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PetIQ, Inc. (PETQ) Q2 2020 Earnings Call Transcript

PETQ Earnings Call - Final Transcript

PetIQ, Inc. (NASDAQ: PETQ) Q2 2020 earnings call dated Aug. 06, 2020

Corporate Participants:

Jeff Sonnek — Investor Relations

McCord Christensen — Chief Executive Officer and Chairman of the Board

Susan Sholtis — President

John Newland — Chief Financial Officer & Corporate Secretary

Analysts:

Joseph Altobello — Raymond James Financial, Inc. — Analyst

David Westenberg — Guggenheim Securities — Analyst

Kevin Grundy — Jefferies — Analyst

Bill Chappell — SunTrust Robinson Humphrey — Analyst

Jon Andersen — William Blair — Analyst

Presentation:

Operator

Greetings. Welcome to the PetIQ Second Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded.

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

Jeff Sonnek — Investor Relations

Good afternoon, and thank you for joining us on PetIQ’s second quarter 2020 earnings conference call. On today’s call are Cord Christensen, Chairman and Chief Executive Officer; Susan Sholtis, President; and John Newland, Chief Financial Officer. 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 or 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.

Please note, on today’s call management will refer to certain non-GAAP financial measures, including adjusted gross profit, 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 financial information presented in accordance with GAAP. Please refer to today’s release for a reconciliation of non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. In addition, PetIQ has posted a supplemental presentation on its website for reference. Today, management is conducting the call from their respective remote locations. As such, there may be brief delays, cross talk or other minor technical issues during the call. We thank you in advance for your patience and understanding.

Now, I would like to turn the call over to Cord Christensen.

McCord Christensen — Chief Executive Officer and Chairman of the Board

McCord Christensen — Chief Executive Officer and Chairman of the Board

Thank you, Jeff, and good afternoon, everyone. We appreciate you joining us today to discuss our strong second quarter financial results. Before I update you on our robust sales growth, strength of our diversified pet health and wellness business model and adjusted EBITDA improvement, I’d like to provide an update on the COVID-19 global health crisis and what we are experiencing across our operations. Susan will provide detail on our Services segment, and John will discuss our second quarter financial results in more detail. Finally, Susan, John and I will be available to answer your questions. First, I’d like to express my gratitude to all our team. They demonstrated incredible perseverance and agility to identify solutions in a challenging operating environment and make PetIQ a much stronger business that is ready to operate in any environment in the future.

We are immensely grateful for our frontline employees and their commitment to providing pet parents access to their pet health care needs. Our service organization used the time our clinics were closed during second quarter to implement new safety, denotation and support protocols and are now aggressively executing against our reopening plan, which we expect to position us with 95% of our community clinics and wellness centers back in operation by the end of the third quarter of 2020. More importantly, these procedures allow us to be confident as an essential business we’ll be able to remain open. We are also excited with our initial openings with early results demonstrating that we are quickly returning to pet counts and average ticket per pet, in line with our numbers pre COVID-19.

The Products segment continued to operate with a priority of keeping our teams safe, and through this commitment, we were able to maintain 99% plus fill rates for our customer base, all while delivering the biggest quarter in the company’s history for volume and profitability for this segment. In our veterinarian services segment, second quarter was a challenge due to all clinics being closed for most of the quarter with a limited number starting to reopen at the end of Q2. Our management team estimates that the second quarter impact to the Services segment for these closures was approximately $26 million of revenue and approximately $6.5 million of consolidated adjusted EBITDA. Total Service segment revenue for the quarter would have been approximately $29 million and adjusted EBITDA in excess of $6 million.

Recall, we continue to pay all of our associates while stores were closed, the cost to do this was $4.1 million, which was captured in the company’s G&A and cost of services, but added back to the adjusted EBITDA. We anticipate our results will be similarly impacted in Q3 due to only 5% of our clinics been open at the beginning of Q3 with 50% open by the end of August and 95% open by the end of third quarter. Assuming no further interruption, for the fourth quarter, we expect to return to revenue and EBITDA contribution in line with the prior year plus growth. Now, shifting to our consolidated quarterly financial highlights; even with COVID-19 revenue impact to our service organization, we generated record net sales of $267 million, an increase of approximately 21% and achieved adjusted EBITDA of $28.3 million, an increase of 36%, demonstrating the leverage of our diversified business model and significant increase in sales of our manufactured brands.

Despite the headwinds in our service operations, during the temporary closures, we remain in a healthy financial position, while we have seen increases in inventory and receivables based on strong peak seasonal demand, we continue to have ample liquidity and financial flexibility with our cash on hand, cash generation and existing availability under our revolving credit facility post the closing of our acquisition of Capstar. Near term, our team has also put in place a very conservative capex program to ensure that we are still able to generate cash, while we manage the business through this dynamic operating environment. Taking a closer look at our Products segment for the second quarter, we experienced a record 35.8% increase in sales, led by our e-commerce business that was up over 50% versus Q2 last year.

Our pet Rx business was the most meaningful contributor to this increase as pet parents utilized the e-commerce channel to access safe and affordable health care items for their pets. Importantly, we saw all of our retail partners benefit from the channel shift away from the traditional veterinarian offices. Even with these surges in volume, our distribution and manufacturing sales mix has remained at 75% distributed and 25% manufactured items during the first six months of 2020. Despite these increases in volume, our facilities still have greater than 40% excess capacity with lots of room for future growth. Over the last few years, we have made strategic acquisitions to further diversify our business across products and service offerings as well as sales channels. This business transformation has made PetIQ significantly more insulated, which is particularly evident during times such as this.

To give you a little more perspective on the health and stability of our consolidated operations in the third quarter, we believe that in the third quarter, we will see a similar dynamic to the first half of the year where the acceleration in product sales will significantly reduce some of the financial impact from the Services segment. We believe our financial results also demonstrate the strength of the pet health and wellness industry and our ability to weather any changes in the broader macro economy with explicit success. Dating back to the most recent financial downturn in 2008 to 2009, the pet industry outperformed the broader consumer discretionary market. In the spirit of transparency, we are providing third quarter guidance, which John will walk through in detail.

However, our 2020 annual guidance provided on March 10, 2020, remains suspended due to the uncertainty surrounding the impact and duration from the COVID-19 pandemic on our Services segment. To-date, for the third quarter, our Products segment sales remain robust, and we are expecting minimal contribution from the Services segment in Q3 as we execute on our reopening plan. Also keep in mind, Capstar’s seasonality is consistent with PetIQ’s existing flea and tick business. Based on the July 31st completion of the acquisition, we also have on-hand inventory of Capstar’s historical distributed product margin profile until the middle of September when we will begin to realize our more advantageous manufactured margin profile for the Capstar portfolio of products.

For Q4, we expect to have a more normalized margin and contribution from Capstar. As we look to 2021, we continue to expect incremental EBITDA contribution from Capstar of greater than $20 million, and long term, we remain confident in achieving our previously stated strategic and financial objectives. In summary, we remain uniquely positioned in the animal health industry with our vertically integrated product manufacturing and distribution platform and an unmatched national footprint with convenient access to veterinarian services, prescriptions and OTC medications at a value.

We believe PetIQ’s mission of delivering smarter options for pet parents to help enrich their pets’ lives, through convenient and affordable access to veterinarian products and services has never been stronger as pet parents everywhere are looking for ways to save money. We believe our growth demonstrates how well, our complementary and diversified model is resonating with all pet parents. We are well positioned long term to achieve our strategic and financial objectives and look forward to enhancing value for all shareholders.

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

Susan Sholtis — President

Thank you, Cord. We’re really excited to share our clinic reopening plan with you today. Needless to say, second quarter was incredibly disruptive. But thanks to a resilient team, the outcome of this pandemic has resulted in a more contemporary and more nimble organization, which will serve us well in our next chapter of growth. The nature of our store within a store model is advantageous, both to us and our host retail partners, where we share in the benefit of increased foot traffic to their physical locations. What was a simple and highly efficient model in March quickly became burdened with the challenge of adhering district federal, state and local orders, as well as those put forth by important professional associations such as the American Veterinary Medical Association or the AVMA.

Satisfying these fluid sets of variables was no small feat and required us to temporarily close our national network of locations on March 20. Our objective, moving forward, was very clear. In order to reopen as an essential business, we had to develop a system to keep our teams safe, our retail partner’s team safe and our pet parents safe as well. The great news is that we had the team in place to work through the challenge in a systematic fashion with our retail partners as we piloted and identified solutions. Beginning in May, we started reopening our wellness centers. And last month, we started piloting select reopenings of our community clinics as well. As you can imagine, maintaining social distance is of the utmost concern. Within most of our wellness center formats, we have the luxury of having an independent entrance, isolating our operations from those of the retail partner, which became highly advantageous and allowed us to reopen those locations more quickly.

However, within the community clinic format, we are operating within the store in a pop-up fashion, which created added operational complexity. This required us to work closely with our retail host partners to develop line management systems that help pet parents comply with social distancing requirements, all while still delivering fast, efficient and friendly veterinary wellness services that our pet parents are accustomed to. In terms of the reopening status in both of our formats, today, approximately 60% of our wellness centers are operational, with the goal of approaching 95% of our network to be operational by the end of the third quarter of this year. These percentages exclude the 27 wellness centers that were under construction prior to the COVID-19 pandemic.

While construction on these have since been completed, they are being targeted for their grand openings during the fourth quarter of this year. On the community clinic side, we began piloting select clinic reopenings at approximately 5% of the network in July to test our new operational protocols alongside our retail partners. These tests are going well. And as a result, we currently expect to reopen approximately 50% of our network by the end of August, with a goal of at least 95% reopened by the end of the third quarter of this year. The combined effort is highly organized and structured around localized requirements so that we can get back to business, but do so in a way that satisfies the needs of all of our constituents with a safety first mentality.

What’s more, the strategic investments in our labor force through this period are paying dividends. The employee turnover rates are down to 2%, a greater than 50% decrease from what we typically expect, and our staff is ready to get back to work. The response from our pet parents has been immediate. We’ve experienced a groundswell of support from pet parents, seeking us out, calling their local retailer and asking us to get back to business. We are incredibly grateful for their loyalty. For the clinics that have reopened, we’ve seen an incredible lift in our pet counts and average ticket to the levels that surpass our pre-COVID run rates. Both of these are incredibly encouraging metrics for our business and speak to the pent-up demand in the industry for veterinary services. However, we believe there are even larger forces at play, which put us in an advantageous position in today’s marketplace.

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According to the recent survey by the American Pet Products Association or the APPA, 55% of all respondent pet parents are very concerned about their finances over the next year. And 42% of those surveyed say that COVID-19 has had a significant financial impact on their household. We already knew pre-pandemic that pet parents believed their biggest challenge in caring for their pet was the cost. Today, the data and the demand tell us that challenge and that concern is only exacerbated. There is no denying the bond between pets and pet parents. But in this time of heightened uncertainty, pet parents are seeking out solutions for affordable veterinary care at increasing rates. And PetIQ’s national network of convenience and affordable clinics are the perfect solution to meet their needs. We are extremely excited about our leadership position in the market, the strength of the relationships with our host retail partners, the team we’ve put in place and the years of growth that lie ahead for our business.

With that, I’ll pass the call over to John.

John Newland — Chief Financial Officer & Corporate Secretary

Thank you, Susan. We demonstrated the diverse and resilient nature of our business in second quarter. We were able to produce strong consolidated results, with 21% net sales growth and 36% adjusted EBITDA growth versus prior year, despite the lack of contribution from our Service segment due to the COVID-19 induced temporary closures of our national clinic network. Our Product segment carried us through the quarter and generated strong sales growth of 36%, which was an acceleration from the 32% we posted in the first quarter. The growth we experienced in the second quarter was a continuation of the themes we spoke about during our first quarter call.

We saw heightened consumer concern around and demand for essential pet health and wellness products amid the disruption, the widespread closures of the traditional veterinarian channel and shifts in retail purchasing habits due to social distancing and local stay-at-home orders. More recently, we’re seeing trends normalize to an extent, as access to products has improved and consumers become more accustomed to their new normal. Nonetheless, the financial strength that our Product segment provides our broader business is an important component in the resilient nature of PetIQ, particularly in an uncertain environment like we face today.

The three strategic acquisitions we have completed in the last three years have been highly complementary and provide us the flexibility to maintain a long term view of our strategic and financial position. In fact, despite the temporary headwinds we faced in our Service segment, we were able to largely mitigate its impacts due to the variable nature of the Services segment cost structure and deliver relative margin stability on a year-over-year basis. We view this as a key accomplishment given our estimates for loss contribution from our Services business, which is approximately $26 million in net sales and $6.5 million in adjusted EBITDA for the quarter due to its temporary closure. Based on these estimates, the Services segment net revenue and adjusted EBITDA for the second quarter of 2020 would have been approximately $28.7 million and $7.6 million, respectively.

Shifting to some specifics around second quarter financials, consolidated net sales increased 21% to a record $267 million due to strong sales contribution from our Product segment, which was driven by our Perrigo Animal Health acquisition and ongoing success with our prescription drug program at e-commerce partners. Second quarter gross profit increased 21% to $42.2 million, and gross margin was consistent with the prior year period of 15.8%, even as the company experienced an estimated 200 basis point headwind from the temporary Services segment closures due to COVID-19. Adjusted gross profit was $47.3 million, and adjusted gross margin was 17.7% for the second quarter of 2020 when costs associated with the temporary Services segment closures are added back. If our loss margin from these closures was also included, adjusted gross margin would have been 19.8%.

Finally, adjusted EBITDA increased 36% to $28.3 million, which we think is a great accomplishment in this environment and considering the circumstances surrounding our Services segment. At the segment level, our Product segment net sales for the quarter were $264.5 million, an increase of 35.8% year-over-year. Segment adjusted EBITDA before corporate allocations was $41.9 million, an increase of 98% compared to second quarter last year. Consistent with recent trends, our e-commerce channel experienced disproportionate growth and our manufacturing business continues to perform to our goal of 25% sales growth due to the success we are having integrating our brands, such as PetArmor into our customer network. Combined, we realized a nice gross margin lift when coupled with our fixed G&A in the Product segment.

We were able to generate healthy operating leverage, which is a primary driver for the strong growth of segment adjusted EBITDA. Within our Services segment, net revenues were $2.7 million compared to $26 million in the same period last year. As Cord and Susan discussed, due to the COVID-19 related temporary closures of the service locations, the company generated nominal revenue during the quarter, which primarily represents revenue from the online reorders by our pet parents. Our reported Services segment, adjusted EBITDA was $1.1 million, which compares to $6.8 million in the second quarter of 2019. As it pertains to our balance sheet and liquidity, our long term debt balance, which is largely comprised of our revolving credit facility, term loan and convertible debt was $357.8 million as of June 30, 2020.

Pro forma for the company’s $95 million acquisition of Capstar that closed on July 31, we had total liquidity of approximately $102 million. I’d note that we have an additional $15 million available via an accordion feature of the credit agreement for a total of $117 million of available liquidity. From a cash flow perspective, we generated $26.2 million of cash flow from operations during the second quarter. Working capital increased $146.5 million for the year-to-date period ended June 30, 2020, versus prior year, primarily due to the $123 million of net proceeds from a convertible note offering. We are turning inventory rapidly, fulfilling reorders efficiently and seeing little evidence of excess channel inventory.

We remain confident that working capital will reverse and provide cash out of the business in the second half of the year following a normal seasonal cadence. When combined with our available liquidity, the consistent positive contribution from our Product segment and the temporary reduction of capex as we pause our clinic growth rollout puts PetIQ in a position to drive free cash flow and build cash in the quarters ahead. We are not providing full year 2020 guidance at this time due to the uncertainty surrounding the impact and duration of the COVID-19 pandemic on our service business. However, we are providing the following range of expectations for the current fiscal third quarter ending September 30, 2020. Consolidated net sales are expected to be in the range of $160 million to $170 million, and consolidated adjusted EBITDA is expected in the range of $15 million to $18 million.

This guidance assumes continued growth within our Product segment, but minimal contribution from our Services segment as we execute the reopening plan during the quarter. Third quarter guidance also assumes minimal contribution from the Capstar acquisition that closed on July 31, 2020, due to the seasonality that is consistent with our existing flea and tick business. Additionally, I’d note that we are carrying on-hand inventory of Capstar at our historical distributed product margin profile until the middle of September when we first realized the advantageous manufactured margin profile for this portfolio of products that are now under the company’s ownership.

Following this third quarter transition, we expect normal margin contribution to ensue by the Capstar products, which is the basis for our $20 million EBITDA estimate for fiscal year 2021. In closing, we are very pleased with our second quarter 2020 results, which demonstrates our ability to navigate even the most difficult of circumstances. In fact, based off of the commentary you’ve heard from Cord and Susan, there’s evidence suggesting that we are emerging from this disruption in an even stronger position with broader capabilities to bring convenient and affordable pet wellness products and services to pet parents in the formats that best fit their lives.

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

Questions and Answers:

Operator

[Operator Instructions] First question is from Joe Altobello of Raymond James. Please go ahead.

Joseph Altobello — Raymond James Financial, Inc. — Analyst

Thanks. Hey guys. Good afternoon. First question, I guess, I’ll start with the guide for Q3. The sales number, $160 million to $170 million. If I look at your third quarter last year, you did product sales of $161.5 million, so it would seem like it implies a pretty significant slowdown on the products side from a revenue standpoint. So maybe give us a little more color as to why you’re expecting that slowdown in the third quarter?

John Newland — Chief Financial Officer & Corporate Secretary

Yeah. This is John, Joe. That’s a great question. I’d just remind everyone that our suspended guidance for the full year had us at $800 million in revenue and $80 million in earnings. Prior to COVID, our original guidance for the quarter would have been approximately $210 million in revenue for the quarter. So let’s bridge that gap of where we are in the $160 million to $170 million range versus the $210 million. We’re going to have a $30 million impacted sales for closed clinics and clinics that we haven’t opened through the first half of the year. Additionally, we have $15 million of potential impacted sales from our online retailers. They’ve messaged that their purchasing of eight weeks of on-hand inventory was based off of COVID consumption rates that could potentially slow down based on the settling of the market.

McCord Christensen — Chief Executive Officer and Chairman of the Board

Yeah, Joe, this is Cord. I think to explain even further to John’s point, within the last week, we’ve had a — few of the online retailers let us know that they’d continue to buy inventory based on growth rates we saw during the second quarter that were extremely high. As the veterinarian market has reopened and restabilized, they’ve — consumption at those places has gone down. Still better than what we expected for the year, but definitely less than what it was. They had bought inventory to support the higher growth rates. Again, this is something we aren’t 100% confident it will happen. But with that messaging, we’re being more conservative. And so there is likelihood another $15 million to $20 million of product revenue that would flow through that. But we’re essentially tracking with those two minor issues against what the original $210 million revenue number would have looked like.

Joseph Altobello — Raymond James Financial, Inc. — Analyst

Okay. So it sounds like — long story short, you’re looking at a little bit of a pull forward from the third quarter to the first half.

McCord Christensen — Chief Executive Officer and Chairman of the Board

And I think it’s something that wouldn’t be largely classified as a pull forward, but in the spirit of just normal projections and forecasting, buying your inventory to continue the rate of consumption that was there, gets you to where eight weeks of inventory is very different if it returns back to something slightly better than what was pre-COVID. So still very strong consumption going out and being shipped to the consumer. But purchasing against what the rate was, we saw at the peak of COVID in second quarter, gave them to be a position where we likely believe in August and September. You’ll see some correction on inventory levels that will impact sales slightly in the third quarter. But, again, returning to normal run rates, to normal consumption once that onetime kind of reset is done.

Joseph Altobello — Raymond James Financial, Inc. — Analyst

That’s helpful, Cord. And maybe secondly, on your distribution contracts with some of your third-party manufacturers. Can you give us an idea of what’s the cadence of renewals are for this year and maybe early next year?

McCord Christensen — Chief Executive Officer and Chairman of the Board

Yeah. We are tracking with no open issues right now with either one of them. We are in discussions about modifications are being made for next year. But remember, right now those contracts run through next year. So we’re preemptively pushing to get things down to extend further. But right now no perceived or projected risks to those discussions.

Joseph Altobello — Raymond James Financial, Inc. — Analyst

Okay, great. Thank you.

Operator

The next question is from David Westenberg of Guggenheim Securities. Please go ahead.

David Westenberg — Guggenheim Securities — Analyst

Hi. Thanks for taking the question and congrats on a good Q2. I think this question is probably a little bit more for Susan. What are kind of the puts and takes for — on the timing for opening, if you can get into that a little bit more? And maybe this one is for Cord or John, in continuation of this. If you do have to control lines or any amount of people that can be inside these clinics at a time, do you expect impacts in terms of what the margins are in this? And — I mean, maybe this goes on until the vaccine is out there. So I just want to get kind of a thought on margin impacts as these open up to maybe less consumers than normal.

Susan Sholtis — President

Hey, David, this is Susan. I’ll talk to you just a little bit about our reopening strategy. As you know, when we spoke last time, we started with our wellness clinics that had the independent entrants from — with our retail partners. It just from a safety standpoint, was a — it was a much easier approach to get out the door with those. From there, we moved into additional wellness centers that didn’t have an independent door, and we needed to do that with a line management system. As you can probably imagine, neither us nor our retail partners want lines to form inside their stores. And so, we put a process in place, where basically, pet owners can virtually line up, and that allows them to walk around, walk outside with their pets while they’re waiting for their veterinary services.

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Once we had that put in place, we then opened up some additional wellness centers that did not have that independent door. And then, obviously, once we had that line management system tested and proven, we started to move into the community clinics, because the community clinics are — where we can get some very long lines, and it was important that we’d be able to manage those. So with all of those — that testing, that piloting under our belt over August and September, we will be opening up our 37 community clinic field offices. We’ll be doing that in waves based on size and based on location around the country.

David Westenberg — Guggenheim Securities — Analyst

Got it. No, that’s very helpful. And then on — oh, go ahead.

McCord Christensen — Chief Executive Officer and Chairman of the Board

Yeah. Yeah, I’ve got the second question, Dave. I think to Susan’s point. We, obviously like everyone, anticipated it being more clunky to put people through the clinics with all the new procedures in place and all the new things going on as it related to operating that. We did, during the time we were closed, put in place a line management piece of software and technology. We’ve been opening up a number of clinics, both in the wellness center and the community clinic formats. And you can imagine with the pent-up demand of being closed for some time period, we’ve actually seen the clinics have throughputs well in excess to what we were seeing prior to COVID. And as we get into the weeks — after those first couple of weeks of the pent-up demand, we’re normalizing that rates virtually exactly in line with where we were pre-COVID both from a ticket and from a quantity of pets treated. And so at this point, we’re projecting no impact to the change in procedures. Our ability to take care of the number of pets that we were treating previously are in line with our revenue expectations out of the stores.

David Westenberg — Guggenheim Securities — Analyst

Got it. No, that’s very helpful. Thank you. And then in terms of telemedicine, I realized it’s very early and not a revenue contributor. When do you think that could become a revenue contributor? And should we think about this as being cannibalistic or additive to the services that you have right now?

Susan Sholtis — President

Yeah, Dave, I definitely expect for it to be additive to our business. I think that people will reach out to us more frequently versus putting their pet into the car and bringing them to a clinic. So I definitely see it as being additive. I can tell you right now that through our Telehealth system we take about 200 calls a week. And by the way, this is — we’re really still in a piloting phase, where we’ve not gone out and we’ve not promoted this extensively to the marketplace. So this is just — this is very initial first blush. As you know, those calls are managed through our teletriage process with our partners at whiskerDocs. They had a team of technicians. They’re available 24/7 to answer questions. We piloted telemedicine in three states. So, I think that we talked about this previously in Michigan, Florida and in Georgia. Our expectation is to continue to evolve our process. We’re learning a lot as we develop this process around those three states. But expectation is that we’ll roll out additional states throughout the rest of this year.

McCord Christensen — Chief Executive Officer and Chairman of the Board

And I think, David — I was just going to add to Susan’s comments that the 200 calls a week, that’s having very limited availability of the Telehealth and teletriage programs across the market, whereby no means that’s full distribution. So the response has been fantastic for the limited states that we’re operating in. We are at a place now where we can generate revenue using it. And we think we’re going to see significant upside in the performance there as we look at taking our average revenue per household for pet up, we think, significantly by seeing multiple visits, where it’s a way for them to get to us easier for that second or third consultation.

We also have been in the process of launching and rolling out our subscription program for our wellness plans, and we think that having medicine Telehealth and teletriage and telemedicine as part of those programs is going to allow us to have a higher close rate, higher retention rate and just be a better partner for our pet parents. So it’s early in the game, but I will tell you, we’re way out in front in the work that we’re doing and the resources we’ve dedicated to the Telehealth platform, and see nothing but a very bright future that will continue to be more accretive in the future as we get it into more markets and as the regulatory environment becomes more supportive, which we definitely feel like will happen.

David Westenberg — Guggenheim Securities — Analyst

Appreciate that. And I kind of hog in a little bit of question, I just want to add one more in terms of, have you been able to sell wellness plans online during this or — I’m just trying to think about during this closure, whether or not we could be seeing a little bit of stream of excess services, because wellness has been something that you’ve been interested or trying to push for.

Susan Sholtis — President

Yeah. No, so during the time that we were closed, we were not online selling our wellness services, but at the — or the wellness plans, but we are back up and running with them, and they are selling. So we basically relaunched those again as we’ve started to reopen these clinics. I think interestingly, too, Dave, though, is that what we’re finding is that, interestingly, the pet parents that are coming to us today are disproportionately coming to us also because of minor illness issues, which tells you that there truly is pent-up demand out there, because people have stayed at home with their pets. So a lot of what we are seeing right now are people that have spent a lot of time at home with their pets, noticing the ears, the eyes and literally bringing them in for some of those additional services that maybe previously, had they been working with their pet at home all day, would have never noticed these types of conditions.

David Westenberg — Guggenheim Securities — Analyst

Thank you.

Operator

The next question is from Kevin Grundy of Jefferies.

Kevin Grundy — Jefferies — Analyst

Hey, good evening guys. Question probably for Cord. I wanted to come back to the guidance. A couple of questions on revenue and then one on margins. So Cord, can you share what you think retail takeaway is at this point? So we — it seems like organic growth in products was roughly circa 20% based on your guidance, given that you’re going to get a minimal contribution from services. It seems like it will be up modestly. So kind of averaging those two, you get to up low double digits. Is that how you guys are thinking — how you’re seeing retail takeaway at the moment? And if you do get a return to that growth rate, is that where you’re kind of level setting expectations for 4Q?

McCord Christensen — Chief Executive Officer and Chairman of the Board

I think, Kevin, if you look at the company and you listen to the messaging we’ve given you relative to impact of the sales or the services organization, we’re tracking right now to have in excess of $15 million of revenue impact to the service organization during the closure. And if you look at the product performance first half of the year, plus what we’ve talked in the back half of the year, we’re normalizing to a place that we would have been in line with kind of our 8.15 plus from a revenue perspective and in line with what would be the normal — kind of lift we would have been missing for the full year. There’s still a lot of unknown as some of the COVID impact and purchasing isn’t necessarily a clean linear line that happens across the business. And so we’re doing the best we can.

What we do know is we’re having a great year. That we’re going to be up. That the business is performing great, that the pet counts and tickets are coming back quickly to where we’re confident we would have been able to be ahead of our guidance we gave originally that we suspended. That’s a good place to be when you’re talking about being confident coming into next year. The other thing I would remind you, in Q3 of last — of this last year, we had the full impact of the Perrigo acquisition in where we didn’t have it in the first half of the year. And so we are anniversarying some of those numbers plus some of these oddities in the product business relative to the product business. But I think we — all-in-all, when you normalize it all out, we’re tracking in line very close to what we projected for the total year and where we would have normally been, and we think that will normalize to something that feels like that.

Kevin Grundy — Jefferies — Analyst

Okay. A couple more quick ones for me. Just relatedly, Cord, the slowdown that your online retailers are messaging to you. Are you seeing that in other channels with respect to products? And if so, why do you think that is?

McCord Christensen — Chief Executive Officer and Chairman of the Board

Kevin, we’re not. I mean, literally, the impact is the online consumption at the peak of the business was running at two times to three times and sometimes four times in certain categories of what it was running pre-COVID at the peak. It’s gone back to where it’s running 15% or 20% better than what it was pre-COVID. But when you have some categories that are running at 100%, they were buying 8 weeks of inventory, expecting that type of consumption. And so once you normalize that back, we’re still going to be running growth rates better than what we had projected for the year in that channel. And we expect that channel to continue to run those type of growth rates.

I think in general, we’ve seen across most categories in the times we’re in right now, especially brick-and-mortar retailers that are stronger and have been more important during the COVID environment. We’ve seen their numbers being very stable to slightly up. And then some of the retailers in some of the specialty categories have had traffic — that’s been more impacted and haven’t performed as well. But there’s no doubt that the growth today is skewed towards the online retailers in this environment. But in total, we’re still seeing strong retailers delivering good numbers. They did not have the same drastic increases. So they don’t have the drastic correction to get back to that six to eight weeks of inventory they’d like to hold. So I do think it’s onetime in nature, Kevin.

Kevin Grundy — Jefferies — Analyst

Okay. Thanks. And a quick one from me and I’ll pass it on. So John, on the — also on your third quarter guidance. At the midpoint, it implies your EBITDA margins were down 50 bps year-over-year. Can you just walk us through like sort of tumble through the numbers to get us there? You’re clearly going to have a drag from services, but Capstar should be nicely accretive. Can you talk a little bit about channel and product mix dynamics that are going to lead to some margin compression in the third quarter? And then I’ll pass it on.

John Newland — Chief Financial Officer & Corporate Secretary

I tell you what, Kevin, what I — how I’d like to start this is to give to — take you through the full walk down of the EBITDA bridge. When we talked about that guidance, I’d said that previously, we had expected to have approximately $210 million in revenue and $22 million in earnings for Q3. So when we bridge that and we look at — if you just take the middle of the guide that we provided — the $15 million to $18 million of $16.5 million. The impact to EBITDA on the clinic closures for Q3 is $6.5 million. And so then let’s break out all of the Capstar contribution as well. Capstar, traditionally in the third quarter — so if you look towards next year, you should expect to see approximately $6.5 million of EBITDA contribution for Capstar.

This year, based off of the timing of when it was completed and the fact of our on-hand inventory that includes the previous margin structure, we’re only going to see about $1 million of contribution of that this year. So next year, there would be an additional $5.5 million of earnings associated with that. So the bridge is, if it was on a normalized basis, you would see something that looked a lot more like $28 million of EBITDA associated with the $210 million of revenue. So we didn’t get the expected contribution from the Capstar just based off of the timing of when it was completed and our on hand inventories. But you should expect to see going forward a higher EBITDA percentage associated with having that as part of our portfolio of products.

Kevin Grundy — Jefferies — Analyst

Okay. Thanks John. I’ll pass it on.

Operator

The next question is from Bill Chappell of Truist [Phonetic]. Please go ahead.Hi, good afternoon. Hey, I’m sorry to go back to this but just want to maybe help me on the bridge on the third quarter product sales. I mean, if you were doing — you did $162 million last year and you’re growing, kind of 15% rate gets you to $186 million, what would be normal for the September quarter? If I’m bridging that down to the $160 million to $170 million, are you saying kind of 15% to 20% — or sorry, 10% to 15% was just showed up in the June quarter, and the rest was just sales you would have gotten through your services channel that just isn’t showing up. Is that the right way to look at it?

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McCord Christensen — Chief Executive Officer and Chairman of the Board

Yes, Bill, that’s the right way to look at it. Third quarter, obviously, flea and tick season stops significantly. Inventories start reducing. It’s a huge contributor to our growth. Heartworm and other ones also fall off. So we always have seen a softer growth rate in the products business in Q3 as those inventories are brought down. This year, we have the anomaly of what we just described as the Rx business and that rightsizing their inventories and getting that impact to the quarter. So Q3 has always been a tougher quarter year-over-year from — versus like a Q1 and Q2, where we’re really loading in those other categories that have been growing significantly and continue to grow for us. But, again, the annualized growth rate, I think it’s going to be right where we would expected it to be.

Bill Chappell — SunTrust Robinson Humphrey — Analyst

And what you’re seeing in kind of these earlier sales, it’s largely in Rx, not OTC?

McCord Christensen — Chief Executive Officer and Chairman of the Board

It’s, yes, largely Rx. There is some OTC, but largely Rx, where you had virtually all veterinarian offices closed and anyone that need a prescription fill was online. And like I said, if they were projecting to run 25% increases year-over-year, Rx ran 100% increases for — at the peak, and it’s now running better than the 25% originally projected, but nowhere near the 100%. And so it’s just a rightsizing of the inventory.

Bill Chappell — SunTrust Robinson Humphrey — Analyst

Got it. And then, Susan, I don’t mean to be armchair quarterback in certainly a difficult situation. But why is it taking so long to reopen everything? I mean, Tractor Supply stores never shut down. A lot of pet stores are — around the country are back up and running. So — even the Walmart is open, it’s a separate entrance. So is there a hesitancy from your vets to get back? Is there something else that’s a gating factor? I’m just kind of surprised that you’re kind of expecting limited contribution in the third quarter from that business. It seems like we should be further along.

Susan Sholtis — President

Yes. No, I think it’s a good question, Bill. And I think that it comes back to, first of all, being able to open up safely and keep our teams safe to keep our retail partner — our partner’s team safe as well as pet parents as well, too. So we needed to get the appropriate protocols in place in order to be able to do that. There is no hesitancy whatsoever on our side or on our retailer side, but we have probably worked as best as we possibly could together to develop plans to get these clinics back open. As I mentioned earlier, our retail partners are actually receiving phone calls from our pet parents looking for us to get that open. But we also know that managing those lines is incredibly important. So I think that — once we got this line management system in place that actually helps us to be able to manage it without putting multiple additional people into the clinic to be able to manage it.

It was a solution that needed to be developed, and it was a solution that is definitely up and absolutely ready to go. Community clinics were the biggest challenge. Wellness clinics, not so much because you have the ability to manage the number of people that actually come into the clinic, but the wellness — the community clinics, if you remember, we get clients and I’m telling you that post — that post coming out of this pandemic, we are seeing 50 and 60 pet parents in a 2.5 hour time period. So I’m not talking about a small number of people. Being able to manage that and being able to manage the distancing is incredibly important, and again, we do that hand-in-hand with our retail partners. So we are actually very proud of the success rate that we’ve had and our ability to get these back up and running, and we will have all these locations back up and running by the end of September.

McCord Christensen — Chief Executive Officer and Chairman of the Board

Bill, the other thing I would add to it is, as we worked with the — sorry, but I cut you off.

Bill Chappell — SunTrust Robinson Humphrey — Analyst

No, please go ahead.

McCord Christensen — Chief Executive Officer and Chairman of the Board

I was just going to say, as we worked closely with our retail partners, they are really the negating factor. We’re ready and can open up much quicker than what they are. But I will tell you that the procedures and the processes and the operational reviews we’ve done with their senior leadership up the CEOs of these company, is why we’ve been very strong in the language that when we do reopen, we won’t close. They’re incredibly impressed with what we’ve put in place that we’re ready to go. And now that they’re through the tough diligence period of being ready to let other people operate in their store environment. Again, open arms at this point, getting back to 95% by the end of Q3 — and quantity is more than we expected to have open in that time period, maybe not as fast as we want to get there. But the fact that we’re going to end Q3 with 95% reopen is well ahead of what we were estimating prior. So we actually would love to have gotten more done. Everything that’s controlled by us has been controlled. And we now have all of our partners in a place where they’re with us driving the process forward, and we will get that back to full revenue contribution very soon.

Susan Sholtis — President

The other item that I would add, Bill, is that in a two-month period of time, we’ll have 2,700 locations up and running, and that’s doing that in a two-month period of time.

Bill Chappell — SunTrust Robinson Humphrey — Analyst

Got it. Thank you.

McCord Christensen — Chief Executive Officer and Chairman of the Board

Thanks Bill.

Operator

The next question is from Jon Andersen of William Blair. Please go ahead.

Jon Andersen — William Blair — Analyst

Hi. Good afternoon everybody.

McCord Christensen — Chief Executive Officer and Chairman of the Board

Hi, Jon.

Jon Andersen — William Blair — Analyst

Hi. First question is just on the 95% target for service capacity by the end of the third quarter. When you think about the clinic side of the business, the community clinic, does the 95% — does that represent clinics themselves or the number — the locations that will be open? Because, right — you run multiple clinics in a given location, so I’m just trying to understand on that side of the business, what the 95% represents?

Susan Sholtis — President

Yeah, John, the 95% represents the number of clinics.

McCord Christensen — Chief Executive Officer and Chairman of the Board

Yeah, so we will have all the 95% of locations open, returning to their normalized schedule frequency. So being able to, what we believe, get back to 95% of revenue at that point. So we’re, again, so far, so good. The indication is that pet parents are coming back at rates that will be back to those rates, but we are going back to our normalized schedule for the time of year that we would be in that store, and we should be returning back to normalized revenue.

Jon Andersen — William Blair — Analyst

Great. That’s super helpful. On the — how do you parse the pent-up demand that you’re seeing versus maybe ongoing demand? Have you had wellness centers open long enough now that you can kind of see the difference there between the pent-up and what you suspect will be kind of the ongoing?

Susan Sholtis — President

Yeah, we believe that what we’re seeing is a combination of two different effects that are happening. First of all, that pent-up demand. And I think interestingly, when I mentioned earlier, the minor illnesses that we’re seeing, people are spending more time with their pets, and they’re noticing those funny — those — the runny — funny ears and the runny eyes and things of that nature. And so number, one, there is pent-up demand, but it’s pent-up demand because they’ve not been able to get these conditions seen or these conditions taking care of. So they’re coming in. They’re not coming in necessarily to get their vaccination.

They’re coming in to get issues taken care of. So we believe that those clients will continue to come back to us even for the basic services. But I think also back to my other point about the pet parents being disproportionately impacted by COVID. 44% of our pet parents to-date — and I’m talking about since we have reopened, are people we have never seen before. That’s to 44%. That tells me that, yes, we’re dealing with pent-up demand, but we’re also dealing with a pet population or a pet audience that, quite frankly, is looking for affordable services.

Bill Chappell — SunTrust Robinson Humphrey — Analyst

Interesting. So 44% are new users essentially.

Susan Sholtis — President

Brand new. Have never been to see us.

McCord Christensen — Chief Executive Officer and Chairman of the Board

And John, we’ve — that’s been a number that’s been similar in our past that we track to see what the percentages are, and that’s in the range of what we’ve always seen. We’re just seeing a significant increase in quantities. So that 44% represents a much larger number. We do have our existing patients that are in our database, and we’re looking at those. And yes, people that we didn’t get to see for those couple of months, maybe those have doubled up where you’ve seen a person that normally comes in April now has come in July.

And we’re able to track that they came every year, and so we’re able to see that person, and we’re going to recover some of that revenue as well. But we feel very good that we’re going to be able to return quickly. That we’re not going to have this slow build back to our pet counts or average tickets per pet. So we’re feeling very good about the initial indication we’re getting. Obviously, every week we get more data, more stores open, but we have not seen a change in the data since we started the reopening this past 6 weeks, and we continue to see it building. And we’re excited about the 95%. We couldn’t be happier that we’re going to really get back to 95% by the end of the third quarter.

Bill Chappell — SunTrust Robinson Humphrey — Analyst

Yeah, for sure. The last one I had was with the work that you’ve done now with safety protocols and other things that you’ve put in place to maintain social distancing standards and the health and wellness of your employees. Does this make it less likely in the case of a resurgence of the virus in a particular area or region? Does this make it less likely that you’d have to reclose a facility — a location at this point?

Susan Sholtis — President

Yeah, that’s exactly what it does. We needed to get those protocols in place. We needed to get those — that PPE in place. So because we’re classified as an essential business — veterinary services across the country are essential businesses. Because we now have these protocols, these procedures in place, it does mean that we would be able to operate in an environment, should there be any additional shutdowns.

Bill Chappell — SunTrust Robinson Humphrey — Analyst

Okay, really helpful. Thanks a lot. Good luck going forward.

McCord Christensen — Chief Executive Officer and Chairman of the Board

Thanks Jon.

Operator

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

McCord Christensen — Chief Executive Officer and Chairman of the Board

Again, I’d like to first thank all of our people here at PetIQ and our retail partners for all the work that was done during the quarter to become a stronger company coming out of the quarter and all the work that was done for us to be able to ship and produce the record results in a very tough work environment with our people. So thank you to all of them. I want to thank all the shareholders that have been with us and continue to support us and thank all the analysts that were with us today for the great questions and the time we’re able to spend with you. PetIQ is becoming a stronger company through COVID. We are ready to come back to work and be in a place where we won’t have to close.

We will get our stores all back up in and running, being able to provide such a valuable service that as more pet parents are more cost-conscious than ever before in this pandemic. We will be a place where they can find the best cost for their services and their products in the country. And that’s going to resonate and continue to build. And we’re confident that the company will continue to grow and produce the kind of results you’ve seen us produce for many quarters. So thank you again for your time, and we look forward to reporting again in a few weeks as we get through the Q3 and the rest of the year. Thanks, everybody.

Operator

[Operator Closing Remarks]

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