PetMed 1Q Disappoints

America’s largest pet pharmacy, PetMed Express ( PETS - Analyst Report ) began fiscal 2013 on a disappointing note. The company reported earnings per share (‘EPS’) of 20 cents for the first quarter of fiscal 2013, a couple of cents below the year-ago quarter and missing the Zacks Consensus Estimate of 23 cents. Net sales dropped 6% year over year to $69 million, well below the Zacks Consensus Estimate of $78 million.

The Florida based company added 197,000 new customers during the quarter compared with 226,000 in the first quarter of fiscal 2012. PetMed reported lower reorder sales (down 3% to $55.1 million) accompanied by a 3% drop in online sales to $52.8 million. Approximately 77% of PetMed’s orders were generated on the website compared with 73% in the corresponding year-ago quarter. New order sales decreased by 18% to $13.9 million for the quarter primarily due to an increase in customer acquisition cost, reduction in average order size and somewhat reduced advertising.

Gross margin contracted 40 basis points (bps) to 32.3% during the quarter with the average order size declining by $7 to $73. This reduction was primarily due to smaller quantities being purchased by customers, additional discounts, a lower-priced product mix and an earlier peak season that shifted sales to the March quarter. In addition, the company’s sales were adversely affected by the unavailability of branded products from Novartis ( NVS - Snapshot Report ) due to suspension of its production.

A 3.0% drop in general and administrative expenses (to $5.9 million) and a 2.5% decline in advertising expenses (to $9.8 million) led to a 2.7% reduction in operating expenses (without depreciation) to $15.8 million. Despite lower operating expenses, a disappointing top-line performance led to a 130 bps drop in operating margin to 9.5%.

PetMed reduced advertising late during the quarter due to increase in costs. This is reflected in the 11% increase in cost to acquire a new customer (to $50). However, the company would continue to advertise efficiently along with shifting sales to higher-margin products while expanding its product portfolio, including generic pet medications. Given these initiatives, we expect operating margin to remain under pressure in the near future.

PetMed exited the fiscal with cash and cash equivalents of $57.4 million compared with $46.8 million at the end of March 2012. Cash flow from operations during the reported quarter increased 62% year over year to $13.8 million.

Recommendation

We are disappointed with the performance of PetMed during the quarter. Although the company is attempting several strategies to revive its top line, it will be a while before any impact is witnessed. We believe economic uncertainty has been taking a toll on the company.

PetMed offers a wide range of products for dogs, cats, and horses. The company markets its products primarily under well-known brands of medication such as Frontline Plus, K9 Advantix, Advantage, Heartgard Plus, Sentinel, and Interceptor, among others. The presence of players like PetSmart ( PETM - Snapshot Report ) makes the pet pharmacy market very competitive. To address competition, the company has adopted an aggressive pricing strategy that is hurting its margins.

The stock retains a Zacks #4 Rank (Sell) in the short term.