petq_Current_Folio_10Q

Table of Contents 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑Q

 

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March  31, 2019

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to              

Commission File Number: 001-38163

 

 

PetIQ,  Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

35‑2554312

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

923 S. Bridgeway Pl.

83616

Eagle, Idaho

(Zip Code)

(Address of principal executive offices)

 

208‑939‑8900

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes   ☒    No   ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes   ☒    No   ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.

Large accelerated filer ☐

Accelerated filer ☒

 

 

Non-accelerated filer ☐   

Smaller reporting company☐

 

 

Emerging growth company  ☒

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act). ☐ Yes    No

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of Each Class

Trading Symbol

Name of Each Exchange on Which Registered

Class A Common Stock, $0.001 par value

PETQ

The Nasdaq Global Select Market

 

As of May 8, 2019, we had 22,361,504 shares of Class A common stock and 5,840,196 shares of Class B common stock outstanding.

 

 

 


 

Table of Contents 

PetIQ, Inc.

 

Table of Contents

 

 

 

 

 

 

 

 

    

 

    

Page

 

 

 

 

 

Part I. 

 

Financial Information

 

3

 

 

 

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements (Unaudited)

 

 

 

 

 

PetIQ, Inc. Condensed Consolidated Balance Sheets 

 

3

 

 

 

PetIQ, Inc. Condensed Consolidated Statements of Income (Loss)

 

4

 

 

 

PetIQ, Inc. Condensed Consolidated Statements of Comprehensive Income (Loss)

 

5

 

 

 

PetIQ, Inc. Condensed Consolidated Statements of Cash Flows

 

6

 

 

 

PetIQ, Inc. Condensed Consolidated Statements of Equity

 

8

 

 

 

PetIQ, Inc. Notes to Condensed Consolidated Financial Statements

 

9

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

29

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

35

 

 

Item 4.

Controls and Procedures

 

36

 

 

Item 5

Other information

 

37

 

 

 

 

 

Part II. 

 

Other Information

 

 

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

37

 

 

Item 1A.

Risk Factors

 

37

 

 

Item 6.

Exhibits

 

39

 

 

 

 

 

Signatures 

 

40

 

 

 

 

2


 

Table of Contents 

PetIQ, Inc.

Condensed Consolidated Balance Sheets

(Unaudited, $’s in 000’s except for share and per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

    

March 31, 2019

    

December 31, 2018

    

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

54,367

 

$

66,360

 

Accounts receivable, net

 

 

65,466

 

 

45,007

 

Inventories

 

 

112,539

 

 

92,142

 

Other current assets

 

 

4,313

 

 

4,212

 

Total current assets

 

 

236,685

 

 

207,721

 

Property, plant and equipment, net

 

 

26,811

 

 

27,335

 

Operating lease right of use assets

 

 

9,860

 

 

 —

 

Deferred tax assets

 

 

46,585

 

 

43,946

 

Other non-current assets

 

 

2,667

 

 

2,857

 

Intangible assets, net

 

 

87,366

 

 

88,546

 

Goodwill

 

 

125,279

 

 

125,029

 

Total assets

 

$

535,253

 

$

495,434

 

Liabilities and equity

 

 

  

 

 

  

 

Current liabilities

 

 

  

 

 

  

 

Accounts payable

 

$

71,023

 

$

54,768

 

Accrued wages payable

 

 

4,158

 

 

5,295

 

Accrued interest payable

 

 

607

 

 

728

 

Other accrued expenses

 

 

919

 

 

1,154

 

Current portion of operating leases

 

 

2,862

 

 

 —

 

Current portion of long-term debt and finance leases

 

 

2,446

 

 

2,251

 

Total current liabilities

 

 

82,015

 

 

64,196

 

Operating leases, less current installments

 

 

7,170

 

 

 —

 

Long-term debt

 

 

115,274

 

 

107,418

 

Finance leases, less current installments

 

 

1,944

 

 

2,319

 

Other non-current liabilities

 

 

268

 

 

524

 

Total non-current liabilities

 

 

124,656

 

 

110,261

 

Commitments and contingencies

 

 

  

 

 

  

 

Equity

 

 

  

 

 

  

 

Additional paid-in capital

 

 

271,916

 

 

262,219

 

Class A common stock, par value $0.001 per share, 125,000,000 shares authorized, 22,156,706 and 21,619,875 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively

 

 

22

 

 

22

 

Class B common stock, par value $0.001 per share, 100,000,000  shares authorized,  6,027,847 and 6,546,791 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively

 

 

 6

 

 

 7

 

Accumulated deficit

 

 

(2,839)

 

 

(4,450)

 

Accumulated other comprehensive loss

 

 

(941)

 

 

(1,316)

 

Total stockholders' equity

 

 

268,164

 

 

256,481

 

Non-controlling interest

 

 

60,418

 

 

64,496

 

Total equity

 

 

328,582

 

 

320,977

 

Total liabilities and equity

 

$

535,253

 

$

495,434

 

 

 

See accompanying notes to the condensed consolidated financial statements

3


 

Table of Contents 

PetIQ, Inc.

Condensed Consolidated Statements of Income (loss)

(Unaudited, $’s in 000’s except for share and per share amounts)

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

    

March 31, 2019

    

March 31, 2018

    

 

 

 

 

 

 

 

 

Product sales

 

$

126,084

 

$

97,851

 

Services revenue

 

 

22,352

 

 

17,215

 

Total net sales

 

 

148,436

 

 

115,066

 

Cost of products sold

 

 

108,064

 

 

84,586

 

Cost of services

 

 

15,642

 

 

14,597

 

Total cost of sales

 

 

123,706

 

 

99,183

 

Gross profit

 

 

24,730

 

 

15,883

 

Operating expenses

 

 

 

 

 

  

 

General and administrative expenses

 

 

20,538

 

 

18,968

 

Contingent note revaluations (gain) loss

 

 

(680)

 

 

141

 

Operating income (loss)

 

 

4,872

 

 

(3,226)

 

Interest expense, net

 

 

(1,937)

 

 

(1,765)

 

Foreign currency loss, net

 

 

(122)

 

 

(78)

 

  Other income, net

 

 

13

 

 

45

 

Total other expense, net

 

 

(2,046)

 

 

(1,798)

 

Pretax net income (loss)

 

 

2,826

 

 

(5,024)

 

Income tax (expense) benefit

 

 

(500)

 

 

1,067

 

Net income (loss)

 

 

2,326

 

 

(3,957)

 

Net income (loss) attributable to non-controlling interest

 

 

715

 

 

(1,929)

 

Net income (loss) attributable to PetIQ, Inc.

 

$

1,611

 

$

(2,028)

 

Net income (loss) per share attributable to PetIQ, Inc. Class A common stock

 

 

 

 

 

 

 

-Basic

 

$

0.07

 

 

(0.14)

 

-Diluted

 

$

0.07

 

 

(0.14)

 

Weighted Average shares of Class A common stock outstanding

 

 

 

 

 

 

 

-Basic

 

 

21,800,033

 

 

14,574,883

 

-Diluted

 

 

21,977,898

 

 

14,574,883

 

 

 

See accompanying notes to the condensed consolidated financial statements

 

 

4


 

Table of Contents 

PetIQ, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited, $’s in 000’s)

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

March 31, 2019

    

March 31, 2018

Net income (loss)

 

$

2,326

 

$

(3,957)

Foreign currency translation adjustment

 

 

539

 

 

436

Comprehensive income (loss)

 

 

2,865

 

 

(3,521)

Comprehensive income attributable to non-controlling interest

 

 

848

 

 

(1,767)

Comprehensive income (loss) attributable to PetIQ

 

$

2,017

 

$

(1,754)

 

 

See accompanying notes to the condensed consolidated financial statements

 

 

5


 

Table of Contents 

PetIQ, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited, $’s in 000’s)

 

 

 

 

 

 

 

 

    

For the Three Months Ended March 31, 

 

 

2019

 

2018

Cash flows from operating activities

 

 

 

 

 

 

Net income (loss)

 

$

2,326

 

$

(3,957)

Adjustments to reconcile net income (loss) to net cash used in operating activities

 

 

  

 

 

  

Depreciation and amortization of intangible assets and loan fees

 

 

3,091

 

 

2,522

Foreign exchange (gain) loss on liabilities

 

 

 —

 

 

53

(Gain) Loss on disposition of property, plant, and equipment

 

 

(34)

 

 

(20)

Stock based compensation expense

 

 

1,544

 

 

698

Deferred tax adjustment

 

 

500

 

 

(1,067)

Contingent note revaluations

 

 

(680)

 

 

141

Other non-cash activity

 

 

17

 

 

(334)

Changes in assets and liabilities

 

 

 

 

 

 

Accounts receivable

 

 

(20,444)

 

 

(28,997)

Inventories

 

 

(20,366)

 

 

(27,238)

Prepaid expenses and other assets

 

 

21

 

 

16

Accounts payable

 

 

17,335

 

 

22,508

Accrued wages payable

 

 

(1,150)

 

 

(482)

Other accrued expenses

 

 

(359)

 

 

(2,274)

Net cash used in operating activities

 

 

(18,199)

 

 

(38,431)

Cash flows from investing activities

 

 

  

 

 

  

Proceeds from disposition of property, plant, and equipment

 

 

47

 

 

57

Purchase of property, plant, and equipment

 

 

(897)

 

 

(2,224)

Business acquisitions (net of cash acquired)

 

 

 —

 

 

(91,986)

Net cash used in investing activities

 

 

(850)

 

 

(94,153)

Cash flows from financing activities

 

 

  

 

 

  

Proceeds from issuance of long-term debt

 

 

134,134

 

 

162,278

Principal payments on long-term debt

 

 

(125,717)

 

 

(59,533)

Tax Distributions to LLC Owners

 

 

(1,378)

 

 

(540)

Principal payments on finance lease obligations

 

 

(371)

 

 

(242)

Payment of deferred financing fees and debt discount

 

 

(50)

 

 

(2,613)

Exercise of options to purchase common stock

 

 

315

 

 

 —

Net cash provided by financing activities

 

 

6,933

 

 

99,350

Net change in cash and cash equivalents

 

 

(12,116)

 

 

(33,234)

Effect of exchange rate changes on cash and cash equivalents

 

 

123

 

 

52

Cash and cash equivalents, beginning of period

 

 

66,360

 

 

37,896

Cash and cash equivalents, end of period

 

$

54,367

 

$

4,714

 

 

 

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements

6


 

Table of Contents 

PetIQ, Inc.

Condensed Consolidated Statements of Cash Flows, Continued

(Unaudited, $’s in 000’s)

 

 

 

 

 

 

 

 

 

For the Three Months Ended March 31, 

Supplemental cash flow information

 

2019

 

2018

Interest paid

 

$

2,146

 

$

831

Property, plant, and equipment acquired through accounts payable

 

 

(51)

 

 

(511)

Finance lease additions

 

 

210

 

 

34

Net change of deferred tax asset from step-up in basis

 

 

3,138

 

 

8,981

Income taxes paid

 

 

176

 

 

46

Accrued tax distribution

 

 

257

 

 

434

Non cash consideration - Contingent notes

 

 

 —

 

 

6,900

Non cash consideration - Guarantee note

 

 

 —

 

 

10,000

Non cash consideration - Issuance of Class B common stock and LLC Interests

 

 

 —

 

 

90,031

 

 

 

 

 

 

7


 

Table of Contents

PetIQ, Inc.

Condensed Consolidated Statements of Equity

(Unaudited, $’s in 000’s)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

Accumulated

 

Comprehensive

 

 

 

 

 

 

 

 

 

Paid-in

 

Non-controlling

 

Total

 

Deficit

 

Loss

 

Class A Common

 

Class B Common

 

Capital

 

Interest

 

Equity

 

 

 

 

 

Shares

 

Dollars

 

Shares

 

Dollars

 

 

 

 

 

 

Balance - January 1, 2019

$

(4,450)

 

$

(1,316)

 

 

21,619,875

 

$

22

 

 

6,546,791

 

$

 7

 

$

262,219

 

$

64,496

 

$

320,977

Exchange of LLC Interests held by  LLC Owners

 

 —

 

 

(31)

 

 

518,944

 

 

 1

 

 

(518,944)

 

 

(1)

 

 

5,049

 

 

(5,018)

 

 

 —

Net increase in deferred tax asset from LLC Interest transactions

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

3,138

 

 

 —

 

 

3,138

Accrued tax distributions

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(257)

 

 

(257)

Other comprehensive loss

 

 —

 

 

406

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

133

 

 

539

Stock based compensation expense

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

1,195

 

 

349

 

 

1,544

Exercise of Options to purchase Common Stock

 

 —

 

 

 —

 

 

16,553

 

 

 0

 

 

 —

 

 

 —

 

 

315

 

 

 —

 

 

315

Issuance of stock for vesting of RSU's

 

 —

 

 

 —

 

 

1,334

 

 

 0

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 0

Net Income

 

1,611

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

715

 

 

2,326

Balance - March 31, 2019

$

(2,839)

 

$

(941)

 

 

22,156,706

 

$

22

 

 

6,027,847

 

$

 6

 

$

271,916

 

$

60,418

 

$

328,582

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Accumulated

 

Comprehensive

 

 

 

 

 

 

 

 

 

Paid-in

 

Non-controlling

 

Total

 

 

Deficit

 

Loss

 

Class A Common

 

Class B Common

 

Capital

 

Interest

 

Equity

 

 

 

 

 

 

Shares

 

Dollars

 

Shares

 

Dollars

 

 

 

 

 

 

Balance - January 1, 2018

$

(3,493)

 

 

$

(687)

 

 

13,222,583

 

$

13

 

 

8,268,188

 

$

 8

 

$

70,873

 

$

38,130

 

$

104,844

ASC 606 adoption, net of tax

 

(175)

 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(110)

 

 

(285)

Issuance of equity for business combination

 

 —

 

 

 

112

 

 

 —

 

 

 —

 

 

3,042,794

 

 

 3

 

 

36,281

 

 

53,635

 

 

90,031

Exchange of LLC Interests held by  LLC Owners

 

 —

 

 

 

(126)

 

 

2,909,460

 

 

 3

 

 

(2,909,460)

 

 

(3)

 

 

21,385

 

 

(21,259)

 

 

 —

Net increase in deferred tax asset from LLC Interest transactions

 

 —

 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

8,981

 

 

 —

 

 

8,981

Accrued tax distributions

 

 —

 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(434)

 

 

(434)

Other comprehensive loss

 

 —

 

 

 

274

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

162

 

 

436

Stock based compensation expense

 

 —

 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

396

 

 

302

 

 

698

Net loss

 

(2,028)

 

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(1,929)

 

 

(3,957)

Balance - March 31, 2018

$

(5,696)

 

 

$

(427)

 

 

16,132,043

 

$

16

 

 

8,401,522

 

$

 8

 

$

137,916

 

$

68,497

 

$

200,314

 

 

See accompanying notes to the condensed consolidated financial statements

 

 

8


 

Table of Contents

PetIQ Inc.

Notes to the Condensed Consolidated Financial Statements (unaudited)

 

Note 1 – Principal Business Activity and Significant Accounting Policies

Principal Business Activity and Principles of Consolidation

PetIQ is a leading, rapidly growing pet health and wellness company. Through over 60,000 points of distribution across retail and e-commerce channels, PetIQ and VIP Petcare, a wholly-owned subsidiary, have a mission to make pet lives better by educating pet parents on the importance of offering regular, convenient access and affordable choices for pet preventative and wellness veterinary products and services. PetIQ believes that pets are an important part of the family and deserve the best products and care we can give them.

 

We are the managing member of PetIQ Holdings, LLC (“Holdco”), a Delaware limited liability company, which is the sole member of PetIQ, LLC (“Opco”) and, through Holdco, operate and control all the business and affairs of Opco.

 

The condensed consolidated financial statements as of March 31, 2019 and December 31, 2018 and for the three months ended March 31, 2019 and 2018 are unaudited. The condensed consolidated balance sheet as of December 31, 2018 has been derived from the audited financial statements at that date but does not include all of the disclosures required by U.S. GAAP. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements as of and for the year ended December 31, 2018 and related notes thereto included in most recent annual report and filed with the Securities and Exchange Commission (“SEC”) on Form 10-K on March 12, 2019. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of property, plant, and equipment and intangible assets; the valuation of property, plant, and equipment, intangible assets and goodwill, the valuation of assets and liabilities in connection with acquisitions, the valuation of deferred tax assets and liabilities, the valuation of inventories, and reserves for legal contingencies.

Foreign Currencies

The Company operates subsidiaries in foreign countries who use the local currency as the functional currency.  The Company translates its foreign subsidiaries’ assets and liabilities denominated in foreign currencies into U.S. dollars at current rates of exchange as of the balance sheet date and income and expense items at the average exchange rate for the reporting period. Translation adjustments resulting from exchange rate fluctuations are recorded in the cumulative translation account, a component of accumulated other comprehensive income. The Company records gains and losses from changes in exchange rates on transactions denominated in currencies other than each reporting location's functional currency in net income for each period.

Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level 1—Quoted prices in active markets for identical assets or liabilities.

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Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The categorization of a financial instrument within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The carrying amounts of the Company’s financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities, are at cost, which approximates fair value due to their relatively short maturities. The guarantee notes are carried at cost, which approximates fair value as the stated interest rate is consistent with current market rates. Our term loan and revolving credit facility bear interest at a variable interest rate plus an applicable margin and, therefore, carrying amounts approximate fair value.

The following table presents liabilities measured at fair value on a recurring basis:

 

 

 

 

 

 

 

$'s in 000's

 

 

March 31, 2019

 

December 31, 2018

Liabilities:

 

 

 

 

 

 

2019 Contingent note

 

$

2,000

 

$

2,680

 

In connection with the acquisition of Community Veterinary Clinics, LLC d/b/a VIP Petcare (“VIP” and such acquisition, the “VIP Acquisition”) a portion of the purchase price was structured in the form of Contingent Notes (the “Contingent Notes”) that vest based on the combined Company EBITDA targets for the years ending December 31, 2018 and 2019 (“Measurement Dates”).  See Note 2 – “Business Combinations” for more information regarding the VIP Acquisition.  The Company is required to reassess the fair value of the Contingent Notes at each reporting period. As of December 31, 2018, $7.5 million was payable pursuant to the 2018 Contingent Note, subject to the same payment terms described below.  As such, the portion of the liability as it relates to the 2018 Contingent Note became fixed as of December 31, 2018.

For the 2019 Contingent Note, a Monte Carlo simulation method was utilized in estimating the fair value (Level 3) of the Contingent Notes. The simulation model is a numerical algorithm that generates thousands of scenarios for the future EBITDA in order to assess the probability of achieving the EBITDA hurdles. The valuation model simulates the last twelve months EBITDA from the Valuation Date to the end of each Measurement Date in one 'jump'. The Contingent Notes were valued within a risk-neutral option pricing framework with the real growth rate adjusted for the market price of EBITDA risk. The Company used the WACC less risk-free rate as a proxy for the EBITDA risk premium. 

Although the Company believes its estimates and assumptions are reasonable, different assumptions, including those regarding the operating results of the Company, or changes in the future may result in different estimated amounts.

The contingent consideration is included in long-term debt in the accompanying condensed consolidated balance sheets. The Company will satisfy this obligation with a cash payment to the sellers due in July 2023 upon the achievement of the respective milestones discussed above.  The Contingent Notes will bear interest at a fixed rate of 6.75%, beginning upon the achievement of the respective milestones discussed above.

 

 

 

 

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The following table summarizes the Level 3 activity related to the Contingent Notes:

 

 

 

 

 

 

 

Three months ended

$'s in 000's

March 31, 2019

 

March 31, 2018

Balance at beginning of the period

$

2,680

 

$

 —

Fair value of contingent consideration at VIP Acquisition date

 

 —

 

 

6,900

Change in fair value of contingent consideration

 

(680)

 

 

141

Transfer out of level 3

 

 —

 

 

 —

Balance at the end of the period

$

2,000

 

$

7,041

 

Cash and Cash Equivalents

Cash equivalents consist of highly liquid investments with an original maturity of three months or less at the date of acquisition. All credit card, debit card and electronic transfer transactions that process in less than seven days are classified as cash and cash equivalents.  The Company maintains its cash accounts in various deposit accounts, the balances of which at times exceeded federal deposit insurance limits during the periods presented.

Receivables and Credit Policy

Trade receivables due from customers are uncollateralized customer obligations due under normal trade terms generally requiring payment within 45 days from the invoice date. Accounts receivable are stated at the amount billed to the customer, net of discounts and estimated deductions. The Company does not have a policy for charging interest on overdue customer account balances. The Company provides an allowance for doubtful accounts equal to estimated uncollectible amounts. The Company’s estimate is based on historical collection experience and a review of the current status of trade accounts receivable.  Payments of trade receivables are allocated to the specific invoices identified on the customer's remittance advice.

Other receivables consists of various receivables due from vendors, banking partners, and notes receivable from suppliers.  Non-current portions of these other receivables are included in other non-current assets on the consolidated balance sheets.

Accounts receivable consists of the following as of:

 

 

 

 

 

 

 

$'s in 000's

    

March 31, 2019

    

December 31, 2018

Trade receivables

 

$

61,618

 

$

43,531

Other receivables

 

 

4,164

 

 

1,764

 

 

 

65,782

 

 

45,295

Less: Allowance for doubtful accounts

 

 

(243)

 

 

(216)

Non-current portion of receivables

 

 

(73)

 

 

(72)

Total accounts receivable, net

 

$

65,466

 

$

45,007

 

Inventories

Inventories are stated at the lower of cost or net realizable value, which approximate the first-in first-out (“FIFO”) method and includes earned rebate amounts.  The Company maintains reserves for estimated obsolete or unmarketable inventory based on the difference between the cost of inventory and its estimated net realizable value.  In estimating the reserves, management considers factors such as excess or slow-moving inventories, product expiration dating, and

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market conditions.  Changes in these conditions may result in additional reserves.  Major components of inventories consist of the following as of:

 

 

 

 

 

 

 

$'s in 000's

    

March 31, 2019

    

December 31, 2018

Raw materials

 

$

6,445

 

$

6,106

Work in progress

 

 

54

 

 

94

Finished goods

 

 

106,040

 

 

85,942

Total inventories

 

$

112,539

 

$

92,142

 

Property, Plant, and Equipment

Property, plant, and equipment are recorded at cost. Expenditures for improvements that significantly add to the productive capacity or extend the useful life of an asset are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred.

Depreciation and amortization is provided using the straight-line method, based on useful lives of the assets, except for leasehold improvements and capital leased assets which are depreciated over the shorter of the expected useful life or the lease term. Depreciation and amortization expense is recorded in cost of sales and general and administrative expenses in the condensed consolidated statements of operations, depending on the use of the asset.  The estimated useful lives of property, plant, and equipment are as follows:

 

 

 

 

Computer equipment and software

    

 

3 years

Vehicle and vehicle accessories

 

 

3-5 years

Buildings

 

 

33 years

Equipment

 

 

2-15 years

Leasehold improvements

 

 

3-15 years

Furniture and fixtures

 

 

5-10 years

 

Revenue Recognition

When Performance Obligations Are Satisfied

 

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account for revenue recognition.  A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied.  The Company’s performance obligations are product sales and the delivery of veterinary services. 

 

Revenue is generally recognized for product sales on a point in time basis when product control is transferred to the customer.  In general, control transfers to the customer when the product is shipped or delivered to the customer based upon applicable shipping terms, as the customer can direct the use and obtain substantially all of the remaining benefits from the asset at this point in time.  

 

The Company determined that certain products manufactured to a customers specifications do not have an alternative future use at a reasonable profit margin due to costs associated with reworking, transporting and repackaging these products.  These products are produced subject to purchase orders that include an enforceable right to payment.  Therefore the Company determined that revenue on these products would be recognized over time, as the products are produced.  This represents a minor subset of the products the Company manufactures.

 

Revenue is recognized for services over time when the service is delivered. 

 

Customer contracts generally do not include more than one performance obligation.  When a contract does contain more than one performance obligation, we allocate the contract’s transaction price to each performance obligation based on its relative standalone selling price.  The standalone selling price for each distinct good is generally determined by directly observable data.   

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The performance obligations in our contracts are satisfied within one year. As such, we have not disclosed the transaction price allocated to remaining performance obligations as of March 31, 2019.

 

Significant Payment Terms

 

Our customer contracts identify the product, quantity, price, payment and final delivery terms.  Payment terms usually include early pay discounts.  We grant payment terms consistent with industry standards. Although some payment terms may be more extended, no terms beyond one year are granted at contract inception.  As a result, we do not adjust the promised amount of consideration for the effects of a significant financing component because the period between our transfer of a promised good or service to a customer and the customer’s payment for that good or service will be one year or less.

 

Shipping

 

All shipping and handling costs associated with outbound freight are accounted for as fulfillment costs and are included in the cost of sales.  This includes shipping and handling costs after control over a product has transferred to a customer. 

 

Variable Consideration

 

In addition to fixed contract consideration, most contracts include some form of variable consideration.  The most common forms of variable consideration include discounts, rebates, and sales returns and allowances.  Variable consideration is treated as a reduction in revenue when product revenue is recognized.  Depending on the specific type of variable consideration, we use either the expected value or most likely amount method to determine the variable consideration.  We believe there will not be significant changes to our estimates of variable consideration when any related uncertainties are resolved with our customers.  The Company reviews and updates its estimates and related accruals of variable consideration each period based on the terms of the agreements, historical experience, and any recent changes in the market.  Any uncertainties in the ultimate resolution of variable consideration due to factors outside of the Company’s influence are typically resolved within a short timeframe therefore not requiring any additional constraint on the variable consideration.   

 

Trade marketing expense, consisting primarily of customer pricing allowances and merchandising funds are offered through various programs to customers and are designed to promote our products. They include the cost of in-store product displays, feature pricing in retailers' advertisements and other temporary price reductions. These programs are offered to our customers both in fixed and variable (rate per case) amounts. The ultimate cost of these programs depends on retailer performance and is subject to management estimates.

 

Certain retailers require the payment of product introductory fees in order to obtain space for the Company's products on the retailer's store shelves. This cost is typically a lump sum and is determined using the expected value based on the contract between the two parties.

 

Both trade marketing expense and product introductory fees are recognized as reductions of revenue at the time the transfer of control of the associated products occurs. Accruals for expected payouts, or amounts paid in advance, under these programs are included as other current assets or accounts payable in the Condensed Consolidated Balance Sheet.

 

Warranties & Returns

 

PetIQ provides all customers with a standard or assurance type warranty.  Either stated or implied, the Company provides assurance the related products will comply with all agreed-upon specifications and other warranties provided under the law.   No significant services beyond an assurance warranty are provided to customers. 

 

The Company does not grant a general right of return.  However, customers may return defective or non-conforming products.  Customer remedies may include either a cash refund or an exchange of the product.  As a result, the right of

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return and related refund liability is estimated and recorded as a reduction in revenue.  This return estimate is reviewed and updated each period and is based on historical sales and return experience. 

 

Contract balances

 

Contract asset and liability balances as of March 31, 2019 and December 31, 2018 are immaterial.  The Company does not have significant deferred revenue or unbilled receivable balances because of transactions with customers.

 

Cost of Services

Cost of Services are comprised of all service and product costs related to the delivery of veterinary services, including but not limited to, salaries of veterinarians, technicians and other clinic based personnel, transportation and delivery costs, rent, occupancy costs, supply costs, depreciation and amortization of clinic assets, certain marketing and promotional expenses and costs of goods sold.

Research and Development and Advertising Costs

Research and development and advertising costs are expensed as incurred and are included in general and administrative expenses. Research and development costs amounted to $97 thousand and $49 thousand for the three months ended March 31, 2019 and 2018, respectively.  Advertising costs were $655 thousand and $594 thousand for the three months ended March 31, 2019 and 2018, respectively.  Advertising costs do not include trade marketing programs which are part of net sales.

 

Income taxes

The Company records a tax provision for the anticipated tax consequences of the reported results of operations. The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company may record a valuation allowance, if conditions are applicable, to reduce deferred tax assets to the amount that is believed more likely than not to be realized.

 

Non-controlling interest

The non-controlling interests on the condensed consolidated statements of income represents the portion of earnings or loss attributable to the economic interest in the Company’s subsidiary, Holdco, held by the non-controlling holders of Class B common stock and limited liability company interests in Holdco. Non-controlling interests on the condensed consolidated balance sheet represents the portion of net assets of the Company attributable to the non-controlling holders of Class B common stock and limited liability company interests in Holdco, based on the portion of the LLC Interests owned by holders of Class B common stock and limited liability company interests in Holdco. As of March 31, 2019 and December 31, 2018 the non-controlling interest was approximately 21.4% and 23.2%, respectively.

Litigation

The Company is subject to various legal proceedings, claims, litigation, investigations and contingencies arising out of the ordinary course of business. If the likelihood of an adverse legal outcome is determined to be probable and the amount of loss is estimable, then a liability is accrued in accordance with accounting guidance for Contingencies. If the assessment indicates a potentially material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, is disclosed.  The Company consults with both internal and external legal counsel related to litigation.

 

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Adopted Accounting Standard Updates

 

In February 2016, the FASB issued ASU 2016-02, Leases.  The Company adopted the provisions of this guidance effective January 1, 2019, using the modified retrospective optional transition method. Therefore, the standard was applied beginning January 1, 2019 and prior periods were not restated. The adoption of the standard did not result in a cumulative-effect adjustment to the opening balance of Retained earnings. The Company elected the package of practical expedients and implemented internal controls and system functionality to enable the preparation of financial information upon adoption.  In addition, the Company has elected to apply the practical expedient to not separate the lease and non-lease components for all of the Company's leases.

 

The adoption of the new standard resulted in the recognition of a right of use asset and short-term and long-term liabilities recorded on the Company's consolidated balance sheet related to operating leases. Accounting for finance leases remained substantially unchanged. In addition, the adoption of the standard did not have a material impact on the Company's results of operations or cash flows.

 

 

 

Note 2 – Business Combination

 

VIP Acquisition

On January 17, 2018 PetIQ, Inc. completed the acquisition of VIP from VIP Holdings, LLC (“VIPH” or the “Sellers”).

 

The fair value of the consideration is summarized as follows:

 

 

 

 

$'s in 000's

 

Fair value

Current assets

$

15,617

Property, plant, and equipment

 

8,885

Other assets, net

 

295

Intangible assets - Customer relationships (20 year useful life)

 

77,200

Intangible assets - Brand names (10 year useful life)

 

9,600

Goodwill

 

112,643

Total assets

 

224,240

 

 

 

Current liabilities

 

22,908

Capital lease obligations

 

3,032

Total liabilities

 

25,940

 

 

 

Estimated purchase price

$

198,300

 

 

 

Cash paid, net of cash acquired

$

92,082

LLC Interests and shares of Class B common stock

 

90,031

Guarantee note

 

10,000

Contingent notes

 

6,900

Post-closing working capital adjustment

 

(713)

 

 

 

Estimated fair value of total consideration transferred

$

198,300

 

The definite-lived intangibles primarily relate to customer relationships and brand names. The $86.8 million represents the fair value and will be amortized over the estimated useful lives of the assets through January 2038. Amortization expense for these definite-lived intangible assets for the three ended March 31, 2019 and 2018 was $1.3 million and $1.0 million, respectively. 

 

Goodwill represents the future economic benefits that do not qualify for separate recognition and primarily includes the assembled workforce and other non-contractual relationships, as well as expected future synergies. Approximately $49.8 million of the $112.6 million of goodwill will not be tax deductible, and the remaining balance is expected to be deductible for tax purposes.  Goodwill was allocated to the Products and Services segments.

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HBH Enterprises

On October 17, 2018, the Company completed the acquisition of HBH Enterprises, LLC (“HBH”) (the “HBH Acquisition”).  Total consideration, net of cash acquired, was approximately $14.7 million consisting of cash of $1.7 million and equity consideration of approximately $13.0 million.  The equity consideration consisted 400,000 LLC interests of Holdco and 400,000 shares of Class B common stock, $0.001 par value per share, of the Company.  

 

The estimate of fair value and purchase price allocation were based on information available at the time of closing the HBH Acquisition and the Company continues to evaluate the underlying inputs and assumptions. The Company is in process of finalizing valuation studies.  Accordingly, these preliminary estimates are subject to adjustments during the measurement period, not to exceed one year, based upon new information obtained about facts and circumstances that existed as of the date of closing the HBH Acquisition.The purchase price allocation has been preliminarily allocated as follows: 

 

 

 

 

 

 

 

 

 

$'s in 000's

 

Preliminary Estimated Fair Value

 

Working Capital, net

$

1,676

 

Property, plant, and equipment

 

2,686

 

Intangible assets - Customer relationships

 

3,800

 

Goodwill

 

7,607

 

Total assets

 

15,769

 

 

 

 

 

Capital lease obligations

 

1,114

 

Total liabilities

 

1,114

 

 

 

 

 

Estimated purchase price

$

14,655

 

 

 

 

 

Cash paid, net of cash acquired

$

1,683

 

LLC Interests and shares of Class B common stock

 

12,972

 

 

 

 

 

Estimated fair value of total consideration transferred

$

14,655

 

 

Goodwill represents the future economic benefits that do not qualify for separate recognition and primarily includes the assembled workforce and other non-contractual relationships, as well as expected future synergies. Approximately $5.0 million of the $7.6 million of goodwill will not be tax deductible, and the remaining balance is expected to be deductible for tax purposes.  Goodwill was allocated to the Products segment.

 

 

 

Note 3 – Property, Plant, and Equipment

Property, plant, and equipment consists of the following at:

 

 

 

 

 

 

 

$'s in 000's

 

 

March 31, 2019

 

 

December 31, 2018

Leasehold improvements

 

$

10,906

 

$

10,776

Equipment

 

 

14,782

 

 

14,477

Vehicles and accessories

 

 

4,004

 

 

3,989

Computer equipment and software

 

 

6,131

 

 

5,839

Buildings