Business Context and Reporting Period
PetMed Express, Inc. (NASDAQ: PETS), doing business as 1-800-PetMeds, is a nationwide direct-to-consumer pet pharmacy selling prescription and non-prescription medications, health products, and supplies for dogs and cats through its website, contact center, and direct mail. This Form 10-K covers the fiscal year ended March 31, 2017; the fourth quarter ended March 31, 2017 is included in the annual results.
The company operated approximately 3,000 SKUs, attracted approximately 32 million website visitors, converted approximately 8% of visitors into orders, and generated approximately 83% of fiscal 2017 sales through the Internet. It acquired approximately 514,000 new customers, compared with 489,000 in fiscal 2016.
Financial Performance and Position
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Sales | $249.2 million | $234.7 million | +6.2% |
| Gross profit | $79.3 million | $76.3 million | +4.0% |
| Gross margin | 31.8% | 32.5% | Down 70 basis points |
| Operating income | $37.5 million | $32.4 million | +15.7% |
| Operating margin | 15.0% | 13.8% | Up 120 basis points |
| Net income | $23.8 million | $20.6 million | +15.8% |
| Diluted earnings per share | $1.17 | $1.02 | +14.7% |
| Net cash from operations | $47.2 million | $21.1 million | +124% |
Fiscal 2017 quarterly sales were $72.5 million in the June quarter, $60.8 million in September, $52.9 million in December, and $63.0 million in March. Fourth-quarter net income was $7.5 million, or $0.37 diluted earnings per share, compared with $5.4 million and $0.27 per share in the prior-year fourth quarter.
At March 31, 2017, cash and cash equivalents were $58.7 million, working capital was $63.4 million, total assets were $112.8 million, and shareholders’ equity was $93.4 million. The company reported no debt obligations, no off-balance-sheet arrangements, and no outstanding lease commitments. Property and equipment, net, increased to $30.2 million following investment in the Delray Beach headquarters and distribution facility.
Cash used in investing activities was $10.6 million, principally for property and equipment. Cash used in financing activities was $15.5 million, principally dividends. The company paid $15.5 million in dividends during fiscal 2017 and declared quarterly dividends of $0.19 per share. On May 8, 2017, the board increased the quarterly dividend to $0.20 per share, or approximately $4.1 million.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher reorder and new-order sales. Reorder sales increased 5.5% to $206.3 million, while new-order sales increased 9.6% to $42.9 million.
- Internet sales increased 7.8% to $205.6 million and represented 82.5% of reported sales, compared with 81.3% in fiscal 2016. Contact-center sales declined 0.8% to $43.5 million.
- Cost of sales increased 7.2% to $169.9 million, and gross margin declined because of higher product costs on certain brands and additional customer discounts.
- Operating expenses declined 4.7% to $41.8 million. Advertising expense fell 19.1% to $17.7 million after television advertising and other less-efficient spending were eliminated. Customer acquisition cost improved to $34 from $45.
- General and administrative expense increased 7.0% to $22.8 million, primarily because of higher stock compensation, headquarters relocation costs, bank fees, chargebacks, and other professional and office expenses.
- Depreciation increased to $1.4 million from $0.8 million because of additions associated with the new headquarters and distribution facility.
- Operating cash flow increased substantially, aided by higher net income, a $5.4 million reduction in inventory, and a $10.2 million increase in accounts payable.
- The company purchased its Delray Beach property for $18.5 million plus closing costs in January 2016, occupies approximately 97,000 square feet, and leased 48% of the property to two tenants at March 31, 2017.
Guidance, Outlook, Risks, and Unusual Items
- Management anticipated fiscal 2018 advertising expense of approximately 7% to 8% of sales and an effective tax rate of approximately 37.0%. The filing provides no formal sales or earnings guidance.
- Management forecast approximately $1.0 million of fiscal 2018 capital expenditures, to be funded from operating cash flow, and stated that it had no current need or plans to obtain additional capital.
- Sales are seasonal, particularly for heartworm and flea-and-tick products. Fiscal 2017 sales were distributed approximately 29%, 25%, 21%, and 25% across the June, September, December, and March quarters.
- Four suppliers represented approximately 50% of product purchases. The company relies partly on domestic distributors and other secondary sources and has no guaranteed supply or prices.
- Key risks include pharmacy licensing and prescription-dispensing compliance, administrative complaints, competition from veterinarians and online and traditional retailers, pricing pressure, inventory management, supplier concentration, customer acquisition costs, payment fraud and chargebacks, cybersecurity, technology outages, and reliance on a single South Florida operating location.
- The company has settled prior complaints filed with state pharmacy boards and states that routine litigation and administrative complaints are not expected to have a material effect; however, future regulatory actions cannot be assured against.
- The company early adopted ASU 2016-09 for share-based compensation in the fourth quarter, including a $156,000 reclassification of year-to-date excess tax benefits into income tax expense. Management reported effective disclosure controls and internal control over financial reporting, and RSM US LLP issued unqualified audit opinions.
- A previously discontinued information-technology project generated a one-time $1.7 million charge in fiscal 2015; the filing states that it had no fiscal 2017 impact and requires no additional expenditures.
Most Important Facts to Verify
- Whether gross-margin pressure from product costs and customer discounts persists despite continued sales growth.
- Whether reduced advertising spending can sustain new-customer acquisition and reorder growth.
- The company’s ability to maintain pharmacy licenses and comply with state and federal prescription regulations.
- Supplier availability, pricing, and concentration, particularly for high-volume prescription and preventative products.
- Seasonal sales performance and quarterly volatility in fiscal 2018.
- Use of excess cash among dividends, the remaining $10.2 million share-repurchase authorization, capital expenditures, and operating needs.
- Execution and utilization of the Delray Beach headquarters and distribution property, including tenant occupancy and lease revenues.