Earnings Call Transcript - PETS Q2 2021

Operator, Operator

Welcome to PetMed's conference call to review the financial results for the second fiscal quarter ended on September 30, 2021. At the request of the company, this conference call is being recorded. Founded in 1996, PetMed is America's most trusted pet pharmacy, delivering prescription and nonprescription pet medications and other health products for dogs, cats and horses direct to the customer. PetMed markets its products through national advertising campaigns which direct customers to order by phone or on the Internet to increase the recognition of the PetMed brand name. PetMed provides an attractive alternative for obtaining pet medications in terms of convenience, price and ease of ordering and rapid home delivery. At this time, I'd like to turn the call over to the company's Chief Financial Officer, Mr. Bruce Rosenbloom.

Bruce Rosenbloom, CFO

I would like to welcome everybody here today. I would 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. Also, certain information that will be included in this press conference may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 or the Securities and Exchange Commission that may involve a number of risks and uncertainties. These statements are based on our beliefs as well as assumptions we have 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 now introduce our newly appointed CEO and President, Matt Hulett. Matt?

Matthew Hulett, CEO

Thanks, Bruce. Good morning, and thank you for joining us. My name is Matt Hulett, and I'm the new CEO of PetMed. I'm incredibly honored and enthusiastic to join this iconic company, and I'm excited to be on this earnings call today. I would like to begin by thanking Bruce Rosenbloom for acting as interim Chief Executive Officer prior to my arrival. Before we update you on our progress on Q2, I would like to first share my personal thoughts and motivations regarding why I'm so optimistic about PetMed and our future. First, I'd like to introduce you to my dog, Harry, who's featured on this slide. He's the latest addition to our family and he's also a puppy. In fact, Harry is the first dog for my family. Our family had no idea what we were getting ourselves into. It's like having a newborn again, and as many of you fellow pet parents know, puppies can be challenging. We also can't imagine not having Harry in our lives, and we think of him as a member of our family. Personally, it is fulfilling to be involved in an organization where you can spend your time and energy on a business that has a positive social impact on society, while you are focused on generating returns for shareholders. Now that we've established my personal connection to the business, I'd like to spend some time walking through the rationale as to why I believe PetMed is a great long-term investment. Having a large addressable market is important. It enables more optionality for new brands and products to be developed. It provides more opportunity to develop a myriad of go-to-market strategies, targeted at different cohorts of customer segments. This also means that there's room for more market participants and for those market participants to coexist and flourish. The pet industry's total addressable market is very large, and it is growing. Currently, it is over $100 billion and the service addressable pet medication market, where we have participated to date, is approximately $10 billion. We are one of the leading pet pharmacies today. And as such, I see a future where we can extend our already sizable customer reach, combined with our widely respected and known brand into additional segments of the total pet care market as our future vision comes fully into focus. In addition to the benefits of participating in a large market, the market timing is also considerably favorable. Pet ownership has always been high in the United States, but we have seen an increase in pet ownership, especially due to the macro effects of COVID-19. Pet ownership has surged to record heights and now 7 out of 10 U.S. households own a pet. Those new and existing pet parents will need more pet medications and other related health care services for their pet family members. As we have seen in other digital e-commerce verticals, the adoption curve of the digitization of retail is a favorable tailwind. This pull-forward of digital-based retail experiences has now given customers a taste of the future and has created new buying habits of purchasing more products and services online. Today, our addressable market is largely dominated by offline sales, and we see the trend to purchase online is clearly very favorable to us. Pet parents see their pets as an extension of their own families, and they are increasingly demanding more healthy pet care options for their furry friends. We see this as a positive trend for PetMed and an opportunity. For example, we have increased the number of products that we carry and have started to include specialty dog food and higher-end wellness products, which we believe have contributed to the increase in our average customer order value. Lastly, just like we've seen in the human health care market, COVID-19 accelerated the increasing trend for the digitization of health care. In fact, in the pet market, for the first time, regulations related to in-person veterinary visits and prescription fulfillment were temporarily waived and moved online in unprecedented ways. We think this opens the door to the acceleration of digital-based telehealth services. As I look at the business, there are several key competitive advantages that we can leverage in the future. First, our brand is widely known and trusted. Having a strong brand takes years to develop, and our customers view PetMed as their trusted pharmacy and as their pet medication experts. Second, we have strong operational and quality efficiency as a pharmacy. Our customer care integration with our pharmacy is world-class, which ensures that customers get their products delivered quickly, but also accurately. Our vet partners receive high-quality fulfillment and service delivered through our vet platform. Our deep experience with the vet community is a latent competitive advantage. We currently have one of the largest direct-to-consumer vet networks in the online retail space. PetMeds has a large network of over 70,000 veterinarians that we have worked with over the company's history. Our online vet portal currently has 17,000 veterinarians and vet clinics. This is a core capability and asset because it enables us to expand our fulfillment capability as we scale our business. Our prescription medication authorization rates are the highest they have ever been, which speaks volumes to the level of veterinarian cooperation we receive. Our pet pharmaceutical category expertise is something that I view as a unique strength. Being a differentiated provider allows PetMeds to focus our offering, especially as the market continues to get even more competitive. Again, more to come on where we see our branded business going in the coming months. PetMeds has long enjoyed close bonds with many of our supplier partners. Those relationships have developed over time to become even more strategic. Today, we have direct relationships with all our major suppliers and we partner with them to market their products to our customer base. Our customer service and overall customer-centric ethos permeates our culture and our team. I've personally sat in on hours of phone calls between our customers and our service agents and I've never experienced such a tightly integrated and empathetic customer-centric organization in my entire career. We don't just have a transactional interaction with our customers, we have built trusted relationships. Before we comment on our earnings performance, I would like to reiterate several compelling reasons to invest and to continue to invest in PetMeds. PetMeds has several core fundamentals that are compelling, including: a strong balance sheet. We do not have debt. We have over $100 million in cash, and we are cash flow positive. We have a long history of providing shareholder returns through our dividend and a strong return on equity that has been historically over 30%. We have started to build a recurring subscription base to our customers with a program, which we just recently launched in July of this year through our new AutoShip & Save program, where we are building higher lifetime value and recurring relationships with our customers. In September, approximately 20% of our customers signed up and ordered via our AutoShip & Save subscription program, and that number continues to rise. Our customers responded very positively and enrollment in AutoShip & Save has increased steadily throughout the quarter. We expect many of our reorder sales to eventually transition to AutoShip & Save by the end of our fiscal year, which will only continue to strengthen our relationship with our customers. We also continue to have a large base of returning customers, which is an indication of the quality of service and the value that we deliver to our customers. So to sum up the core company strengths, we have over 25 years of experience as a pure-play pet pharmacy, licensed in 50 states, delivering fantastic service and value, which is recognized by our customers and continues to be rewarded with their loyalty. Our NPS score is over 80, which puts us in the upper quartile along with some of the most beloved brands in the world. We are a direct-to-consumer brand with a rapidly growing addressable market, and we have successfully serviced more than 2 million active customers over the last two years. Now I would like Bruce Rosenbloom, our Chief Financial Officer, review our financials for the quarter.

Bruce Rosenbloom, CFO

Thanks, Matt. Now we'll review the financial results. We will compare our second fiscal quarter ended on September 30, 2021 to last year's quarter ended on September 30, 2020. And in some cases, we'll refer back to September 30, 2019. Similar to the quarter ended June 30, 2021, we faced a unique situation comparing two totally different environments between the 2020 pandemic and the 2021 post-pandemic. We were coming off a strong September quarter last year, which was primarily driven by increased e-commerce demand as a result of the pandemic, which caused many retail stores to close and many veterinarians to be unavailable. However, during the most recent quarter, while the pandemic was abating and retail stores and veterinarians were open for business, the advertising market continued to surge with increased demand, dramatically driving up CPC and CPM rates by more than 50%. As a result, we spent approximately 33% less on advertising due to these cost increases. For the second fiscal quarter ended on September 30, 2021, sales were $67.4 million compared to sales of $75.4 million for the same period the prior year, a decrease of 10.7%. But sales were only down 3.6% versus the quarter ended September 30, 2019, prior to the pandemic. The decrease in sales was due to decreases in both new order and reorder sales. Our sales were negatively impacted by a much more competitive market in a crowded advertising space with substantially higher costs compared to the same quarter last year. In addition, during the past six months, there was a dramatic increase in veterinarian visits by both pet owners who were unable to visit their veterinarian during the pandemic. We believe the increase in veterinary visits was primarily due to pet owners needing to visit their veterinarians for their pet exams and to renew their prescriptions. Since some pet owners purchase medications directly from their vets during the visit, the company believes this negatively impacted sales and especially reorder sales during the quarter. We were disappointed with our sales results during the quarter. However, sales were trending more positively in the months of August and September 2021 when you compare them to August and September 2019. Reorder sales decreased by 8.5% to $62 million for the quarter compared to reorder sales of $67.8 million for the same quarter last year. While for the quarter ended September 30, 2019, our reorder sales were $61.9 million. Encouragingly, reorder sales in the most recent quarter, while down versus a year ago, were up slightly compared to 2019 pre-pandemic. We would expect to see stronger reorder sales in the back half of fiscal 2022 as we anticipate more prescriptions being renewed. A positive trend to highlight for the quarter was the continued increase in our average order size. Our average order value was approximately $92 for the quarter compared to $87 for the same quarter last year and $85 for the quarter ended September 30, 2019. The increase in AOV can be attributed to a shift in our product mix to more prescription items and less over-the-counter items, with prescription items having a higher gross margin profile in comparison to over-the-counter items. As I mentioned earlier, during the quarter ended September 30, 2021, the advertising market was extremely competitive. And this increased demand drove up ad prices dramatically. As a result, our advertising spending was less efficient than usual and delivered fewer impressions than in prior years. Because of this, we believe our advertising spending was less effective in the most recent quarter in its ability to attract new customers. New order sales decreased by 30% to $5.4 million for the quarter compared to $7.7 million for the same quarter of the prior year. We acquired approximately 65,000 new customers in our second fiscal quarter compared to 96,000 for the same period the prior year. However, we anticipate that advertising prices should revert back to more normal levels as the pandemic further subsides, which should help increase the efficiency and effectiveness of our media spending and thereby continue to help us gain more new customers in the future. We are also in the process of reevaluating many of our current marketing relationships, which has resulted in changing some of our marketing partners with the expectation of improved marketing efficiency and results. For the second fiscal quarter, net income was $6.3 million or $0.31 diluted per share compared to $8.4 million or $0.42 diluted per share for the same quarter last year, a decrease in net income of 25%. For the second fiscal quarter, our gross profit as a percentage of sales was 28.5% compared to 30.5% for the same period a year ago. The percentage decrease for the quarter can be attributed to some of the major manufacturers shifting their funding from discounting product costs to cooperative marketing rebates. There may be an opportunity to improve gross margins in the second half of fiscal year 2022 if the shift to prescription medications continues. We had $106.6 million in cash and cash equivalents and $19.7 million in inventory with no debt as of September 30, 2021. The Board of Directors also declared a quarterly dividend of $0.30 per share on the company's common stock. The dividend will be payable on November 19, 2021 to shareholders of record at the close of business on November 8, 2021. The company continues to be committed to returning capital to our stockholders. However, the declaration and payment of future dividends is discretionary and will be subject to a determination by the Board of Directors each quarter following its review of the company's financial performance. This ends the financial review. Operator, we are now ready to take questions.

Operator, Operator

And our first question is from Anthony Lebiedzinski from Sidoti.

Anthony Lebiedzinski, Analyst

Welcome, Matt, and welcome back, Bruce. Regarding new order sales, it's clear that the decline in the advertising market has had an impact. What gives you the confidence that things will improve in the second half of the fiscal year? I'm curious about the factors driving that confidence. Additionally, have you seen any positive results in the current quarter? I'm interested in your outlook on your ability to recover in terms of new order sales.

Matthew Hulett, CEO

Anthony, this is Matt. And thanks for the question. Great to hear from you again. And then Bruce, feel free to chime in. A couple of things about that. One is, I would say that we're taking a small bite-too-fast approach to looking at our new customer acquisition. We basically rewired our entire marketing partnerships and agencies in the last, I would say, well, I've been here 2 months, though we've done that in the last 4 weeks. And that will be rolling out very soon. So we're looking at our capital allocation spend to where we spend. I think we've been spending too aggressively in some channels where we haven't seen the return and we haven't been taking advantage of new sources of traffic where we actually think we have a lot of advantage. That's one. Two, is we're spending a lot more time rewiring our system and databases around tracking our customers better and really focusing on reengagement. And for rates in general, we are seeing some changes to the rates out there. I think some of the channels like Facebook have obviously gotten more expensive due to the loss of first-party data due to the Apple IDFA decision. So those are some channels that obviously, I think, are just still getting hotter in terms of increased CPMs and CPCs. But in others, we're seeing favorable trends. So it depends on the channel. But for us, we're really looking at each channel and seeing how we get incrementality out of each channel, which is different than what we did in the past.

Anthony Lebiedzinski, Analyst

Okay. I understand. Regarding your gross margins, you mentioned that you've been shipping more specialty dog products, which are heavier than typical pet medications. As we work to refine our models, how should we consider the impact on gross margins? On one hand, it seems like you're successfully increasing your average order value, but what will the effect on gross margins be because of that?

Bruce Rosenbloom, CFO

Yes, Anthony, I’ll address that question. Regarding our margins in the past quarter, our vendors have shifted their funding to our co-op marketing instead of providing discounts on products, which negatively affected our gross margins during that period. This trend is likely to continue; rather than receiving price discounts on products or inventory, the rebates and promotions will appear in the advertising section of our financials. Thus, moving forward, this will be a significant factor affecting our gross margins. But however, as we've also seen our ship moving back to more prescription than OTC, we do expect a positive trend in margins moving forward because of that going back to some sense of normalcy pandemic versus post-pandemic when it comes to our mix shift of items.

Anthony Lebiedzinski, Analyst

Okay. Got it. I'm curious to hear your thoughts, Matt, on capital allocation, particularly regarding pets. The company has historically maintained a strong cash position and has grown its dividend. What should we consider when thinking about that, especially in relation to the dividend? What are your thoughts?

Matthew Hulett, CEO

Yes, there are several points to discuss. That's a great question. I've been a regular listener of PetMed's earnings calls too, so I'll provide a slightly different perspective. Regarding the dividend, we continually evaluate it, and while it may fluctuate, we have been quite steady with it and have no new announcements at this time. In terms of cash, with over $100 million on hand and current interest rates being low, I believe there are numerous opportunities in this area to effectively deploy cash and allocate capital for better returns. There's also a lot of businesses in the pet ecosystem that, fortunately, in this market, different than other verticals, there's a lot of ways to partner, a lot of ways to look at M&A as well. So we're certainly going to be looking at those in the future since we do have such a large cash position. And lastly, it's a little early for me to articulate the strategy. I have been around for 2 months. I think the first 4 weeks felt like 6 months because there was a lot to do and learn and now I'm kind of settling in and feeling better about things. But yes, I think there's a lot of opportunity to deploy capital differently, especially given the tailwinds in pet ownership.

Operator, Operator

And our next question is from Steph Wissink with Jefferies.

Stephanie Schiller Wissink, Analyst

The first is I wanted to just go back to some of the comments in your prepared remarks around vet visits. And I think I heard you correctly that there's an inverse correlation, meaning when vet visits go up, you tend to see vets sell prescription and OTC directly and so your business feels that impact. Is that the right way to think about it? Or is there a net second derivative where in follow-up to those primary prescriptions, you'll start to see some of the secondary prescription refills in your business?

Bruce Rosenbloom, CFO

Steph, this is Bruce. Let me address that question. The information about vet visits is meant to help us understand what we observed last year compared to this year. Last year, during the pandemic, most vet offices were closed, leaving pet owners with very few options for medications, and many tried online pet medication services for the first time, which we welcomed. This year, however, all the clinics are open and are working to catch up. They are ensuring that if pets haven't been seen in the last 12 months, pet owners are bringing them in for appointments. It’s essentially a reset of the prescription cycle. Many pet owners are visiting the vet and purchasing medications there. Then, we are positioned to handle the refills, as we can track when it's time for them to reorder, and we will market for those reorder requests. We anticipate seeing this activity increase in the second half of this fiscal year, as I mentioned earlier in the call.

Stephanie Schiller Wissink, Analyst

Okay, I understand. My second question is about advertising expenses. You mentioned that you anticipate advertising prices to adjust. Could you clarify whether you expect them to return to pre-pandemic levels in terms of purchase prices, or do you foresee some level of inflation continuing post-pandemic? Additionally, you mentioned that the advertising is less efficient. Can you discuss what adjustments you are planning to make to your marketing strategies in the upcoming quarters to enhance efficiency, even if costs remain somewhat high?

Matthew Hulett, CEO

Yes. And I'll take your second question first. A couple of things. I would say, overall, the way in which we've been purchasing media is going to change significantly. We're looking at new and have actually implemented new marketing partners to help us with that, that specialize in specific areas of media. I won't get into the channels themselves. But obviously, Google, Facebook, Connected TV, there's a lot of options out there. And I think the way we've configured media spending to date needed a fresh pair of eyes. So that's one. Two is just adding more data around the decisions that we're making around our media buys was another, I'd say, quick win that we've implemented. And then, lastly, to your first question, media rates have been dancing around quite a bit. I was in the language learning space prior to this with Rosetta Stone, and we took advantage of favorable rates during the pandemic because advertisers were leaving things like brand advertising to performance. I would say going into the holiday season, it's too early to tell since it's a very competitive time to be buying advertising. But I would say that I'm a little bit more optimistic about rates than I was when I started 2 months ago.

Operator, Operator

Our next question is from Ben Rose with Battle Road Research.

Ben Rose, Analyst

Yes, I look forward to meeting you after the call, Matt. I have a couple of questions about pet health advice. In your slides, you mentioned the growth in the telehealth market, and I'm curious about your thoughts on the Ask the Vet service you currently offer. Do you see any potential for expanding or monetizing that service in the future?

Matthew Hulett, CEO

I'm looking forward to our future discussions, Ben. I'm genuinely excited about the pet telehealth sector. There has been significant innovation in this area, and I've personally spoken with a number of start-ups to gather insights. When assessing businesses, I always consider not just the total addressable market, timing, and fundamentals, but also customer relationships. Many of our customers are seeking additional services from us and are essentially encouraging us to provide more guidance than we currently do, as they see PetMed as a trusted expert in pet healthcare. As customers leave our store, we are still developing our expert experience. I believe Pet Telehealth places us in a strong position to expand our services, which we do not currently offer. Customers primarily see us as a specialty pharmacy rather than a major retailer with a wide range of services. We are not recognized for selling food; our reputation is built on selling dog toys and providing expert advice. For pet telehealth, even though the market is quite small, I see an opportunity to connect with our AutoShip customers in unique ways and offer them additional services. There’s nothing to announce at this time, but we plan to conduct a lot of testing on this subject even this quarter, and I hope to share more about it next time.

Ben Rose, Analyst

Okay. Great. And with regard to the company's relationships with the veterinarian community in vet clinics, this is the first time that I've heard you quantify the number of veterinarians and clinics that you work with and find that to be an intriguing opportunity. I was curious to know plans that you have to perhaps reduce friction with the veterinarians or to improve relationships with them?

Matthew Hulett, CEO

Yes, Ben, thanks for noticing that. And it was intentional to put that in there because I was quite surprised when I first started the company. We have a vet portal that's used today. I've seen other competitors in the space "numbers". And I think some might be surprised that we have a larger network than most. I think our relationship with vets has been a little confrontational, to be honest, over the stand of the company when we first started because we are the pioneers in the space. I think when we would go to the veterinarian conferences, we are probably the least likely to be welcomed. And I think now there's other players in the space, and we've kind of opened the door for them. And I think we're kind of seen as a more friendly player in the space, to be honest. Our vet verification rates are as high as they've ever been. I think there's a lot of things we could do in our best portal to make the veterinarian's life easy. We're very sympathetic to veterinarians. They are overworked. They have some of the highest suicide rates of any profession. And I think that there's a lot we could do to be a better friend to the vet. And our vet portal, I think, has a great start, but I think there's a lot of opportunity to automate what they do in their clinics. And we're going to be pro-vet in terms of how we approach the market. Our intent is not to be anti-vet. Operator, and our questions-and-answers portion of the call has ended. I would now like to turn the call back to Matt Hulett, the company's CEO, for his concluding remarks. Thank you. I want to emphasize what Bruce mentioned in his financial highlights. We are disappointed with our sales results for the quarter. However, after my two months in this role, I am confident that there are numerous opportunities for us to improve our business growth. It is important to recognize that in a growing market, PetMed needs to make the necessary changes to our operating strategies to capitalize on market trends. In my first weeks here, I've listened in on countless customer service calls, engaged with over 20 pet industry leaders, briefed research analysts and have engaged with our own main pharmaceutical partners. I've already seen in a lot of core areas that we can and have already begun to improve in this business, and these include the following: using more data insights to acquire and retain customers; better segmentation of our customer base in order to drive more mass personalization of our offers and services; improved new customer acquisitions through a different allocation of variable marketing spend; expanded product and services that are already being demanded by our customers. Since I've only been with PetMeds for a short period of time, I'm not ready yet on today's call to provide a comprehensive future strategy or capital allocation plans for the business, and that would be premature. However, I do have a 90-day and 180-day plan that I presented to our Board of Directors, and I'll be sharing more about our vision and strategy with you during our Q3 earnings call. But I'll say this today. We firmly believe that we can take advantage of the large market tailwinds, leverage the main core strengths we highlighted today and execute on a broader strategic vision for the company. We look forward to briefing you in the coming quarters on our strategy and our progress. Thank you for listening in. Operator, this ends the conference call.

Operator, Operator

Thank you. This ends today's conference call. You may disconnect your lines at this time. Thank you for your participation.