx management business. And just want to get an update on where that dynamic stands currently. And maybe, Ben, you've talked about some off the strong performance trends in the proprietary products business particularly within the European segment. Maybe just provide a little bit more detail behind that in terms of what's driving that? Is it really geographic expansion, share gains, utilization new products, any additional detail there would be helpful? Thanks.

[Ben Wolin:]

Yes. Thanks Elliot. Why don't I can take both of those questions. On prescription management, I mean, obviously, we ended the year well and we kind of continue that trajectory going into January, the first couple of weeks of February here. I would really attribute it to just strong execution by the team. There's a lot of levers to pull here when you're marketing to consumers or improving integration with our software piece of our business to drive that utilization. And so there's not one thing to point to. There's just a lot of execution across the board that's showing up in the end numbers. So, we're really proud of that group and really excited to see how the rest of the year goes. In terms of diets, you are right. Last year, especially in Q1 and the first half of the year we really struggled with our major vendors there or major suppliers, I should say, with very significant product outages. In Q4 and the beginning of the year that has really stabilized. So diet is growing for the first time in many quarters now on pace with commercial pharmacy or above depending on the time period that you're looking at. So feeling quite good about the progress there. I would point out that those suppliers are not out of the woods yet and I'm sure if you're a consumer of these products, you're aware of the challenges if you're using a prescription diet. But for us it's gotten much more stable and our ability to manage consumers appropriately, it has gotten a lot better. So that's kind of that Rx management near term highlights. In terms of proprietary brands, I would tell you that it's not about new markets or new products quite yet, that's in the coming attractions. For now, it's really about execution and focus and John had asked about the combined sales force and how that can drive all in customers. It's the same concept here about focusing on proprietary brands. I mean, we've just done a lot to get sales incentives aligned around the value creators of the business. And that's what's helping drive the growth of proprietary brands across the globe. So we're really excited about the opportunity there, excited about our new leadership under César França. And we expect to see great things on proprietary brands in the quarters to come.

[Operator:]

Your next question comes on the line of Balaji Prasad from Barclay. Sir, line is open.

[Balaji Prasad:]

Thank you. Hi, good evening. Probably just a couple from my side. Firstly on Covetrus Pulse, I would like to have greater granularity around this. Especially your commentary around estimating a 3x increase in revenue from a fully configured practice. So help me understand what will that option curve look like and how can you drive this adoption curve. And for a customer to reach that kind of a contribution for your revenues, is it three years or five years? How does it play out? And secondly, I think this is an extension to the previous response. With regard to the proprietary brand what is the size of the business currently and for the incoming President what kind of KPIs do you have around the segment over the next three to five years. Thanks.

[Ben Wolin:]

Yes. Balaji. So in terms of Pulse, the -- first of all, we're obviously thrilled that we have a thousand customers in beta and have visibility to 20 -- more than 2,000 by the end of Q2 so lots of confidence in our ability to execute there. I'm sure from being around other technology businesses getting to that scale of customers is no small feat. What drives the revenue increase is really the utilization of all of the different services that used to be sold in a kind of a la carte or point solution basis that are now all bundled together in one complete veterinary operating system. So, if you think about what those things are beyond the electronic medical record, you have appointment management client communications payments and other features that used to be integrated in and you couldn't choose. You might, you might choose it, you might not choose it. Now we still allow for choice. But the offering is just so compelling from an economic standpoint as well as an ease-of-use standpoint that that that's what drives us to see that pretty significant step up in revenue for customer when they adopt the veterinary operating system. So excited about that and we'll be excited to get back on the call with you guys in q2 and give you an update on where we are on that front. In terms of proprietary brands, that business is just under $0.5 billion and we obviously it flows through our distribution business and flows through other channels where we have access to customers, but it's predominantly coming from our own channels. In terms of KPIs it's really about sales velocity, product margin and overall end-to-end profitability on the portfolio that we have. And then, on the portfolio that we're building it's going to be about new product launches and category introduction over the coming months and quarters. So early days but I think something that we are going to increasingly focus on and communicate out against here at Covetrus.

[Balaji Prasad:]

That's helpful. Thank you.

[Operator:]

Next question from the line of Erin Wright from Morgan Stanley. Your line is open.

[Erin Wright:]

Great. Thanks for taking my follow-ups. How has uptake been of the prescription management offering across the corporate accounts? Is that an area of focus for you given maybe some of the conflicts of interest with the other prescription management player out there? And could you -- is this an area, I guess, that you could increasingly target in terms of corporate accounts? And then just on that front since we're talking about it as well, I mean, does guidance imply any sort of changes in your corporate account relationships both in the U.S. and internationally?

[Ben Wolin:]

Yes. The guidance does not imply any change in our corporate account relationships. I think those are in a good place. We see continued opportunity. As you know, Erin, there's kind of two -- I would split the corporate accounts into two basic models. One where there's tight centralized control. They make one decision for a prescription management provider and that gets deployed across all of the local hospitals. And then there's the federations where there's not as much tight controls and local veterinarians are making their own decisions. I think what our feedback in the market is that we have a superior solution and it shows up in the numbers. The only limitation is just given how busy our customers are making any changes from a workflow standpoint are just hard. But all indications are that we have the premier solution in the market and feel good about our market position and hope to build on it in the coming years.

[Erin Wright:]

Okay, great. Thank you.

[Operator:]

There are no further questions at this time. Speakers you may continue for closing remarks.

[Ben Wolin:]

We have no closing remarks at this time.

[Operator:]

Thank you everyone. This concludes today's conference call. Thank you all for participating. You may now disconnect.