Covetrus Inc (CVET) 2021 Q4 法說會逐字稿

Good day, and thank you for standing by. At this time, I would now like to welcome everyone to Covetrus Fourth Quarter and Full Year 2021 Earnings Conference Call. (Operator Instructions) I would now like to turn the call over to your speaker today, Mr. Nicholas Jansen, Vice President of Investor Relations. Please go ahead.

Thank you, Anne, and good afternoon. Thank you for joining us for Covetrus' Q4 and Full Year 2021 Earnings Conference Call. Joining me on this afternoon's call are Ben Wolin, our President and Chief Executive Officer; and Matthew Foulston, our Executive Vice President and Chief Financial Officer. Ben and Matthew will begin with prepared remarks, and then we will be happy to take your questions.

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

Forward-looking statements may be identified with words such as will, expect, believe, should or similar terminology and the negative of these terms. Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those contemplated in these forward-looking statements.

These risks and uncertainties include those under the heading Risk Factors in our most recent annual report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission, which are available on the Investors section of our website at ir.covetrus.com or on the SEC's website, www.sec.gov. Forward-looking statements speak only as of the date hereof, and except as required by law, we undertake no obligation to update or revise these forward-looking statements.

You can find this afternoon's release announcing our fourth quarter 2021 and full year 2021 results and the accompanying slide deck for this call on ir.covetrus.com. The release and presentation also contain further information about the non-GAAP financial measures that we will discuss today. Please refer to those documents for a reconciliation of non-GAAP measures to our GAAP financial results.

With that, I will now turn it over to Ben to provide the highlights beginning on Slide 3.

Thanks, Nick. Good afternoon, everyone, and thank you for joining us. I hope everyone is safe, given the turbulent times that we live in. We have a lot of ground to cover, so I'll dive right into my prepared remarks starting on Slide 3.

Next week marks my second anniversary as the company's permanent CEO. And while there is still much to be done to deliver Covetrus' full potential within the attractive and growing animal health market, I am proud of all the progress the team has made over the last 2 years.

In 2021, we accelerated our pace of innovation. We strengthened our value proposition to our veterinary practice customers, pet owners and manufacturer partners. We continue to steadily push forward towards our end goal of becoming the leading global, technology-enabled veterinary health care solutions company.

Financially, 2021 was also a successful year where we delivered 5% year-over-year non-GAAP organic net sales growth. We increased non-GAAP adjusted EBITDA by 8% year-over-year, which was faster than net sales growth. And we continued to scale our technology solutions and proprietary brands.

On the latter front, I would highlight another year of success in our North American prescription management business where we grew net sales 24% year-over-year or 28% when normalized for an accounting change. And we increased non-GAAP adjusted EBITDA by more than 90% year-over-year to $44 million, a rather impressive outcome on top of what was a phenomenal 2020 for the business during the peak of the pandemic.

The financial success came despite some unanticipated headwinds in our U.K. and German markets and higher-than-planned corporate costs during the year, including the negative impact from FX on our intercompany loans and elevated costs tied to certain legal developments.

Importantly, with many of these challenges now in the rearview mirror, we are in a healthy position to accelerate net sales and non-GAAP adjusted EBITDA growth in 2022 as we build upon our underlying financial momentum and monetize our innovation coming to market.

Turning to Slide 4. As many of you have heard me say in the past, at Covetrus, everything we do is centered on helping veterinarians drive better health and business outcomes. We exist to help our customers thrive. As we have emphasized on these calls, we have the tools needed for a veterinarian to address their primary day-to-day challenges, improve their practice workflow and continue to grow their business.

And our platform only got stronger in 2021. We invested significantly in our practice management solutions. We acquired new capabilities to further strengthen the vet-2-pet relationship. We've built and opened 2 new pharmacies and invested in consumer marketing to better position the veterinarians for success amidst the increased competition from online retailers.

We also launched new proprietary products to support better clinical care and enhance our operational infrastructure to reduce our cost to serve while delivering added value to our veterinary practice customers. Lastly, we transformed our commercial sales model to make it easier for our customers to partner with Covetrus.

Turning to Slide 5 now. Our enhanced value proposition in North America, where our platform is the most advanced, is clearly resonating in the market. North America net sales reached $2.7 billion in 2021 and have grown at a compound annual growth rate of 14% over the last 2 years, which is faster than the overall market growth during this corresponding time frame.

And while the sales growth has been broad based, we have delivered strong growth in the higher-margin parts of the business, including prescription management and proprietary brands, which has led to a 21% CAGR in North America segment adjusted EBITDA. In fact, prescription management non-GAAP adjusted EBITDA has gone from a roughly breakeven business 2 years ago to $44 million in 2021, accounting for almost 60% of the growth of North America segment profitability during the same time period.

What really excites me, however, is what we show on Slide 6 in the presentation, which highlights how early we are in the process in driving our comprehensive all-in solution for veterinarians in North America. At the end of 2021, slightly more than 10% of our customers were "all-in" customers, using our overall services for supply chain, practice management, prescription management and compounding. This increased by approximately 100 basis points year-over-year in 2021, and we have significant momentum entering 2022 with our new commercial go-to-market model for both independently operated and corporately owned veterinarian practices.

All-in customers in North America generate more than 6x in sales than our distribution-only customers with transactional gross margins more than 250 basis points higher. As we continue to invest in innovation, we see our penetration rate with all-in customers moving higher and providing a strong foundation for above-average market growth in the years ahead.

Importantly, in our Europe and APAC & Emerging Markets segment, we have a growing portfolio of proprietary brands, a burgeoning software business and a newly aligned global commercial strategy that bodes well for us replicating our U.S. success overseas in the future. Our recent financial success in our APAC & Emerging Markets segment provides a glimpse of the opportunity as our Australian market is the furthest along outside the U.S. on their comprehensive all-in journey.

Another way to look at the progress we are making in driving our higher-margin solutions can be seen on Slide 7 where 44% of our 2021 gross profit is now coming from the company's technology, e-commerce and proprietary products and services across our segments. This is an improvement of 300 basis points year-over-year as gross profit of these solutions increased 16% year-over-year, which is 5x faster than the growth in our third-party product distribution.

As more and more of our supply chain customers expand, they're buying to these higher-margin solutions and adopt other new innovative offerings we are bringing to market in 2022 and beyond, which I will detail shortly. We should continue to see consolidated gross margin expansion consistent with the 50 basis point improvement delivered in 2021.

Moving to Slide 8. I'm very excited about our upcoming launch of Covetrus Pulse in North America, a new innovative cloud-based veterinary operating system, or vOS as we call it, that has united a comprehensive suite of Covetrus applications relied on daily by veterinary practices in the U.S. into one secure, easy-to-use cloud platform, driving improved efficiencies in business operations, animal health and client experiences.

With Covetrus Pulse, veterinarians will be able to create, renew and improve prescriptions, communicate with clients and coworkers, personalize business dashboards, manage pet care plans and customize with preferred third-party apps, all from one central operating system to fit their practices' needs.

This product launch is a culmination of almost 2 years of significant investment, along with great partnerships with the veterinary community, to bring in best-in-class platform to market, which drives increased efficiencies and delivers a new standard of care for practice management. Best of all, we now have more than 1,000 beta customers using the new platform and expect more than 2,000 customers by the end of Q2 of this year, assuming no significant disruption to the productivity of our software teams based in the Ukraine.

While the financial impact from the launch of Pulse is modest in the very short term, we estimate Pulse customers that leverage the full suite of applications could deliver a 3x increase in sales to Covetrus versus a legacy software customer. While we are enthusiastic about the pending launch of the Pulse vOS in the U.S., I would be remiss not to highlight a number of the other new innovations planned for 2022.

These include first -- our first international cloud-based practice management solution, Ascend, offered in the U.K., Australia and New Zealand. Second, new features added to along with deeper integration of VCP and Rapport into our leading on-prem software solutions, AVImark and ImproMed. And third, our next-generation e-commerce storefront for prescription management customers that we'll be rolling out in late Q4 of this year.

This next-generation storefront will significantly improve the consumer experience while enhancing our ability to drive increased revenue for our veterinary practice customers through consumer engagement optimization. There's more to come on the significant opportunity as we approach launch later this year.

This provides a good segue to our other strategic priorities for 2022 as outlined on Slide 9. These priorities include. One, continuing to optimize our integrated go-to-market strategy to secure new business and grow our net sales faster than the overall market. Second, driving significant adoption of our tech platform in '22, which will translate into accelerated software net sales growth and another year of 20-plus percent net sales growth in prescription management in North America.

Third, increasing our investment in consumer marketing and technology capabilities to further strengthen the vet-2-pet relationship. Fourth, restoring profitable growth in Europe with the recent cost actions taken in the U.K. and in Germany. Fifth, enhancing our proprietary brand strategy through the additions of new and proven talent, including our recent hires César França; and new product development launches.

And sixth and lastly, leveraging our corporate infrastructure for growth as we have reached the necessary base without further investment to support the business moving forward.

By bringing these 6 strategic priorities together, not only do we expect to help our veterinarians drive better outcomes, but we believe their success will accelerate our business and market opportunities. Driving increased adoption and usage of our platform, owning more margin and delivering innovation to our customers and their clients positions Covetrus for another great year in 2022.

I will now turn the call over to Matthew to discuss our financials in more detail.

Thanks, Ben. Good afternoon, everyone, and thanks for joining us today. I will now review our fourth quarter and full year 2021 financial results and provide additional commentary on our initial 2022 expectations. The focus of my comments will be on our non-GAAP results where applicable. Please refer to today's press release for a more detailed description of our fourth quarter and full year 2021 GAAP financial results and reconciliations of non-GAAP measures to the GAAP results.

Starting on Slide 11, some brief financial highlights for the fourth quarter. Q4 non-GAAP organic net sales increased 2% year-over-year, and non-GAAP adjusted EBITDA increased 13% year-over-year to $63 million. Strong performance in our North America and APAC & Emerging Markets segments led the way and more than offset the $4 million collective headwind in Europe from the previously disclosed challenges in the U.K. and in Germany.

We delivered 50 basis points of year-over-year gross margin improvement during Q4 and another 10 basis points of adjusted operating expense leverage, resulting in 60 basis points of year-over-year non-GAAP adjusted EBITDA margin expansion to 5.6%.

Additionally, our net leverage improved modestly during the fourth quarter of 2021. And we generated another $22 million in free cash flow, which enabled us to prepay $30 million of our required 2022 term loan principal amortization payments in December.

Now turning to the consolidated details on Slide 12. Covetrus net sales were $1.12 billion in Q4, relatively flat versus the prior year and an increase of 2% year-over-year on a non-GAAP organic basis against the challenging 12% growth comparison from the prior year period. The previously disclosed items in our U.K. and German markets continued to impact year-over-year comparisons, with non-GAAP organic net sales growth negatively impacted by approximately 700 basis points.

Encouragingly, Germany operations have started to stabilize and actually turn back to positive year-over-year net sales growth in Q4. North America continues to deliver exceptional results with another quarter of double-digit year-over-year growth in non-GAAP organic net sales.

Turning to Slide 13. Consolidated non-GAAP adjusted EBITDA was $63 million for the fourth quarter of 2021 compared to $56 million in the prior year period. The 13% year-over-year growth was driven by strong double-digit growth in our North America and APAC & Emerging Markets segments, which more than offset the moderate decline in Europe, driven by our U.K. and Germany challenges.

FX losses on intercompany loans and higher legal costs also were a drag on year-over-year growth, but much lower than we experienced during the third quarter. Non-GAAP adjusted EBITDA margins were 5.6% during Q4, a 60 basis point year-over-year improvement, driven by the strength in North America and APAC & Emerging Markets. We were pleased with the margin expansion delivered during the fourth quarter, particularly considering increased supply chain disruption and cost pressures experienced in the quarter across many of our global businesses, driven by primarily the Omicron variant.

For full year 2021 on Slide 14, consolidated non-GAAP adjusted EBITDA increased 8% year-over-year to $244 million, led by 43% growth in APAC & Emerging Markets and 19% growth in North America. Europe was flattish year-over-year despite a $19 million collective headwind from the challenges in our U.K. and German markets, which highlights the strength of the rest of the European operations, particularly that of our proprietary brands.

While corporate expense increased $29 million year-over-year, approximately 50% of that increase was an unanticipated negative foreign exchange impact on our intercompany loans, which is not expected to repeat in 2022 now that we have put in place hedges to reduce our economic exposure to FX volatility on these loans.

Encouragingly, we were still able to deliver 10 basis points of non-GAAP adjusted EBITDA margin expansion in 2021 despite these unanticipated headwinds. Our underlying financial momentum, the recent cost actions taken in Europe and the flattening of corporate expenses provide increased visibility into our outlook for accelerating non-GAAP adjusted EBITDA growth in 2022.

Moving to our operating segments beginning on Slide 15. North America net sales increased 11% year-over-year in Q4 on both the reported and non-GAAP organic basis. Segment adjusted EBITDA increased 27% year-over-year in Q4, with segment adjusted EBITDA margins expanding 110 basis points versus the prior year period, reflecting the increased contribution from higher-margin areas of the business, including prescription management and Covetrus-branded products.

We were pleased with the margin expansion delivered during the fourth quarter, particularly considering higher-than-expected Omicron-driven supply chain disruption experienced in the quarter, including increased freight expense.

Encouragingly, we delivered another quarter of market share gains in our supply chain business and 22% year-over-year net sales growth in prescription management. Excluding the accounting change that we have previously discussed, prescription management net sales increased 25% year-over-year during the fourth quarter and 28% for the full year.

Importantly, we delivered significant operating leverage in prescription management during Q4, with non-GAAP adjusted EBITDA increasing $12 million year-over-year to $14 million. And for the full year 2021, prescription management non-GAAP adjusted EBITDA was $44 million or nearly double 2021 levels of $23 million. This equates to a 22% flow-through of incremental net sales into incremental non-GAAP adjusted EBITDA in 2021, representing the second consecutive year of meeting or exceeding our 15% to 20% conversion aspiration.

Encouragingly, 2022 is off to a strong start in prescription management where sales increased by 30-plus percent year-over-year in January and are trending well in February.

Turning to our Europe segment on Slide 13. Non-GAAP organic net sales decreased 13% year-over-year in Q4, reflecting the previously disclosed challenges we are experiencing in the U.K. and German markets, which negatively impacted organic growth by 17% and more than offset healthy veterinary demand fundamentals and strong execution across the rest of our European markets.

Our businesses operating in Ireland, Poland, Switzerland and Romania were notable contributors that helped offset these headwinds during the quarter. On a positive note, Germany returned to year-over-year net sales growth during the fourth quarter, a good sign entering 2022, particularly with our recent cost-cutting measures now in place.

Turning to profitability. Our Europe segment adjusted EBITDA in Q4 decreased 22% year-over-year to $14 million, with margins declining 30 basis points year-over-year to 4.2%. The combined U.K. and German markets accounted for the entire decline in profitability in Q4. The difficult year-over-year comparison in proprietary brands also impacted growth metrics during the quarter.

Moving on to our APAC & Emerging Markets segment on Slide 17. Our team delivered 5% year-over-year growth in non-GAAP organic net sales in Q4, reflecting another quarter of strong sales execution, despite challenging comparisons and some incremental COVID-19 pandemic restrictions in several of these markets.

Australia delivered healthy 7% year-over-year non-GAAP organic net sales growth during Q4, alongside more modest growth in our New Zealand and Brazilian markets in the quarter. Segment adjusted EBITDA increased 22% year-over-year during Q4. And segment adjusted EBITDA margin expanded by 130 basis points year-over-year, driven by ongoing operating leverage from healthy net sales growth.

Now turning to the balance sheet on Slide 18. We generated $22 million in free cash flow in Q4 and $42 million for the full year 2021. We executed strategic inventory purchases during the quarter ahead of anticipated price increases, which impacted our cash flow generation during the fourth quarter, but should provide incremental margin during the first half of 2022.

We ended the year with more than $480 million in available liquidity, which is comprised of cash and cash equivalents and availability under our revolving credit facility, and approximately 1.6 turns of headroom under our net leverage covenant as defined in our credit agreement. And as I mentioned earlier, we prepaid $30 million of our required 2022 term loan principal amortization payments in December, which combined with our lower bank leverage will reduce interest costs this upcoming year.

Now turning to our detailed 2022 guidance as outlined on Slide 19. We forecast non-GAAP organic net sales growth of 7% to 8%. The outlook includes 10% to 11% growth in North America alongside the continued adoption of our all-in platform, 3% to 4% growth in Europe as we anniversary the 2021 challenges in the U.K. and Germany and 6% to 7% growth in APAC & Emerging Markets. Our global outlook assumes market growth rates above pre-COVID-19 levels, but below the robust growth seen in both 2020 and 2021 as end market conditions normalize.

Looking at non-GAAP adjusted EBITDA, our outlook of $270 million to $280 million remains unchanged versus our preliminary outlook released at the JPMorgan Healthcare Conference earlier this year and reflects 11% to 15% year-over-year growth, an acceleration versus the compound annual growth rate delivered over the last 2 years. This is driven by the lapping of the specific challenges in our U.K. and German markets and the nonrepeat of certain headwinds in corporate costs.

We anticipate over 20% growth in net sales and continued growth in profitability in prescription management and an improvement in our software growth outlook with multiple new products coming to market in 2022. We also anticipate general stability in our supply chain businesses around the globe, with continued focus on growing our higher-margin proprietary brands.

Some of this growth will be offset by higher freight costs, continued labor market tightness and the return of discretionary spending as global economy reopen.

We also continue to monitor the Russian-Ukraine situation, and the downstream impact that might have on the global supply chain and some of our European markets, but have not factored anything explicit into our outlook at this time, given the current state of affairs.

Finally, while we do not provide specific quarterly guidance, given the timing of our Europe cost-cutting actions and the fact that some of the global supply chain challenges emerged in the second half of 2021, we do expect year-over-year non-GAAP adjusted EBITDA growth rates to be stronger in the second half of 2022, with Q1 2022 growth rates expected to be flattish year-over-year.

With that, I'll now turn the call back over to Ben for some brief closing remarks.

Thanks, Matthew. In closing and outlined on Slide 20, we have a solid foundation in place, a clear plan and visibility looking forward to deliver accelerated growth in 2022. Our end market is attractive and durable, and we are aggressively investing in our platform to enhance our value proposition to secure new business and to accelerate our end-market opportunities.

We are also focused on driving our Covetrus branded and proprietary product portfolio and streamlining operations to deliver increased efficiencies while reinvesting back into our tech platform. I'm confident in our strategy and encouraged by the momentum we have in the core drivers of our business.

We're still in the early innings of the journey towards the company's long-term goals of above-market net sales growth and annual non-GAAP adjusted EBITDA margin expansion. But I believe we have a solid blueprint and a team to execute it as we drive sustainable shareholder value creation.

This concludes our prepared remarks, and I will now turn the call back over to Nicholas Jansen to moderate the Q&A session.

Thanks, Ben. We will begin our Q&A session now, so we want to take as many questions as possible. (Operator Instructions) So Anne, can you please provide instructions, and we are ready to take the first question.

(Operator Instructions) Your first question comes from the line of Jon Block from Stifel.

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

That's a great question. Clearly, the prescription management business will be a big contributor in 2022. I would say the situation we and everyone else faced in Q4 was pretty unique in terms of having not just increased freight pricing pressure, but also a massive absenteeism driven by the Omicron variant.

And when we have absenteeism, we have a spark in temp labor, our productivity drops. And we just struggled to get the shipments out, and we ended up missing a couple of rebates. So I think Q4, a little bit of a perfect storm and a little bit worse than you ought to expect flowing forward.

Fair enough. That's helpful. And then second question, Ben or Matthew, the gross adds for prescription management have been, I think it might be fair to say, somewhat modest over the past couple of quarters. To be clear, the sales growth has still been tremendous, and I know the same-store growth has been tremendous.

But can you talk to how we should think about new store growth versus same-store sales growth in 2022 here in North America? And maybe that's a decent segue into sort of the timing for international prescription management. Your thoughts there? And could that be a 2023 event?

Yes. Thanks, John. I'll take that, Matthew. Look, I think if you look backwards 2 years ago, we were very deliberate and vocal about our focus on driving utilization of the platform. We had reached a pretty significant market penetration, almost 1/3 of the customers in the U.S. But as you know, we only had about 4% of clinics consumers transacting on the platform. And so that 4% has now grown almost 50% and with some customer cohorts even higher than that. And that's what really has fueled the growth from, say, $200-plus million of revenue to north of $500 million of revenue in 2021.

I think some of that same mentality and focus will exist in 2022. When you think about a lot of our focus on things like Pulse, so much of that is about driving better workflow and, as a result, more of that initiated prescriptions on the platform. So the lion's share of the volume increase in 2022 is going to come from greater and greater utilization. And Matthew mentioned that 30% growth number in January. So obviously, it's well ahead of the overall 20%-plus number that we gave as part of guidance.

So that's where the majority of the growth is going to come. We still will pick up new accounts. I would expect that to be in the 5% to 10% range over the next 12 months or so. But in terms of really propelling the business forward and where the market opportunity is, it's again just mostly focused on driving greater and greater utilization.

And any comments on international, Ben, from a timing perspective?

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

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

I was hoping you might be able to give us a little bit more perspective on where you see sort of market trends going. I know some of your claims data and sales data probably gives you good insight. Just curious if from your perspective, trends like patient traffic, spending per visit are kind of still in a sort of post-COVID sort of normalization phase? Or are we stable? And what kind of assumptions are you making for '22?

Yes, John, thanks for the question. It's -- it has been fairly stable on the end market side of things now for a couple of quarters. In the deck that we provided, you get a good sense of some of the growth rates that we're anticipating. So in the U.S., still high single-digit growth, a little bit more modulated internationally.

I think the biggest issue, honestly, is capacity with our customers, and I'm sure you see this from covering other companies and just being out in the market. But wait time to get into a hospital, driven by staffing limitation, is still driving the huge part of the business dynamic. So I think if you just look at the back half of '21, we anticipate similar growth rates for 2022 with the biggest gating factor, honestly, being customer capacity.

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

Yes, sure thing. There's really 2 main levers to drive that adoption rate. The first is just ease of doing business with us through the integration of the various platforms. So when you think about, whether it be Pulse or greater integration into AVImark and ImproMed, so much of the adoption of additional solutions comes from data interoperability, enhanced workflows.

And so whether that be compounding or prescription management or appointment management, any of those add-on solutions, they just get a lot better and easier to use when they're integrated. So I think there's just kind of an overall ease of using the platform, which will drive adoption.

The second, which you alluded to, is really on the sales and marketing front. And so we're now 1 year into our unified sales approach. As you know, we ripped off the band-aid at the end of Q4 of last year and went to an account manager, specialist model, one case a customer. And so that is, like any large-scale sales force change, always a work-in-progress, but really pleased with the results.

And I think you see that in the prepared remarks if you just look at North America top line growth, 3-year CAGR of almost 40% ahead of where the market is. Not -- that would not have been possible if it weren't for the combined efforts or the efforts of going through our combined sales force. So a lot of optimization left to go there and getting incentive right, getting packaging right, but we feel like there's just a ton of running room. And obviously, the data is pretty compelling when you get it right.

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

I wanted to start with the prescription management margins, and how we should think about that going forward? I think you had previously talked about targeting kind of incremental margins in the high teens. I think the last 2 quarters, though, looking at 3Q and 4Q were well above that at about 30%. So could you maybe just talk about what drove the margins that you saw in Rx Management in the back half of this year and how you're thinking about that playing out for 2022?

Certainly. Matthew, would you like to field that?

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

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

Yes. Let me start with freight. We continue to see upward pressure on freight. And by and large, as you can see from the margin performance, we're managing to get it covered with price. But I would tell you, the pace of those changes feels like we're always catching up. So we do suffer a bit of a lag issue there. So we really have a little bit of a timing problem. But essentially, we're pushing the pricing through to get that covered.

Labor, very tight labor market. As we said, fourth quarter was very difficult with Omicron and all the knock-on impact of that. But we're continuing to manage through it. Attrition rates remain high and inflation in the low to mid-single digits on labor. I don't know if you want to talk a bit about pricing, Ben?

Yes. Nathan, I think we have seen -- we expect kind of mid- to high single-digit price increases from suppliers. As you know, that gets largely passed through or almost entirely passed through on to customers and then on to consumers. We don't have perfect insight into the number of price increases that occur during the year, but we would expect it to be similar to previous years, where it's somewhere between 1, 2 or 3 price increases depending on the manufacturer and the product line. But cumulatively, I would expect mid- to high single digits on a price increase basis.

Next question from the line of Erin Wright from Morgan Stanley.

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

Yes. So Erin, I think the price increases are largely in line with previous years. Again, as you know, manufacturers are in different places in their own portfolios and have different opportunities there. So it's not always the same from manufacturer-to-manufacturer, product-to-product. But I think on average, it's a pretty -- a year consistent with previous years.

In terms of our relationships with suppliers, I think we're in a much different place than we were a year or 2 years ago, both in terms of when we have visibility to that and the nature of our relationships with those suppliers. So we are basically done with all of our suppliers and have come to terms with everybody a year ago. There was still a lack of visibility on that front.

Second, the economics are basically the same against puts and takes across the different parts of the portfolio, but very similar to 2021 economics. And in some cases, we have suppliers, and you mentioned some of them, who are really leaning into our capabilities. A lot of that comes from having an omnichannel solution. We are clearly the only player in the market that is both global as well as can reach veterinarians in clinic and consumers online, all under the same umbrella.

So we feel very differentiated versus the other players out there in the market. And I think that's starting to show up in how we work with suppliers, not just the top 4, but really the top 10 or 15. Our relationships have really -- I think have evolved and are excited about where we're headed on that front.

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

Yes. Why don't -- Matthew, I'll start with just kind of end market dynamics, and then you can talk about bridging that to the guide and how kind of the lapping of Germany and U.K. play into the numbers. So in terms of the end market, Erin, we expect kind of mid-single-digit growth rates, again, emerging markets within Europe growing faster than some of the more traditional markets.

And so that should be pretty similar to end market growth in the past. Of course, we don't have a lot of visibility into what's going to happen here in the Ukraine and whether that's going to create any short-term instability in some of these markets. But absent that, we expect to see mid-single-digit growth rates. And Matt, you can talk about how you translate that into the guide for the full year.

Yes. And just to give you a little bit of history on what we've actually done physically, we have new leadership in both of those markets. We took out modest restructuring charge in Q4 to downsize the cost structure and better align it with revenue. And as we said in the prepared remarks, Germany did return to [growth] in the fourth quarter.

From a go-forward perspective, the U.K. still has Q1 to lap. So U.K. is going to be a drag on top and bottom line in Q1. But once we get into the second half, the U.K. will stop being a drag. We talked about both of those markets being about a $19 million year-over-year drag in 2021. Our hope is we get at least half of that back in 2022 in terms of year-over-year improvement.

(Operator Instructions) Your next question comes from the line of Elliot Wilbur from Raymond James.

Maybe just some additional questions around some of the performance trends you referred to with respect to 2022, specifically thinking about the strong start to the year in terms of Rx Management. Any particular dynamic that you might call out there that I believe may have led to the better-than-expected or strong performance kind of in light of what's been a relatively slow start to the year, at least in terms of the growth rate in overall vet clinic visits?

And I think you've previously talked about some supply issues, particularly with respect to dietary products that may have negatively impacted growth in the Rx Management business. I just want to get an update on where that dynamic stands currently.

And maybe, Ben, you've talked about some of the strong performance trends in the proprietary products business, particularly within the European segment. Maybe just provide a little bit more detail behind that in terms of what's driving that. Is it really geographic expansion, share gains, utilization, new products? Any additional detail there would be helpful.

Yes. Thanks, Elliot. Why don't I take both of those questions. On prescription management, I mean -- obviously, we ended the year well, and we kind of continued that trajectory going into January and the first couple of weeks of February here. I would really attribute it to just strong execution by the team. There's a lot of levers to pull here when you're marketing to consumers or improving integration with our software piece of our business to drive vet utilization.

And so there's not one thing to point to. There's just a lot of execution across the board that's showing up in the end numbers. So we're really proud of that group and really excited to see how the rest of the year goes.

In terms of diet, you are right, last year, especially in Q1 and the first half of the year, we really struggled with our major vendors there -- our major suppliers, I should say, with very significant product outages. In Q4 and the beginning of the year, that has really stabilized. So diet is growing for the first time in many quarters now on pace with commercial pharmacy or above, depending on the time period that you're looking at. So feeling quite good about the progress there.

I would point out that those suppliers are not out of the woods yet. And I'm sure if you're a consumer of these products, you're aware of the challenges if you're using a prescription diet. But for us, it's gotten much more stable, and our ability to manage consumers appropriately has gotten a lot better. So that's kind of the Rx Management near-term highlights.

In terms of proprietary brands, I would tell you that it's not about new markets or new products quite yet. That's in the coming attraction. For now, it's really about execution and focus. And John had asked about the combined sales force and how that can drive all-in customers. It's the same concept here about focusing on proprietary brands.

I mean we've just done a lot to get sales incentive aligned around the value creators of the business, and that's what's helping drive the growth of proprietary brands across the globe. So we're really excited about the opportunity there, excited about our new leadership under César França, and we expect to see great things on proprietary brands in the quarters to come.

Your next question comes from the line of Balaji Prasad from Barclays.

Probably just a couple from my side. Firstly, on Covetrus Pulse, I would like to have greater granularity around this, especially your commentary around estimating a 3x increase in revenue from a fully configured practice. So help me understand what will the adoption curve look like and how can it drive this adoption curve. And for a customer to reach that kind of a contribution for your revenues, is it 3 years or 5 years? How does it play out?

And secondly, I think this is an extension to the previous response. With regard to the proprietary brand, what is the size of the business currently? And for the incoming President, what kind of KPIs do you have around the segment over the next 3 to 5 years, if you do?

Yes. Thanks, Balaji. So in terms of Pulse, the -- first of all, we're obviously thrilled that we have 1,000 customers in beta and have visibility to more than 2,000 by the end of Q2. So lots of confidence in our ability to execute there. And I'm sure you know from being around other technology businesses, getting to that scale of customers is no small feat. What drives the revenue increase is really the utilization of all of the different services that used to be sold in a kind of à la carte or point solution basis that are now all bundled together in one complete veterinary operating system.

So if you think about what those things are, beyond the electronic medical record, you have appointment management, client communication, payment and other features that used to be integrated in and you could choose it. You might choose it, you might not choose it. Now we still allow for choice, but the offering is just so compelling from an economic standpoint as well as an ease-of-use standpoint that, that's what drives us to see that -- a pretty significant step-up in revenue per customer when they adopt the veterinary operating system.

So excited about that, and we'll be excited to get back on the call with you guys in Q2 and give you an update on where we are on that front.

In terms of proprietary brands. That business is just under $0.5 billion. And we -- obviously, it flows through our distribution business and flows through other channels where we have access to customers, but it's predominantly coming from our own channels.

In terms of KPIs, it's really about sales velocity, product margin and overall end-to-end profitability on the portfolio that we have. And then on the portfolio that we're building, it's going to be about new product launches and [category adoptions] over the coming months and quarters. So early days, but I think something that we are going to increasingly focus on and communicate out against here at Covetrus.

Next question from the line of Erin Wright from Morgan Stanley.

How is uptake, Ben, of the prescription management offering across the corporate accounts? Is that an area of focus for you, given maybe some of the conflicts of interest with the other prescription management player out there? And could you -- is this an area, I guess, that you could increasingly target in terms of corporate accounts?

And then just on that front, since we're talking about it as well, I mean, does guidance imply any sort of changes in your corporate account relationships, both in the U.S. and internationally?

Yes. The guidance does not imply any change in our corporate account relationships. I think those are in a good place. We see continued opportunities. As you know, Erin, there's kind of -- I would split the corporate accounts into 2 basic models, one where there's tight centralized control. They make one decision for a prescription management provider, and that gets deployed across all of the local hospitals. And then there's the federations where there's not as much tight control and local veterinarians are making their own decisions.

I think what our feedback in the market is that we have a superior solution, and it shows up in the numbers. The only limitation is just given how busy our customers are. Making any changes from a workflow standpoint are just hard. But all indications are that we have the premier solution in the market and feel good about our market position and hope to build on it in the coming years.

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

We have no closing remarks at this time.

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