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 supplies primarily for dogs and cats. The company markets through national advertising, its website, and a contact center.
This Form 10-Q covers the three months ended June 30, 2018, the first quarter of fiscal 2019. Comparative results are for the three months ended June 30, 2017. The financial statements are unaudited. The company adopted ASC 606 on April 1, 2018 using the modified retrospective method, with no opening balance adjustment and no restatement of comparative information.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Sales | $87.4 million | $79.7 million | +9.7% |
| Gross profit | $30.0 million | $27.5 million | +9.1% |
| Gross margin | 34.3% | 34.5% | Down 0.2 percentage points |
| Income from operations | $15.8 million | $14.4 million | +9.3% |
| Operating margin | 18.0% | 18.1% | Down 0.1 percentage points |
| Net income | $12.6 million | $9.3 million | +35.6% |
| Net margin | 14.4% | 11.6% | Up 2.8 percentage points |
| Diluted earnings per share | $0.62 | $0.45 | +37.8% |
| Operating cash flow | $22.0 million | $13.9 million | +58.5% |
Reorder sales increased 10.9% to $71.5 million and represented 81.8% of sales. New-order sales increased 4.6% to $15.9 million. Internet sales increased 11.5% to $74.3 million and represented 85.0% of total sales; contact-center sales increased 0.5% to $13.1 million. Approximately 169,000 new customers were acquired in each comparable quarter, while average purchase size increased to approximately $90 from $87.
Cost of sales increased 10.0% to $57.4 million, reflecting higher product costs and additional customer discounts. General and administrative expense increased 11.4% to $6.9 million, and advertising expense increased 6.6% to $6.7 million. Advertising cost per new customer increased to $40 from $37.
The effective tax rate declined to approximately 23.5% from 37.1%, primarily because the Tax Cuts and Jobs Act reduced the federal corporate tax rate from 35.0% to 21.0%. Interest and other income increased to $696,000 from $324,000, primarily due to higher interest income.
Financial Position, Cash Flow, Debt, and Liquidity
- Cash and cash equivalents were $94.6 million at June 30, 2018, compared with $77.9 million at March 31, 2018.
- Working capital was approximately $95.4 million, up from $87.1 million at March 31, 2018.
- Total liabilities were $28.8 million and shareholders’ equity was $123.9 million at June 30, 2018.
- The company reported no debt obligations, no outstanding lease commitments, and no off-balance-sheet arrangements.
- Operating cash flow was $22.0 million. Investing cash flow used $306,000, primarily for property and equipment, and financing cash flow used $5.1 million for dividends.
- The company had approximately $10.2 million remaining under its share repurchase plan, although no shares were repurchased during the quarter.
- Approximately $750,000 of capital expenditures was forecast for the remainder of fiscal 2019, expected to be funded from operating cash flow.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by both reorder and new-order sales, with reorder sales providing the majority of the increase.
- Gross margin declined modestly because of higher product costs and increased customer discounts.
- Operating expenses increased, but operating margin remained broadly stable because sales growth offset the expense increases.
- Net income and earnings per share benefited materially from the lower federal tax rate under the Tax Cuts and Jobs Act.
- Operating cash flow improved substantially, partly due to higher net income and a larger increase in accounts payable.
- The quarterly dividend paid increased to $5.1 million from $4.1 million. Subsequent to quarter-end, the board declared an increased quarterly dividend of $0.27 per share, estimated at approximately $5.6 million.
Guidance, Outlook, Risks, and Unusual Items
- Management expects advertising expense to be approximately 7.0% to 8.0% of sales in fiscal 2019, subject to seasonality and advertising availability.
- Management estimates a fiscal 2019 effective tax rate of approximately 24.0%.
- Sales are seasonal, particularly because of heartworm and flea-and-tick medications. Management cautions that increased competition and greater consumer price sensitivity could adversely affect sales and that continued growth is not guaranteed.
- The company expects to fund planned capital expenditures and operations from cash generated by operations and states that it has no current need or plans to obtain additional capital.
- The majority of cash and cash equivalents was invested in money market funds. Changes in interest rates could affect interest income and investment values.
- Past complaints filed with state pharmacy boards have been settled, but similar actions could occur in the future. The company also initiates litigation to protect its trademarks and cannot guarantee success.
- No legal proceedings, defaults, unregistered securities sales, or issuer share repurchases were reported during the quarter.
- Subsequent to quarter-end, the company approved the issuance of 47,450 restricted employee shares and 37,500 restricted director shares.
Important Facts for Investors to Verify
- Whether sales growth and customer retention continue after the seasonal second quarter and amid heightened competition and price discounting.
- Whether gross margin remains under pressure from product costs and promotional discounts.
- The sustainability of the unusually favorable tax-rate comparison and the company’s approximately 24.0% fiscal 2019 tax-rate estimate.
- Whether operating cash flow continues to benefit from working-capital movements, particularly accounts payable, or normalizes in subsequent quarters.
- The effect of dividends, potential share repurchases, and planned capital expenditures on the $94.6 million cash balance.
- Potential future actions by state pharmacy boards and the outcome of trademark-related litigation.
- The company’s adoption of ASC 606 and whether future disclosures identify any material changes in revenue recognition, returns, discounts, or contract balances.