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Executives

Bruce S. Rosenbloom - Chief Financial Officer

Menderes (Mendo) Akdag - President and Chief Executive Officer

Analysts

Mark Arnold - Piper Jaffray

Kristine Koerber - JMP Securities

Michael Kupinski - Noble Financial

Anthony Lebiedzinski - Sidoti & Company

Mitchell Bartlett - Craig-Hallum

Edward Woo - Wedbush Morgan Securities Inc.

PetMed Express, Inc. (PETS) F3Q09 (Qtr End 12/31/08) Earnings Call January 20, 2009 8:30 AM ET

Operator

Welcome to the PetMed Express Incorporated, doing business as 1-800-PetMeds conference call to review the financial results for the third fiscal quarter ended on December 31st 2008. 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 non-prescription pet medications and other health products for dogs, cats and horses direct to the consumer. 1-800-PetMeds markets its products through national television, online and direct mail advertising campaigns which direct consumers to order by phone or on the Internet and aim to increase the recognition of the 1-800-PetMeds brand name. 1-800-PetMeds provides an attractive alternative for obtaining pet medications in terms of convenience, price, ordering and rapid home delivery.

At this time, I would like to turn the call over to the company's Chief Financial Officer, Mr. Bruce Rosenbloom.

Bruce S. Rosenbloom

Thank you. I would like to welcome everyone here today. Before I turn the call over to Mendo Akdag, our President and Chief Executive Officer, I'd like to remind everyone that the first portion of this conference call will be listen-only until the question-and-answer session, which will be later in the call.

Certain information that will be included in this conference may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 or the Securities and Exchange Commission and may involve a number of risks and uncertainties. These statements are based on our belief as well as assumptions 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.

Let me introduce today's speaker, Mendo Akdag, President and Chief Executive Officer of 1-800-PetMeds. Mendo?

Menderes (Mendo) Akdag

Thank you, Bruce. Welcome everyone. Thank you for joining us. Today, we'll review the highlights of our financial results, and we'll compare our third fiscal nine months (ph) ended on December 31st, 2008 to last year's quarter nine months ended December 31st, 2007.

For the third fiscal quarter ended on December 31st, 2008, our sales were $43.4 million compared to sales of $37.3 million for the same period of prior year, an increase of 16%.

For the nine months ended on December 31st, 2008, our sales were $171.3 million compared to sales of $147.9 million for the nine months of the prior year, also an increase of 16%. The increase was due to increased reorders and new order.

For the third fiscal quarter, net income was $4.9 million or $0.21 diluted per share compared to $4.4 million or $0.18 diluted per share for the same quarter of the prior year, an increase to earnings per share of 15%.

For the nine months, net income was $17.3 million or $0.73 diluted per share compared to $15.1 million or $0.62 diluted per share a year ago, an increase to earnings diluted per share of 18%.

Reorder sales increased by 13% to $32.2 million for the quarter compared to reorder sales of $28.4 million for the same quarter the prior year.

For the nine months, the reorder sales increased by 16% to $119.6 million compared to $103.4 million for the same period a year ago.

New order sales increased by 25% to 11.2 million for the quarter compared to $9 million for the same period of prior year. The increase in new sales can be directly attributed to an 18% increase in advertising spending with a better return compared to the same quarter last year.

For the nine months, the new order sales increased by 16% to $51.6 million compared to $44.4 million for the same period last year.

We acquired approximately 154,000 new customers in our third fiscal quarter compared to 127,000 for the same period the prior year. And we acquired approximately 650,000 (ph) new customers in the nine months compared to 585,000 for the same period a year ago.

Our average retail order was approximately $28 for the quarter compared to $36 (ph) for the same quarter the prior year. And approximately 66% of our sales were generated on our website for the quarter.

Seasonality in our business is due to the proportion of tick and heartworm medications in our product mix. Spring and summer are considered peak season with fall and winter being the off season. For the third fiscal quarter, our gross profit as a percent of sales was 39.9% compared to 40.6% for the same period a year ago.

For the nine months, our gross profit as a percent of sales was 38.5% compared with 38.9% for the nine months a year ago. The percentage decrease can be attributed to increased product costs offset by the impact of reduction (ph) in freight expenses due to a shift from priority to standard shipping.

Our general and administrative expenses as a percent of sales decreased to 11.6 % for the quarter compared to 12.2% for the same quarter the prior year. And for the nine months, the G&A expenses as a percent of sales were 9.6% compared to 10.5% a year ago. The improvement shows the leverage of the G&A.

For the quarter, we spent $4.9 million for advertising compared to $4.2 million for the same quarter prior year, an increase of 18%. For the nine months, we spent $23.6 million for advertising compared to $20 million a year ago, an increase of 14%.

Advertising cost of acquiring a customer for the quarter was approximately $32 compared to $33 for the same quarter the prior year. And for the fiscal year it was $36 (ph) compared to $35 for the same period a year ago.

Our working capital increased by $20.3 million to $59.1 million since March 31st, 2008. The increase can mainly be attributed to cash flow generated from operations and reduction of long-term auction rate securities investments.

We had $43.7 million in cash and temporary investments and $14.7 million in long-term auction rate securities investments, and $19.7 million in inventory, with no debt as of December 31st, 2008.

Net cash from operations for the nine months was $15.8 million compared to net cash from operations of $9.9 million for the same period last year, an increase of 60%.

In accordance with our share repurchase program, we repurchased approximately 336,000 shares, paying approximately $4.6 million during the quarter. And for the nine months, we repurchased approximately 580,000 shares, paying approximately $6.8 million.

Capital expenditures for the nine months were approximately $3.5 million which included warehouse expansion and automation and infrastructure update.

Overall, we're pleased with the results. The new order growth was encouraging and is an indication of consumers turning to 1-800-PetMeds to save time and money. Also, the favorable advertising environment enabled us to reach more of these new consumers during the quarter.

And this ends the financial review. Trisha, we're ready to take questions.

Question-and-Answer Session

Operator

Thank you. We'll now begin the formal question-and-answer session. (operator instructions). Mark Arnold with Piper Jaffray, you may ask your question.

Mark Arnold - Piper Jaffray

Good morning.

Menderes Akdag

Good morning.

Mark Arnold - Piper Jaffray

You mentioned the new customer growth was obviously very strong in the quarter. You hit on this a little bit right at the end of your prepared remarks. But do you have any way to gauge how much of that strength is related to the effectiveness of your targeted advertising versus customers may be seeking out cheaper alternatives or more convenient alternatives to visiting their veterinary clinic given the state of economy right now?

Menderes Akdag

That's difficult to point. Having said that, obviously we spend more money. We spent about 18% more in the December quarter compared to the same quarter last year. And our... dollar wise, revenue wise, new orders grew 25%. So we gained basically 7% which is we got better results. We got $32 customer acquisition cost this quarter compared to $33 same quarter last year. So it was a better... little better response and average order size was a little higher.

Mark Arnold - Piper Jaffray

Okay. I knew that was our question. I just... it'd be interesting to... I'm sure you'd be interested in it as well, trying to understand what's really driving that up. I guess, one other follow-up on that then, given that veterinary clinic business during the fall here had been down a bit. Historically when veterinary clinic business had been down, is that a good or a bad thing for your business?

Menderes Akdag

It is... my guess is going to be, it's probably a good thing. If they are not going to the best, they're more likely to refill their pet medications through sources like us.

Mark Arnold - Piper Jaffray

Okay, but you don't typically see a drop-off in the amounts filled... they're filling in at a different place?

Menderes Akdag

No.

Mark Arnold - Piper Jaffray

Okay. And then just one final question for me. The advertising environment, you said it was favorable. Give any sense of how you see that shaping up here in the next few quarters or any visibility as to whether that's going to remain attractive for you guys going forward here?

Menderes Akdag

My guess will be, it should remain favorable to us.

Mark Arnold - Piper Jaffray

Okay. Thank you very much.

Menderes Akdag

You're welcome.

Operator

Kristine Koerber of JMP Securities, you may ask your question.

Kristine Koerber - JMP Securities

Yeah, hi. First of all, can you talk about, if any change in trends in as far as consumer spending behavior during the quarter? Was that pretty consistent?

Menderes Akdag

It's fairly consistent for us. The reorder growth was a little soft which may be due to a decline in medication compliance by pet owners. Having said that, I wouldn't read too much into it since it was our off-peak season. But we'll watch if that trend continues.

Kristine Koerber - JMP Securities

Okay. And as far as gross margin, you talked about gross margin being down a little bit, because of product cost. Can you talk about pricing? I know you are planning on being a little more aggressive with the pricing during the quarter. Were you anymore aggressive than initially planned?

Menderes Akdag

We were not anymore aggressive than what we initially planned, but we gave additional discounts to our customers. In the current economic environment, consumers are seeking sales. So we gave them what they're looking for. And we did that to help medication compliance.

Kristine Koerber - JMP Securities

Can you just comment on the competition? Were they extremely aggressive on discounting?

Menderes Akdag

Really we focus on the veterinary interest where the market share is coming from. And there was no difference in competition compared to last year.

Kristine Koerber - JMP Securities

Thank you.

Operator

Michael Kupinski of Noble Financial, you may ask your question.

Michael Kupinski - Noble Financial

Thank you. I've just got a couple of questions. One is, I just wondered if you can just score for us what your thoughts are on your advertising campaign? You changed that to more animated characters that sort of thing. I was wondering if you saw any type of increased return just based on just the ad themselves and obviously your new customer growth and so forth. And you had favorable environment that I was just wondering what your thoughts were about the advertising itself. And then I have a couple of quick follow-up questions?

Menderes Akdag

We think the new creatives performed well.

Michael Kupinski - Noble Financial

No. Not at this time, no.

Michael Kupinski - Noble Financial

I would anticipate some continuing leverage on the G&A line.

Michael Kupinski - Noble Financial

You're welcome.

Operator

Anthony Lebiedzinski with Sidoti & Company, you may ask your question.

Anthony Lebiedzinski - Sidoti & Company

Yes, good morning. Got a couple of questions from me.

Menderes Akdag

Good morning.

Anthony Lebiedzinski - Sidoti & Company

Good morning. Hi, regarding your sales, can you comment as far as sales by region that you see any notable differences during the quarter?

Menderes Akdag

No, not any material difference from same quarter last year.

Anthony Lebiedzinski - Sidoti & Company

And as far as the gross margin, you had commented little bit about that, and you also mentioned that you did some discounting during the quarter. What are your plans for this quarter and perhaps maybe sort of what's your take on... where you think you'll do... you go ahead with the product pricing during the next few quarters?

Menderes Akdag

In the... as I said in the current economic environment, consumers are seeking sales. So we'll satisfy that request by the public. And we will be more aggressive price wise.

Anthony Lebiedzinski - Sidoti & Company

Okay. And my last question is regarding the tax rate which did... was a tad lower than I expected, any reason for that and also what are your expectations for the March quarter for the tax rate?

Menderes Akdag

The percentage decrease can be attributed to higher tax benefits from stock-based compensation options for the quarter compared to the same quarter last year. For the year, we... our estimate is about 35% to 36%.

Anthony Lebiedzinski - Sidoti & Company

All right, thank you.

Menderes Akdag

You're welcome.

Operator

Mitch Bartlett of Craig-Hallum, you may ask your question.

Mitchell Bartlett - Craig-Hallum

Hi, I wonder if you could just talk in a little bit more depth on the average order value, the average order size and how that continues to do fairly well. Is that just price inflation or is there a mix shift? Or is there anything... any component of that? And then also if you could just maybe touch on the customers and their repeat frequency. Are they coming back more often? Are they coming back for a different set of products, just whatever you can add to that equation?

Menderes Akdag

Okay. The average order size increase... I would say roughly half of the increase is due to price increases and the other half due to up-selling and cross-selling.

Mitchell Bartlett - Craig-Hallum

Okay.

Menderes Akdag

The product mix was a little different due to us focusing more of chronic illnesses.

Mitchell Bartlett - Craig-Hallum

Okay. The more pain medication and that type of thing.

Menderes Akdag

Yes.

Mitchell Bartlett - Craig-Hallum

Great. And on competition, I mean a number of us, I think, have noticed that Amazon seems to be fairly aggressive on price these days. But you are saying that your fight is against the best. And does it not matter that the rest of the channel gets more competitive as... rest of the direct marketing channel gets more competitive? Are you just taking share from the vets at this point?

Menderes Akdag

We're taking share... the share is coming from the vets, and we're a one-stop shop. We are licensed pharmacy to conduct business in all 50 states. Most of the competition, including the name that you've mentioned, is highly unlikely that they will only get into prescription medication. Also, with our advertising and brand name recognition, we're known to the public as pet medication experts.

This and our service levels are the keys for our future success, no matter who enters the market. And there was probably some excess inventory in the market. And it would be surprising if such deep discount can be sustained in the long term.

Mitchell Bartlett - Craig-Hallum

Is it showing up on your price matching at all with the deep discount, and when does that start maybe?

Menderes Akdag

Not anymore than it did before.

Mitchell Bartlett - Craig-Hallum

Okay. Okay, very good. Thank you.

Menderes Akdag

You're welcome.

Operator

(operator instructions). Ed Woo of Wedbush, you may ask your question.

Edward Woo - Wedbush Morgan Securities Inc.

Yeah. Is... was there any difference in the performance to clean (ph) your prescription and non-prescription products and what's the percentage of your products from non-prescription?

Menderes Akdag

For the year it's 70% over the corner and 30% prescription, but off-peak season it skews more to prescription. There is more prescription and less OTC. Still OTC is the majority, but the prescription is higher than 30% during our peak season. It ranges to 40-42% range.

Edward Woo - Wedbush Morgan Securities Inc.

And did you see any changes other than normal seasonality in terms of people buying more or any effect from now I guess the retail weakness?

Menderes Akdag

It was a bit more skewed to prescription this off-peak season compared to last year.

Edward Woo - Wedbush Morgan Securities Inc.

And on an administrative question, how long are pet prescription usually good for... before somebody would have to go back to a vet to be out of order medicine?

Menderes Akdag

It's good for one year.

Edward Woo - Wedbush Morgan Securities Inc.

Great. Thank you.

Menderes Akdag

You're welcome.

Operator

(operator instructions) Mitch Bartlett of Craig-Hallum, you may ask your question.

Mitchell Bartlett - Craig-Hallum

The capital expenditure, the amount that you were going to invest in the expansion of the warehouse and the call center and the like, has that been completed basically at this point?

Menderes Akdag

All was completed. We are very close.

Mitchell Bartlett - Craig-Hallum

And that worked well?

Menderes Akdag

Yes.

Mitchell Bartlett - Craig-Hallum

So how much additional dollars do you think you'll spend in the fourth quarter?

Menderes Akdag

Thanks. That's all I have.

Operator

There are no further questions at this time.

Menderes Akdag

Thank you, Trisha. We'll be focusing our efforts in three areas to capitalize on the pet industry's growth trend: one, capturing additional market share; two, increasing reorders with personalized communication and health education content; and three, improving our current service levels.

This wraps up today's conference call. Thank you for joining us. Trisha, this ends the conference call.

Operator

Thank you. Thank you for your participation. You may now disconnect.

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