Business Context and Reporting Period
PetMed Express, Inc., doing business as 1-800-PetMeds, is a nationwide direct-to-consumer pet pharmacy selling prescription and non-prescription medications, health products, and pet supplies primarily for dogs and cats. The Form 10-Q covers the quarter and six months ended September 30, 2012, within fiscal 2013. The financial statements are unaudited.
Approximately 77% of quarterly sales were generated through the Internet, compared with 74% in the prior-year quarter. The average order declined to approximately $72 from $76 in the quarter and to $73 from $78 for the six-month period.
Financial Highlights
| Metric | Three Months Ended September 30, 2012 | Prior-Year Quarter | Six Months Ended September 30, 2012 | Prior-Year Six Months |
|---|---|---|---|---|
| Sales | $58.1 million | $58.2 million | $127.1 million | $131.8 million |
| Gross profit | $19.4 million | $19.9 million | $41.7 million | $44.0 million |
| Gross margin | 33.3% | 34.2% | 32.8% | 33.4% |
| Income from operations | $6.3 million | $6.1 million | $12.5 million | $13.6 million |
| Operating margin | 10.9% | 10.4% | 9.9% | 10.4% |
| Net income | $4.0 million | $3.9 million | $8.0 million | $8.8 million |
| Net margin | 6.9% | 6.7% | 6.3% | 6.7% |
| Diluted EPS | $0.20 | $0.19 | $0.40 | $0.41 |
Six-month operating cash flow was $15.7 million, compared with $16.2 million in the prior-year period. Investing activities used $5.3 million, primarily reflecting purchases of short-term investments, compared with $9.4 million of investing cash inflow in the prior year. Financing activities used $10.2 million, including $6.1 million of dividends and $3.9 million for share repurchases.
At September 30, 2012, cash and cash equivalents were $47.0 million and short-term investments were $15.4 million, for total cash and short-term investments of $62.5 million. Working capital was $77.2 million, compared with $78.2 million at March 31, 2012. The company reported no debt obligations and no off-balance-sheet arrangements.
Material Changes Versus the Prior Comparable Period
- Quarterly sales were essentially flat, while six-month sales declined 3.6%, or $4.7 million.
- Sales were adversely affected by the unavailability of Novartis brands due to suspended manufacturer production, increased competition, additional discounting, lower-priced product mix, and customers purchasing smaller quantities.
- New order sales decreased 8.1% in the quarter and 13.8% for the six-month period. New customers acquired declined to approximately 177,000 from 184,000 for the quarter and to 374,000 from 410,000 for the six-month period.
- Gross margin declined 90 basis points for the quarter and 60 basis points for the six-month period, primarily due to higher shipping expenses.
- General and administrative expense declined 4.2% for the quarter and 3.5% for the six-month period, primarily due to lower bank service fees, professional fees, and certain other expenses.
- Advertising expense declined 6.1% for the quarter and 4.1% for the six-month period. Advertising cost per acquired customer was $42 for the quarter versus $43 previously, but $46 for the six-month period versus $44 previously.
- Weighted-average diluted shares declined to 20.1 million for the quarter and 20.2 million for the six-month period, from 20.7 million and 21.2 million, respectively, reflecting share repurchases.
- The company repurchased and retired approximately 397,000 shares for $3.9 million during the six months, compared with approximately 2.0 million shares for $22.6 million in the prior-year period.
Guidance, Outlook, Risks, and Unusual Items
- Management expects advertising expense to be approximately 13% of sales for fiscal 2013, subject to seasonality and advertising availability.
- Management estimates an effective tax rate of approximately 37.0% for fiscal 2013.
- The company plans to emphasize advertising efficiency, higher-margin items including generics, and expanded pet-supply offerings. Management does not guarantee that these initiatives will produce sales growth.
- Sales may be adversely affected by competition, consumer price sensitivity, trading down to generics or smaller quantities, seasonal demand, and product availability, including manufacturer disruptions.
- The business is seasonal, particularly because of heartworm, flea, and tick medication demand.
- Approximately $200,000 of capital expenditures was forecast for the remainder of fiscal 2013, expected to be funded from operating cash flow.
- As of September 30, approximately $10.2 million remained under the share repurchase authorization. On October 26, 2012, the board declared a $0.15 per-share quarterly dividend, estimated at approximately $3.0 million, payable November 23, 2012 to shareholders of record November 9, 2012.
- Legal and regulatory risks include potential future actions by state pharmacy boards and litigation concerning the company’s trade and service marks. No legal proceedings were reported in Part II, Item 1.
- Short-term bond mutual funds totaled $15.4 million and are subject primarily to interest-rate and credit risk. The company reported no derivative instruments.
- Management concluded that disclosure controls and procedures were effective as of September 30, 2012, with no significant changes in internal control over financial reporting.
Investor Verification Checklist
- Verify whether Novartis product availability, competitive pricing, order quantities, and new-customer acquisition trends improve in subsequent periods.
- Monitor gross margin and shipping costs, including the effect of product mix and customer discounts.
- Assess whether the planned 13% advertising-to-sales ratio supports sustainable new-order growth and acceptable customer acquisition costs.
- Reconcile operating cash flow with earnings and track cash deployment for dividends, share repurchases, investments, and capital expenditures.
- Review the status of the remaining share repurchase authorization and the company’s continuing dividend policy.
- Evaluate risks relating to seasonal demand, state pharmacy-board actions, trademark litigation, and short-term investment performance.