drugstore.com Q1 2009 Earnings Call Transcript

| About: drugstore.com, inc. (DSCM)

drugstore.com, inc. (NASDAQ:DSCM)

Q1 2009 Earnings Call

April 29, 2009 05:00 AM ET


Brinlea Johnson - Director, The Blueshirt Group

Dawn Lepore - Chief Executive Officer and Chairman

Tracy Wright - Vice President and Chief Finance Officer


Mark Argento - Craig-Hallum


Ladies and gentlemen, thank you for standing by. Welcome to the drugstore.com 2009 First Quarter Earnings Conference Call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Wednesday, April 29, 2009. I would now like to turn the conference over to Ms. Brinlea Johnson. Please go ahead, ma'am.

Brinlea Johnson

Good afternoon. Welcome to the drugstore.com Q1 2009 earnings call. With me today is Dawn Lepore, Chairman and Chief Executive Officer; Tracy Wright, Chief Finance Officer; and Rob Potter, Chief Accounting Officer.

Before we get started, we would like to remind you that the information on this call may include forward-looking statements. Words such as expect, believe, anticipate and similar expressions are intended to identify forward-looking statements, which involve risks and uncertainties that could cause drugstore.com's actual results to differ materially from those discussed in the forward-looking statements.

In particular, comments about drugstore.com's anticipated future revenues, earnings and growth rates are forward-looking. Factors that could cause actual results to differ materially from anticipated results are detailed in our periodic filings with the SEC.

I'd also like to point out that during the call we do mention certain non-GAAP financial measures, which will be explained during the call. A reconciliation of these non-GAAP measures to most comparable GAAP measures can be found in our earnings press release, which was made available prior to today's call.

Finally, today's call is being recorded and will be available for replay on drugstore.com's website at www.drugstore.com under Corporate Information. In addition, the earnings press release for the first quarter 2009, including a summary of our financials and supplemental financial information discussed on this call will be also available on our website, also under Corporate Information.

With that, I'll turn the call over to Dawn Lepore, Chairman and Chief Executive Officer.

Dawn Lepore

Thanks Brinlea. Good afternoon everyone and thank you for joining us. Last quarter I've added three key areas of focus for the company in a more challenging consumer environment.

First, we'll focus on growing our OTC and vision businesses at a faster rate then eCommerce. Second, we're leveraging our profitability initiative to drive further bottom-line improvements even as our customers are taking advantage of more promotions. And finally we're implementing our longer term strategic initiatives that will help us towards incremental growth this year and accelerate our growth moving forward.

I'm very pleased to announce that we've made substantial progresses in all of these areas in the first quarter, posting one of our strongest quarters to date, despite facing a very tough economy.

Here are key highlights from the first quarter. Overall revenues were $98.3million, the highest in company history. OTC revenue grew over 11%, well ahead of recent eCommerce industry trends. Importantly our beauty business grew at an even faster pace, increasing 14% despite the decline in beauty industry. This offers clear evidence that we can continue to gain market share in the current environment.

Our vision business also showed great progress, increasing 13% over last year ahead of the industry. We had a very strong quarter of new customer additions, with 15% new customer growth, inclusive of contributions from strategic partners.

Gross margins were solid at 28.2%, clearly demonstrating how our profitability initiatives enable us to counter balance the increase customer take rate on promotions. Our progress translated to the bottom line, as we delivered record adjusted EBITDA of $5.6 million, which more than doubled over the previous year period. And we once again generated positive net income.

Additionally we finally resolved a seven year old tax case with the State of New Jersey. In the end we think we reached a resolution that worked well for both parties and benefited our bottom-line this quarter, raising our net income to $1.3 million.

I believe our record performance in the first quarter offers evidence that we can continue to grow in a difficult economic environment, while also improving the strategic positioning of the company.

Now, let's go over the first quarter details. Our strong performance starts with our OTC business. We saw customer behavior similar to the fourth quarter, posting order growth of 14% with smaller basket sizes due to both customers putting half unit less in their baskets and increased utilization of discounts.

One clear sign of the impact of the current environment was the over 50% drop in the year-over-year expedited shipment as our customers look to save every dollar they can. There's several notable advantages over other eCommerce and brick and mortar companies in this economy. Most importantly we sell a very high percentage of replenishment items, which account for over 60% of OTC sales.

Once again, higher replenishment categories did well this quarter, including vitamins and supplements, up 22%; skin care, up 26%; and pet care up an impressive, 55%, year-over-year. Additionally beauty growth continued to outperform our OTC growth, as both our overall beauty and beauty.com sales growth accelerated from the fourth quarter, increasing to 14% year-over-year. This compares very favorably to our competitors as NPD reported that the prestige beauty industry experienced a 5.3% decline for the quarter.

Our Vision business continues to exceed expectations, up 13% year-over-year versus overall industry growth in the low single digits. New customer growth was 17% for the quarter, while baskets increase 6.5% year-over-year. In the current environment we believe customers are increasingly moving online to shop for the best deals on contact lenses.

Improvements in our product margin due to pricing and sourcing changes enabled us to be more aggressive in our email marketing and promotion to attract and retain customers. With the strong performance in Q1 we are clearly on track to grow vision in the high single to low double-digit range in 2009.

Moving to pharmacy, as expected Rx mail order revenues decreased 28%, primarily due to the 2008 acquisition of one of our PBM partners. At the same time gross margins increased 20 basis points, in part due to continued price improvements. Looking forward we expect pharmacy to settle at a run rate of 8 million to $8.5 million in revenue per quarter, with healthy contribution margins.

From a operating basis we had a very successful quarter. We achieved our highest conversion in company history, while cost per new customer decreased 1% year-over-year as the marketing and merchandising teams delivered the right promotions at the right time.

Increased utilization of promotions continues to have an impact on margin. But while down sequentially, OTC margins still increased 10 basis points from the prior year as a result of the profitability initiative that we put in place. We're effectively managing our variable costs and contribution margin increased by a 100 basis points year-over-year, mostly due to our investment in our distribution centre excellence program. In fact labor fulfillment cost per order decreased over 10% compared to last year.

We recently implemented our second major round of pricing adjustments, which will impact thousands of our SKUs with both price increases and decreases.

Moving forward we will continue to use counter metric data to make pricing adjustments to benefit our business. Our focus remains on driving both increased revenues and greater overall contribution to our bottom-line.

Complimenting our efforts will be our strategic initiatives and partnerships. At the end of last year we launched our OTC store, with Rite Aid. While the revenues are not yet material to our overall growth, we saw steady progress in Q1.

Turning to our international roll out with E4X, we're still in the learning phase of developing and testing new marketing strategies, with alternative shipping options. But we expect increasing contributions in the second half of the year as we expand our marketing efforts.

Finally, our partnership with Medco Health Solutions, the nation's leading Pharmacy Benefit Manager is set for launch in the second quarter, with a notable ramp in the second half of the year. We believe our partnership is on track and we are in active conversations with other potential partners.

We're also leveraging our success in the current market to expand our beauty business. A strong growth, despite the downturn in the industry has made us an even more attractive potential partner for the major beauty brands. Our customers are responding well to our new brands and they accounted for a healthy part of our growth.

As industry growth has declined and the retail landscape has changed with further consolidations, cosmetics centers are actively searching for ways to grow. Overall we remain confident that we can grow Beauty.com in the 10 to 20% range in 2009 and as importantly lay the ground work for accelerated growth by adding larger brands and new customers.

In summary I am very encouraged with our results for the quarter of 2009. We're focused on our customer base. A high percentage of replenishment items and the success of our promotional activities are the key factors that enabled us to continue to grow, despite the downturn of the economy. Not only do I feel that we've delivered strong results this quarter, I'm also pleased with our strategic position. I believe everything we're doing, our product offering, customer service and partnerships position us well to execute on our long term strategy.

While we are closely focused on delivering in the current challenging environment, we're never losing sight of laying the groundwork for our future success. With that I'll turn the call over to Tracy, our Chief Finance Officer for the Financials.

Tracy Wright

Thanks Dawn. Over the next few minutes I'll walk you through some of the first quarter key metrics and then provide second quarter 2009 guidance.

Before I began, please note that all comparisons with last quarter and last year's numbers, excluded the local pick-up pharmacy business, which as of September 4, 2008, we now report as discontinued operation.

As Dawn mentioned earlier, this quarter we reached a resolution with the State of New Jersey regarding revenues taxes owed by new company for the years 2000 to early 2008. As a result, we recorded a $1.2 million benefit, which positively impacted our net income and adjusted EBITDA for the quarter.

First quarter net sales were a record $98.3 million, up 6% year-over-year. Looking at each one of our business segments, OTC once again was the key driver as net sales grew by over 11% to $72.1 million or approximately 73% of total sales. Vision sales improved by 13% year-over-year to $17.4 million and mail-order pharmacy net sales decrease 28% to $8.8 million.

Overall average net sales per order remained flat sequentially at $67 and were down slightly year-over-year. On a segment basis, average net sales per order was $57 in our OTC segment, $115 in the vision segment and $151 for mail-order pharmacy.

In the first quarter, net sales from repeat customers represented 77% of total sales and new customers, inclusive of our strategic partnerships increased an impressive 15% year-over-year to 400,000, bringing our total life-to-date customer base 10.2 million unique customers. Our trialing 12-month active customer base grew by 10.5% year-over-year to 2.7 million.

Now I'll move on to gross margin. Similar to last quarter we saw our customers take advantage of promotions. In fact in the first quarter there was a 10% increase in utilization of discount, and there was 56% reduction in expedited orders, as our customers were willing to wait longer in order to save on shipping.

Despite the increased promotions, gross margin remained solid at 28.2% in the first quarter, up 80 basis point over the prior year period, as margins benefited from our profitability initiative as well as from improving sales mix. This gross margin expansion help drive 12% year-over-year growth in contribution margin dollars, bringing them up to $19.9 million for the quarter.

Moving on to expenses; marketing and sales expense for the first quarter was $9.4 million, or 9.6% of net sales, compared to 9.7% in the fourth quarter of 2008 and 9% of net sales in the first quarter of last year. The year-over-year increase in marketing and sales expense as a percentage of sales is largely due to the growth in new customers, as well as an increase in stock-based compensation expense.

Marketing and sales expense per new customer in the first quarter remained relatively in line at $23.50. This compares to $22 in the fourth quarter of 2008 and $24 in the prior year period. For the first quarter of 2009 fulfillment and order processing expense was $11 million or 11.2% of net sales, flat with the first quarter of 2008 and down significantly from 11.9% in the first quarter of 2008.

The 70 basis point year-over-year improvement was primarily driven by the reduction in labor fulfillment cost per order as a result of our successful operational excellence program implemented earlier this year. And to a lesser extent reduced consulting expense.

Technology and content expense for the first quarter of 2009 was $5.9 million, or 6% of net sales, versus 6.5% in the fourth quarter of 2008 and 5.6 % in the first quarter of 2008. The 50 basis points sequential improvement is due to leveraging our infrastructure with increased sales. A 40 basis points year-over-year increase in tech and content expense was primarily driven by an increase in depreciation expense as new technology projects were placed into service.

General and administrative expense was $2.9 million or 2.9% of net sales, down a 120 basis points sequentially and 290 basis points from the prior year period due to the impact of the New Jersey tax case. Excluding New Jersey tax case benefit, G&A expense was 4.1%, flat with the fourth quarter of 2008. This was an improvement of 170 basis points year-over-year due to a reduction in consulting costs associated with the profitability spend in the first quarter of 2008, and of the increase in stock compensation expense.

For the first quarter non-cash stock-based compensation expense was $1 million and depreciation expense was $3.1 million. Looking ahead to the second quarter of 2009, we expect non-cash stock-based compensation expense to be $1.1 million and depreciation expense to be $3.5 million. On a GAAP basis, the company reported a net income of $1.3 million or $0.01 per share, compared to net income of $289,000 in the fourth quarter of 2008 and a net loss of $2.7 million or $0.03 per share in the first quarter of 2008.

Our adjusted EBITDA this quarter was up sequentially to $5.6 million and more than doubled from $2 million in the prior year period. Without the benefit associated with the resolution of the New Jersey tax case, our net income and adjusted EBITDA would have been approximately 130,000 and $4.4 million respectively.

We ended the first quarter with an employee base of approximately 840 FTEs. CapEx for the quarter, inclusive of capitalized labor associated with internally developed software projects was approximately $1.7 million, a 66% reduction year-over-year. We ended Q1 with a strong balance sheet and over $36.7 million in cash, cash equivalents and marketable securities.

Negative free cash flow of $580,000 in the first quarter was primarily due to normal working capital fluctuations. We expect to generate positive free cash flow for the full year of 2009.

With that as a review of first quarter results, we move on to our outlook for the second quarter of 2009. It still remains a very challenging market with weakened consumer spending. At the same time our strong first quarter results give us confidence that we can execute ahead of the industry. The company is targeting net sales in the range of 93 to $97 million, net income in the range of $250,000 through a net loss of $1.75 million and adjusted EBITDA in the range of 3 to $5 million.

We'll now move on to Q&A. Operator?

Question-and-Answer Session


Thank you ma'am. We will now begin the question-and-answer session. (Operator Instructions). And our first question comes from the line of Mark Argento with Craig-Hallum. Please go ahead.

Mark Argento - Craig-Hallum

All right good afternoon.

Dawn Lepore

Hi Mark.

Mark Argento - Craig-Hallum

Quick question around the customers, I mean 400,000 new customers, that's a pretty big number. Could you give little color as to where you are finding success in terms of driving new customers in and then any specifics in terms of some of the contribution from some of the relationships partnerships that you have?

Dawn Lepore

The new customers from partnerships was not particularly material this quarter. So it's mostly drugstore customers. And the channels were the same as always, affiliate search, those are channels that are very good for us, when your customers always had been very strong this quarter as well. And I think it's a matter of just having good promotions, good pricing, good range of products. As we mentioned our conversion is strong. Our customers are really liking what they see when they get to the side. And I think that we're priced very effectively and we are promoting very effectively. And I think that's really helped us with our new customers.

Mark Argento - Craig-Hallum

Any type of products doing better than others, given the economy?

Dawn Lepore

No, we have certainly have seen private labeled products do a littlie better. So people are trading whether you say, up or down to private label products and January is always a good month for resolutions. So we see Direct and Federal (ph) do very well in the first quarter, FSA, so the normal FSA products did very well. And we mentioned a couple of the category supplements, pets et cetera, they were up very strongly. They are mostly replenished items. So I would say beauty was strong and replenishment items were strong, that's the summary I would give.

Mark Argento - Craig-Hallum

Are you happy with the I think you said beauty grew 14%, I know it's a highly discretionary item. At the same time, historically in recessions we have seen some of simpler things like make-up and some of the lower $100 items tend to kind of hang in there a little bit better. What's gone on with that business in particular?

Dawn Lepore

Well I think 14%, I was pleased with 14%. We've talked about 10 to 20% range for this year. So I think 14% for both Beauty.com and our overall beauty business with very strong, especially when you look at the NPD data that said the industry was down 5%. So that's a pretty big swing from minus 5% for the industry to plus 14% for us.

We've added some good new brands. Those are doing very well. They've contributed to our growth. So once again I think our customers are liking what they see when they get to the site and they are coming back and our bags are still successful, so all the marketing programs that we've continued to do in beauty continue to work.

Mark Argento - Craig-Hallum

Sure, and this real quickly in terms of can you just walk me through maybe Tracy could help me, in terms of the gain, I know you have the tax situation and I soon that came to the P&L for Q1 here and you said a net gain of 1.2 million but where -- can you just walk me through how that kind of hits the P&L?

Tracy Wright

Sure, it's...

Mark Argento - Craig-Hallum

I know you got it, it looks it's netted off against G&A.

Tracy Wright


Mark Argento - Craig-Hallum

Is that all...?

Tracy Wright

That's all. It's all in G&A and you'll see it there and then obviously our adjusted EBITDA and our net income were affected.

Mark Argento - Craig-Hallum

And then I saw there's a seems you guys term it the net saving (ph) gain from discontinued operations. Is that a tax of $2.985 million. What is that item?

Dawn Lepore

That's LPU, Mark, that's where LPU shows up every quarter. Our local pickup business with Rite Aid, is that correct Tracy?

Tracy Wright


Mark Argento - Craig-Hallum

So that's the million a month?

Dawn Lepore

Yes exactly

Mark Argento - Craig-Hallum

And that, how long does that extend for?

Dawn Lepore

Through the second quarter and I believe is that

Tracy Wright

Through June.

Dawn Lepore

Through June, yes.

Mark Argento - Craig-Hallum

Thank you very much.

Dawn Lepore

Thanks, Mark.


Thank you. (Operator Instructions). And I am sorry there's no further question in queue. I'll turn back over to Ms. Lepore for any closing remarks.

Dawn Lepore

Thank you all very much for joining us today. We're pleased with our quarter. And we look forward to keeping posted as the year progresses. Thanks very much.


Thank you, madam. Ladies and gentlemen, if you'd like to listen to a replay of today's call please dial 303-590-3000 or 800-405-2236. Enter the pass code 11130228. Once again those numbers are 303-590-3000 or 800-405-2236, enter the pass code 11130228.

And that concludes today's drugstore.com 2009 first quarter earnings conference call. Thank you for your participation. You may now disconnect.

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