ITEM 2.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Executive Summary
PetMed Express was incorporated in the state of
Florida in January 1996. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol “PETS.” The Company began selling pet medications and other pet health products in September 1996. In March 2010, the Company started offering for sale additional pet supplies on its website, and these items are drop shipped to customers by third party vendors. Presently, the Company’s product line includes approximately 3,000 of the most popular pet medications, health products, and supplies for dogs and cats.
The Company markets its products through national advertising campaigns which aim to increase the recognition of the “1-800-PetMeds” brand name, and “PetMeds” family of trademarks, increase traffic on its website at
www.1800petmeds.com
, acquire new customers, and maximize repeat purchases. Approximately 84% of all sales were generated via the Internet for the quarter ended December 31, 2017, compared to 83% for the quarter ended December 31, 2016. The Company’s sales consist of products sold mainly to retail consumers. The three-month average purchase was approximately $86 and $81 per order for the quarters ended December 31, 2017 and 2016, respectively, and for the nine months ended December 31, 2017 and 2016, the average purchase was approximately $86 and $82 per order, respectively.
Critical Accounting Policies
Our discussion and analysis of our financial condition and the results of our operations are based upon our Condensed Consolidated Financial Statements and the data used to prepare them. The Company
’s Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. On an ongoing basis we re-evaluate our judgments and estimates including those related to product returns, bad debts, inventories, and income taxes. We base our estimates and judgments on our historical experience, knowledge of current conditions, and our beliefs of what could occur in the future considering available information. Actual results may differ from these estimates under different assumptions or conditions. Our estimates are guided by observing the following critical accounting policies.
Revenue recognition
The Company generates revenue by selling pet medications and pet supplies primarily to retail consumers. The Company’s policy is to recognize revenue from product sales upon shipment, when the rights of ownership and risk of loss have passed to the customer. Outbound shipping and handling fees are included in sales and are billed upon shipment. Shipping expenses are included in cost of sales. The majority of the Company’s sales are paid by credit cards and the Company usually receives the cash settlement in two to three banking days. Credit card sales minimize accounts receivable balances relative to sales.
The Company maintains an allowance for doubtful accounts for losses that the Company estimates will arise from customers’ inability to make required payments, arising from either credit card charge-backs or insufficient funds checks. The Company determines its estimates of the uncollectibility of accounts receivable by analyzing historical bad debts and current economic trends. The allowance for doubtful accounts was approximately $26,000 at December 31, 2017 compared to $27,000 at March 31, 2017.
Valuation of inventory
Inventories consist of prescription and non-prescription pet medications and pet supplies that are available for sale and are priced at the lower of cost or market value using a weighted average cost method. The Company writes down its inventory for estimated obsolescence. The inventory reserve was approximately $55,000
at December 31, 2017 compared to $51,000 at March 31, 2017.
Advertising
The Company's advertising expense consists primarily of Internet marketing and direct mail/print advertising.
Internet costs are expensed in the month incurred and direct mail/print advertising costs are expensed when the related catalogs, brochures, and postcards are produced, distributed, or superseded.
Accounting for income taxes
The Company accounts for income taxes under the provisions of ASC Topic 740 (“
Accounting for Income Taxes
”), which generally requires recognition of deferred tax assets and liabilities for the expected future tax benefits or consequences of events that have been included in the Consolidated Financial Statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting carrying values and the tax bases of assets and liabilities, and are measured by applying enacted tax rates and laws for the taxable years in which those differences are expected to reverse.
Results of Operations
The following should be read in conjunction with the Company’s Condensed Consolidated Financial Statements and the related notes thereto included elsewhere herein. The following table sets forth, as a percentage of sales, certain operating data appearing in the Company’s Condensed Consolidated Statements of Comprehensive Income:
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Three Months Ended
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Nine Months Ended
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December 31,
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December 31,
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2017
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2016
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2017
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2016
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
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Sales
|
|
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100.0
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%
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|
|
100.0
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%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of sales
|
|
|
63.5
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|
|
|
68.5
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|
|
|
64.7
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|
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69.3
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Gross profit
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36.5
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31.5
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35.3
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30.7
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Operating expenses:
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General and administrative
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9.7
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10.1
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8.8
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9.2
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Advertising
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6.8
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6.0
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7.2
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7.2
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Depreciation
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0.9
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|
|
0.9
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|
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0.8
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|
|
|
0.5
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Total operating expenses
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17.4
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17.0
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16.8
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|
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16.9
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Income from operations
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19.1
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14.5
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18.5
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13.8
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Total other income
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0.8
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0.3
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0.5
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0.2
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Income before provision for income taxes
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19.9
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14.8
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19.0
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14.0
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Provision for income taxes
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4.8
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5.7
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5.9
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5.2
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Net income
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15.1
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%
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9.1
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%
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13.1
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%
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|
|
8.8
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%
|
Three Months Ended December 31, 2017 Compared With Three Months Ended December 31, 2016, and Nine Months Ended December 31, 2017 Compared With Nine Months Ended December 31, 2016
Sales
Sales increased by approximately $7.2 million, or 13.7%, to approximately $60.1 million for the quarter ended December 31, 2017, from approximately $52.9 million for the quarter ended December 31, 2016. For the nine months ended December 31, 2017, sales increased by approximately $20.3 million, or 10.9%, to approximately $206.5 million compared to $186.1 million for the nine months ended December 31, 2016. The increases in sales for the three and nine months ended December 31, 2017 were primarily due to increased new order and reorder sales. The Company acquired approximately 106,000 new customers for the quarter ended December 31, 2017, compared to approximately 99,000 new customers for the same period the prior year. For the nine months ended December 31, 2017 the Company acquired approximately 408,000 new customers, compared to 388,000 new customers for the nine months ended December 31, 2016. The following chart illustrates sales by various sales classifications:
Three Months Ended December 31
,
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Sales (In thousands
)
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201
7
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%
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201
6
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|
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%
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$ Varianc
e
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% Varianc
e
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|
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Reorder Sale
s
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$
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50,949
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84.8
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%
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$
|
44,937
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|
85.0
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%
|
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$
|
6,012
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|
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13.4
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%
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New Order Sale
s
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|
$
|
9,161
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|
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15.2
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%
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|
$
|
7,929
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|
|
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15.0
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%
|
|
$
|
1,232
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|
|
|
15.5
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%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
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Total Net Sale
s
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$
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60,110
|
|
|
|
100.0
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%
|
|
$
|
52,866
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|
|
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100.0
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%
|
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$
|
7,244
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|
13.7
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%
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|
|
|
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|
|
|
|
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|
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|
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|
|
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Internet Sale
s
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$
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50,358
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83.8
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%
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$
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43,772
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82.8
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%
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$
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6,586
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|
|
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15.0
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%
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Contact Center Sale
s
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$
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9,752
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16.2
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%
|
|
$
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9,094
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|
|
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17.2
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%
|
|
$
|
658
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|
7.2
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%
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Total Net Sale
s
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|
$
|
60,110
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|
|
|
100.0
|
%
|
|
$
|
52,866
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|
|
|
100.0
|
%
|
|
$
|
7,244
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|
|
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13.7
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%
|
Nine Months Ended December 31
,
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Sales (In thousands
)
|
|
201
7
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|
|
%
|
|
|
201
6
|
|
|
%
|
|
|
$ Varianc
e
|
|
|
% Varianc
e
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reorder Sale
s
|
|
$
|
170,487
|
|
|
|
82.6
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%
|
|
$
|
154,202
|
|
|
|
82.8
|
%
|
|
$
|
16,285
|
|
|
|
10.6
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%
|
New Order Sale
s
|
|
$
|
35,991
|
|
|
|
17.4
|
%
|
|
$
|
31,942
|
|
|
|
17.2
|
%
|
|
$
|
4,049
|
|
|
|
12.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Sale
s
|
|
$
|
206,478
|
|
|
|
100.0
|
%
|
|
$
|
186,144
|
|
|
|
100.0
|
%
|
|
$
|
20,334
|
|
|
|
10.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet Sale
s
|
|
$
|
173,175
|
|
|
|
83.9
|
%
|
|
$
|
153,161
|
|
|
|
82.3
|
%
|
|
$
|
20,014
|
|
|
|
13.1
|
%
|
Contact Center Sale
s
|
|
$
|
33,303
|
|
|
|
16.1
|
%
|
|
$
|
32,983
|
|
|
|
17.7
|
%
|
|
$
|
320
|
|
|
|
1.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Sale
s
|
|
$
|
206,478
|
|
|
|
100.0
|
%
|
|
$
|
186,144
|
|
|
|
100.0
|
%
|
|
$
|
20,334
|
|
|
|
10.9
|
%
|
Going forward sales may be adversely affected due to increased competition and consumers giving more consideration to price. No guarantees can be made that sales will continue to grow in the future. The majority of our product sales are affected by the seasons, due to the seasonality of mainly heartworm, and flea and tick medications. For the quarters ended June 30, September 30, December 31, and March 31 of Fiscal 2017, the Company’s sales were approximately 29%, 25%, 21%, and 25%, respectively.
Cost of sales
Cost of sales increased by approximately $1.9 million, or 5.4%, to approximately $38.2 million for the quarter ended December 31, 2017, from approximately $36.2 million for the quarter ended December 31, 2016. For the nine months ended December 31, 2017, cost of sales increased by approximately $4.6 million, or 3.6%, to approximately $133.6 million compared to $129.0 million for the same period in the prior year. The increase in cost of sales is directly related to the increases in sales during the quarter and nine months ended December 31, 2017. Cost of sales as a percent of sales was 63.5% and 68.5% for the quarters ended December 31, 2017 and 2016, respectively, and for the nine months ended December 31, 2017 and 2016 the cost of sales was 64.7% and 69.3%, respectively. The cost of sales percentage decreases are mainly attributed to a product mix shift to higher margin items, offset by additional discounts given to customers to increase sales during the quarter and nine months ended December 31, 2017.
Gross profit
Gross profit increased by approximately $5.3 million, or 31.9%, to approximately $21.9 million for the quarter ended December 31, 2017, from approximately $16.6 million for the quarter ended December 31, 2016. For the nine months ended December 31, 2017 gross profit increased by approximately $15.7 million, or 27.5%, to approximately $72.9 million, compared to $57.2 million for the same period in the prior year. The increases in gross profit are directly related to increases in sales during the quarter and nine months ended December 31, 2017. Gross profit as a percentage of sales was 36.5% and 31.5% for the three months ended December 31, 2017 and 2016, respectively, and for the nine months ended December 31, 2017 and 2016, gross profit was 35.3% and 30.7%, respectively. The gross profit percentage increases for the quarter and nine months ended December 31, 2017 are mainly attributed to a product mix shift to higher margin items, offset by additional discounts given to customers to increase sales during the quarter and nine months.
General and administrative expenses
General and administrative expenses increased by approximately $457,000, or 8.5%, to approximately $5.8 million for the quarter ended December 31, 2017, from approximately $5.4 million for the quarter ended December 31, 2016. The increase in general and administrative expenses for the quarter ended December 31, 2017 was primarily due to the following: a $496,000 increase in payroll expenses related to increased stock compensation expense; a $164,000 increase in bank service fees; and an $18,000 increase in professional fees. Offsetting the increase was a $198,000 decrease to property expenses; a $20,000 decrease to telephone expenses; and a $3,000 net decrease in other expenses which included licenses, insurance expenses, and bad debt expenses.
For the nine months ended December 31, 2017, general and administrative expenses increased by approximately $1.0 million, or 5.9%, to approximately $18.2 million from approximately $17.2 million for the nine months ended December 31, 2016. The increase in general and administrative expenses for the nine months ended December 31, 2017 was primarily due to the following: a $1.3 million increase in payroll expenses related to increased stock compensation expense; a $453,000 increase in bank service fees; and a $192,000 increase in professional fees. Offsetting the increase was a $582,000 decrease to property expenses; a $296,000 decrease to bad debt expense relating to decreased credit card chargebacks for the period; a $40,000 decrease in licenses and fees; and a $25,000 net decrease in other expenses which included insurance expenses, telephone, and travel expenses.
Advertising expenses
Advertising expenses increased by approximately $956,000, or 30.2%, to approximately $4.1 million for the quarter ended December 31, 2017, from approximately $3.2 million for the quarter ended December 31, 2016. For the nine months ended December 31, 2017, advertising expenses increased by approximately $1.6 million, or 12.3%, to approximately $14.9 million compared to advertising expenses of approximately $13.3 million for the nine months ended December 31, 2016. The increases in advertising expenses for the three and nine months ended December 31, 2017 was intended to stimulate sales and acquire new customers. The advertising costs of acquiring a new customer, defined as total advertising costs divided by new customers acquired, increased to $39 for the quarter ended December 31, 2017, compared to $32 for the quarter ended December 31, 2016. For the nine months ended December 31, 2017 and 2016 the advertising costs of acquiring a new customer were $37 and $34, respectively. Advertising cost of acquiring a new customer can be impacted by the advertising environment, the effectiveness of our advertising creative, advertising spending, and price competition. Historically, the advertising environment fluctuates due to supply and demand. A more favorable advertising environment may positively impact future new order sales, whereas a less favorable advertising environment may negatively impact future new order sales.
As a percentage of sales, advertising expense was 6.8% and 6.0% for the quarters ended December 31, 2017 and 2016, respectively, and for both of the nine months ended December 31, 2017 and 2016 advertising expense was 7.2%. The increase in advertising expense as a percentage of total sales for the quarter ended December 31, 2017 can be attributed to increased advertising spending to stimulate sales and acquire new customers. The Company currently anticipates advertising as a percentage of sales to be between approximately 7.0% and 8.0% for fiscal 2018. However, the advertising percentage will fluctuate quarter to quarter due to seasonality and advertising availability.
Depreciation
Depreciation expense increased by approximately $75,000 to approximately $532,000 for the quarter ended December 31, 2017, from approximately $457,000 for the quarter ended December 31, 2016. For the nine months ended December 31, 2017 depreciation expense increased by approximately $735,000 to $1.6 million compared to $855,000 for the same period in the prior year. The increases to depreciation expense for the quarter and nine months ended December 31, 2017 can be attributed to an increase in new property and equipment additions related to the Company’s new corporate headquarters and distribution facility which were placed into service in fiscal 2017.
Other income
Other income increased by approximately $290,000 to approximately $456,000 for the quarter ended December 31, 2017 from approximately $166,000 for the quarter ended December 31, 2016. For the nine months ended December 31, 2017 other income increased by approximately $870,000 to approximately $1.2 million compared to approximately $302,000 for the same period in the prior year. The increases to other income for the quarter and nine months ended December 31, 2017 are related to increased rental and advertising revenue, and increased interest income. Interest income may decrease in the future as the Company utilizes its cash balances on its share repurchase plan, with approximately $10.2 million remaining as of December 31, 2017, on any quarterly dividend payment, or on its operating activities.
Provision for income taxes
For the quarters ended December 31, 2017 and 2016, the Company recorded an income tax provision of approximately $2.9 million and $3.0 million, respectively, and for the nine months ended December 31, 2017 and 2016, the Company recorded an income tax provision of approximately $12.2 million and
$9.8 million, respectively. The decrease to the income tax provision for the three months ended December 31, 2017, is related to an income tax rate reduction pursuant to the Tax Cuts and Jobs Act of 2017 (“2017 Act”), offset by an increase in operating income. The increase to the income tax provision for the nine months ended December 31, 2017, is related to an increase in operating income offset by the income tax rate reduction due to the 2017 Act. The effective tax rate for the quarter ended December 31, 2017 was approximately 24.0%, compared to 38.3% for the quarter ended December 31, 2016, and the effective tax rate for the nine months ended December 31, 2017 was approximately 31.1%, compared to 37.5% for the nine months ended December 31, 2017. The decrease to the effective rate for the three and nine months ended December 31, 2017 is due to a reduction in the Company’s corporate tax rate pursuant to the 2017 Act. In accordance with SEC Staff Bulletin No. 118, fiscal year end companies were required to determine the appropriate blended rate to apply based on their respective fiscal year end dates. Therefore, instead of applying a 35.0% federal tax rate for the quarter and nine months ended December 31, 2017, the Company applied a blended federal rate of 31.5%. This blended rate was applied to the nine months ended December 31, 2017, resulting in a tax benefit of approximately $1.7 million, which also included a one-time $384,000 reduction to our deferred tax liabilities due to the federal tax rate reduction. The Company also recognized a one-time charge of $175,000 related to a true up of the fiscal 2017 income tax provision, which was recognized in the quarter ended December 31, 2017. Due to the passage of the 2017 Act the company expects an effective tax rate of approximately 34.0% for the quarter ending March 31, 2018, and an effective tax rate of approximately 24.0% for fiscal 2019.
Liquidity and Capital Resources
The Company’s working capital at December 31, 2017 and March 31, 2017 was $80.7 million and $63.4 million, respectively. The $17.3 million increase in working capital was primarily attributable to cash flow generated from operations, offset by dividends paid. Net cash provided by operating activities was $35.1 million and $31.6 million for the nine months ended December 31, 2017 and 2016, respectively. This change can be mainly attributed to an increase in the Company’s net income and income taxes payable offset by increases in the Company’s inventory balance, compared to the same period in the prior year. Net cash used in investing activities decreased to $564,000 for the nine months ended December 31, 2017, compared to net cash used in investing activities of $9.9 million for the nine months ended December 31, 2016. This change in investing activities is related to increased property and equipment additions related to the Company’s new corporate headquarters and distribution facility in Delray Beach, Florida in the previous fiscal year. Net cash used in financing activities was $12.3 million for the nine months ended December 31, 2017, compared to $11.5 million for the same period in the prior year, which represented an increase in dividends paid in the period ended December 31, 2017.
At December 31, 2017, the Company had approximately $10.2 million remaining under the Company’s share repurchase plan. Subsequent to December 31, 2017, on January 22, 2018 our Board of Directors declared an increased quarterly dividend of $0.25 per share. The Board established a February 5, 2018 record date and a February 16, 2018 payment date. Depending on future market conditions the Company may utilize its cash and cash equivalents on the remaining balance of its current share repurchase plan, on dividends, or on its operating activities.
At December 31, 2017, the Company had no outstanding lease commitments. We are not currently bound by any long or short term agreements for the purchase or lease of capital expenditures. Any material amounts expended for capital expenditures would be the result of an increase in the capacity needed to adequately provide for any increase in our business. To date we have paid for any needed additions to our capital equipment infrastructure from working capital funds and anticipate this being the case in the future. Presently, we have approximately $300,000 forecasted for capital expenditures for the remainder of fiscal 2018, which will be funded through cash from operations. The Company’s primary source of working capital is cash from operations. The Company presently has no need for alternative sources of working capital, and has no commitments or plans to obtain additional capital.
Off-Balance Sheet Arrangements
The Company had no off-balance sheet arrangements at December 31, 2017
.
Cautionary Statement Regarding Forward-Looking Information
Certain information in this Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify these forward-looking statements by the words "believes," "intends," "expects," "may," "will," "should," "plans," "projects," "contemplates," "intends," "budgets," "predicts," "estimates," "anticipates," or similar expressions. 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 differ significantly from the results discussed in the forward-looking statements. A reader, whether investing in our common stock or not, should not place undue reliance on these forward-looking statements, which apply only as of the date of this quarterly report. When used in this quarterly report on Form 10-Q, "PetMed Express," "1-800-PetMeds," "PetMeds," "PetMed," "PetMeds.com," “1800PetMeds.com,” "PetMed.com," "PetMed Express.com," "the Company," "we," "our," and "us" refers to PetMed Express, Inc. and our subsidiaries.