PetMed Express, Inc. (PETS) Q1 2013 Earnings Report, Transcript and Summary

Welcome to the PetMed Express, Incorporated Doing Business as 1-800-PetMeds Conference Call to review the financial results for the first fiscal quarter ended on June 30, 2012. At the request of the company, this conference call is being recorded. Founded in 1996, 1-800-PetMeds is America's Largest Pet Pharmacy, delivering prescription and nonprescription pet medications and other health products for dogs and cats direct to the consumer. 1-800-PetMeds markets its products through national television, online, direct mail and print advertising campaigns, which direct consumers to order by phone or on the Internet and aim to increase the recognition of the PetMeds family of brand names. 1-800-PetMeds provides an attractive alternative for obtaining pet medication in terms of convenience, price, ease of ordering and rapid home delivery. At this time, I would like to turn the conference call over to the company's Chief Financial Officer, Mr. Bruce Rosenbloom. And sir, you may begin.

Thank you. I'd like to welcome everybody here today. [Operator Instructions] Also, certain information that will be included in this press conference may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 or the Securities and Exchange Commission that may involve a number of risks and uncertainties. These statements are based on our beliefs, as well as assumptions we have used based upon information currently available to us. Because these statements reflect our current views concerning future events, these statements involve risks, uncertainties and assumptions. Actual future results may vary significantly based on a number of factors that may cause the actual results or events to be materially different from future results, performance or achievements expressed or implied by these statements. We have identified various risk factors associated with our operations in our most recent annual report and other filings with the Securities and Exchange Commission. Now let me introduce today's speaker, Mendo Akdag, the President and Chief Executive Officer of 1-800-PetMeds. Mendo?

Thank you, Bruce. Welcome, everyone. Thank you for joining us. Today, we will review the highlights of our financial results. We'll compare our first fiscal quarter ended on June 30, 2012, to last year's quarter ended on June 30, 2011. For the first fiscal quarter ended on June 30, 2012, sales were $69 million compared to sales of $73.6 million for the same period the prior year, a decrease of 6.3%. The unavailability of Novartis brands disrupted our sales during the quarter. In addition, the decrease was due to the consumers purchasing smaller quantities, for example, 3 packs instead of 6 packs, additional discounts given due to increased competition and a change in product mix to lower-priced items. Also, the peak season started early this year due to the warmer climate in the March quarter, which might have shifted sales from the June quarter to the March quarter. For the first fiscal quarter, net income was $4 million or $0.20 diluted per share, compared to $4.8 million or $0.22 diluted per share for the same quarter last year, a decreased earnings per share of 12%. The decrease was mainly due to a decrease in sales. Reorder sales decreased by 2.8% to $55.1 million for the quarter compared to reorder sales of $56.6 million for the same quarter the prior year. The decrease was due to a decrease in average order size. Reorder sales decreased by 18% to $13.9 million for the quarter, compared to $17 million for the same quarter the prior year. The decrease was mainly due to an increase in customer acquisition costs and decrease in average order size, in addition to slightly reduced advertising. We acquired approximately 197,000 new customers in our first fiscal quarter compared to 226,000 for the same period the prior year. Our average order was approximately $73 for the quarter compared to $80 for the same quarter the prior year. The decline was also due to the consumer purchasing smaller quantities, additional discounts given and a change in product mix to lower-priced items. Approximately 77% of our sales were generated on our website for the quarter compared to 73% for the same period the prior year. The seasonality in our business is due to the proportion of flea, tick and heartworm medications in our product mix. Spring and summer are considered peak seasons, with fall and winter being the off seasons. For the first fiscal quarter, our gross profit, as a percent of sales, was 32.4% compared to 32.8% for the same period 1 year ago. The percentage decrease can be attributed to an increase in freight costs to improve service levels. Our general and administrative expenses, as a percent of sales, was 8.6% for the first fiscal quarter compared to 8.3% for the same quarter the prior year. The increase was due to lower sales. We spent $9.8 million in advertising for the quarter compared to $10.1 million for the same quarter the prior year, a decrease of about 2%. We reduced advertising late in the quarter due to increases in costs. The advertising cost of acquiring a customer was $50 for the quarter compared to $45 for the same quarter the prior year. We had $57.4 million in cash and cash equivalents, $10.4 million in short-term investments and $18.3 million in inventory, with no debt as of June 30, 2012. Net cash from operations for the quarter was $13.8 million. Capital expenditures for the quarter were approximately $207,000. This ends the financial review. Operator, we are ready to take questions.

[Operator Instructions] And Kevin Ellich, Piper Jaffray.

Just wondering if you could quantify the impact of the various components that you think negatively hurt yourselves this quarter? Specifically, the pull forward or the sales you think that went into the March quarter, it sounds like you're unsure of how much of an impact that's had, if any.

Yes, that would be a speculation on our part, which I don't want to get into. But the other components, I can give you a rough idea. Unavailability of the Novartis impact, our estimate is about $3 million to $4 million. A shift to smaller-sized orders, lower packs is about $2 million. Additional discounts given is about $1.5 million, and change in product mix is about $1 million to $1.5 million. Those are some rough estimates.

Okay. So basically, the last one, the shift to different products and the smaller order size, are you actually seeing people substitute to more of a generic products or are they actually just buying different types of products?

Generic products and with unavailability of Novartis, different type products also.

Okay. What can you do to make up for the manufacturing issues with Novartis? Is there anything that you guys have planned or strategically can try to push?

We have been asking the prescribing veterinarian to prescribe an available brand. Our rough estimate is about 60% are shifting, and there's about 40% is our rough estimate that we lost due to unavailability of the brand. And some pet owners are loyal to the brand, and they're waiting for its availability instead of shifting to another available brand.

Got it, got it. And then, why do you think people are buying smaller quantities, the 3 pack instead of the 6 pack? Is it the macro environment, or is it something else?

Our guess is it's macro environment. The retailers are selling the smaller packs. They typically don't sell the largest packs, and I think consumer's getting trained to also compare and buy the smaller packs.

Got it. And then 2 last quick questions here. I guess, what's your view on discounts going forward? Are you going to continue to be competitive? And also, what's your outlook on the advertising rates in the coming months, both online and television?

We're going to continue to be competitive. So the market forces are going to dictate our pricing. As far as advertising is concerned, we shifted some dollars to online, and it did not perform as well as we anticipated. And we cut back towards the end of the quarter. We are anticipating that TV inventory will be tight until -- it's a temporary phenomenon. Obviously, once November 6 is over, the elections will be over. So we think it will open up afterwards.

Next question comes from Mitch Bartlett, Craig-Hallum Company.

The 197,000 customers that you acquired, is there a change in what those customers are coming in for versus the last few years? There's a big swing in tick season. But did they perhaps maybe shift more towards the Rx side, and is that why perhaps, maybe the cost of customer acquisition has gone up?

No, it's similar to last year. There is no material difference between categories.

Okay. And then you said at the end of the quarter, you've kind of cut back because the online advertising wasn't panning out. Is there a point where you need to kind of push hard no matter what to continue to refresh the base of customers?

It will -- I mean when there are better opportunities and the cost is more effective, that's when we like to do that, than forcing it in an environment that the cost is higher. So it has -- the cost has its ups and downs, and we prefer to be more aggressive when the cost is lower than when it's higher.

And then finally, just the inventory was down year-over-year pretty aggressively, you drew down the inventories. Was that because there was a lack of opportunity buys that met your criteria, or what does that say about kind of gross margins going forward?

It's lack of opportunity. There were no advantageous buying opportunities at the end of June, so that's why the inventory is where it was. And what was your next question?

Gross...

Well, just on that, is that because there's just that much more places for that inventory to go, more competitive places? Or is it just a seasonal thing?

No, it's just the way it was. It has its ups and downs, buying opportunities. And there were no reason for us to have higher inventory since there was no advantageous buying opportunities. As far as gross profit margins are concerned, we anticipate continuing pressure on margins, but generics will help stabilize it.

Can you tell us what percentage of sales generics now represent?

We're not going to comment on that.

Next question comes from Erin Wilson, Merrill Lynch Company.

First, I guess, what are your thoughts on the recently proposed FTC meeting on October 2 with regards to the pet prescription market? And do you plan on, I guess, submitting some sort of a comment ahead of that workshop?

We are working on improving our relationship with the veterinary community. So we will -- we probably will not participate in it.

Okay. And I mean, could this be a potential positive or negative for you?

It's a double-edged sword, so it could be either way. It's like Bayer opening to other sources. So obviously, if it will be -- there will be much more competition, if anything passes. So I would say, it's a double-edged sword.

Okay, okay. And then, I guess, from a capital deployment standpoint, we've really liked the dividend, but does this sort of strategy suggest that the potential for getting maybe a better return, possibly through acquisitions isn't an option, or the acquisition pipeline isn't that robust? Or that valuations out there are unrealistically high?

We have a standing policy of not to comment on any possible mergers or acquisitions. But at this time, as far as the -- we, obviously, we have a strong balance sheet. And we still have about $14 million remaining in our buyback plan, and we're paying $0.15 dividend per quarter.

Next question comes from Michael Kupinski, Noble Financial Company.

Mendo, I was wondering if you can talk a little bit about your accessory business, and if it was that material in this last quarter? And you indicated that you're anticipating kind of a, maybe possibly broadening out the product lines. I was wondering if you can just give us some thoughts on what you might be expanding those product lines to include? And whether or not that includes expanding the accessory business?

It is -- the accessory business is growing, but it's still not material. And the reason is we're not growing the SKUs as fast as we should be because we're using third-party fulfillment. And we are not happy with the service. So we anticipate that either we'll have our own infrastructure or a different infrastructure to speed up, increasing the SKUs that will be -- we'll make available to our customer base.

And Mendo, does that mean necessarily that you might take inventory in this product categories then, or...

Yes.

Okay. And then what would be the types of gross margins in that -- do you anticipate in, if you do -- if you move forward with that?

It depends on the accessories. It's probably similar to our gross margins that we have right now.

Okay. And also, can you talk a little bit about the television creative? Is that performing to plan? Or do you think -- do you anticipate to make any changes there?

We just made a change actually today. We have a new creative that started running. So we'll see how that performs.

Okay. And you indicated that certainly, you don't -- in the past, if the television prices do rise, you tend to cut back on advertising. It seems like this cycle might be a little bit different in that auto category, it seems to be, continues to be quite strong even through for television and so forth. And I was just wondering if you anticipate that pricing might hold up in the -- following the election in that you might still not buy as much advertising even well into the next quarter?

Typically, it tightens up while we are getting closer to the holidays, it's usually the case. And when it opens up is in January, but that happens every year. So it's going to be similar comparison to prior years.

Okay. And then just a follow-up on the earlier question. Has the company looked at other acquisitions or opportunities recently? Or is it -- I just want to know the appetite, I suppose, for looking at other businesses at this point?

As I said, we have a standing policy not to comment on that.

[Operator Instructions] And our next question comes from Anthony Lebiedzinski, Sidoti & Company. Anthony C. Lebiedzinski - Sidoti & Company, LLC: Just to follow up on the -- one of the previous questions. As you look to take on some of the inventory for pet accessories or other products, would you need to open up another distribution center in order to do that? Because I believe your current facility is fairly small. So if you are looking at another DC, what kind of costs would we be looking at?

It will -- we haven't decided yet. So I don't want to comment as far as that. But yes, it will be a separate DC and a different location. Anthony C. Lebiedzinski - Sidoti & Company, LLC: Okay. And as far as average order value, you gave the number, total number. I was wondering if you could provide us with some color in regards to AOV for new customers versus reorder customers?

Do we have that, Bruce? New customer versus -- Bruce is looking at that. I don't have it in front of me. Anthony C. Lebiedzinski - Sidoti & Company, LLC: Yes, just want to have a better understanding of what kind of trend are you seeing, is it...

Average order size, new customer versus reorders. Usually, the new customers or average order size is lower than reorder customers. But we don't have the -- unfortunately, we don't have the math in front of us right now. Anthony C. Lebiedzinski - Sidoti & Company, LLC: Okay, I could follow up later then. And as far as new customer acquisition costs, obviously, this was pretty high for this quarter. Can you give us any sort of sense as what you expect next couple of quarters, especially with the elections coming up over the year?

We are working on being more efficient. So I would guess that it will be in the 40s, not 50s.

Our next question comes from Ross Taylor, CL King Company. Ross Taylor - CL King & Associates, Inc.: Just 2 or 3 questions. First, with regard to the accessories business, I mean, can you elaborate at all as to what categories in the accessories market you would be looking to add to your inventories? And would pet food play a significant role in that? And then my second question, I think this has been asked in various ways, but given the increase in customer acquisition costs, I mean, how exactly do you think you do respond to that? I mean, how would dollars shift between TV and Internet, or any other changes you anticipate?

The pet supplies and the food, high-end food, will be included in that, to answer your first question. The second question was your -- the advertising. Obviously, we want to be efficient. And we already shifted some dollars from television to online, which did not do as well. It's the creative plays a role in what the response is. And we just changed the creative actually. It's – we are running a new creative starting today, so we'll see how that performs. So we'll test different creatives and different media to lower the cost, is the general idea I can give you.

And our last question comes from Mitch Bartlett of Craig-Hallum Company.

Yes, I just want to follow up on the response to the last question. Did you say you would be including food as a component of the new accessories category?

Yes, we already carry food, by the way. So if you go out to our site, you will see food. But it would be high-end food.

High-end, like dog food and 30-pound bags and things like that?

The higher-priced food, how about that?

Okay. That changes the business pretty dramatically. That's a very hard category to distribute. So you would have to scale a distribution facility for something like that. You'd have to spend a lot money to get a distribution facility capable of distributing food. Is that a fair way of thinking about it or not?

Yes.

Thank you. At this time, I would like to turn the conference call back over to Mr. Mendo Akdag. Sir, you may begin.

To address the decrease in sales for the quarter, we are focusing on advertising efficiency and shifting sales to higher-margin items, while continuing to expand our product offerings. This wraps up today's conference call. Thank you for joining us. Operator, this ends the conference call.

Thank you. Thank you for participating. You may disconnect at this time.