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PETS > SEC Filings for PETS > Form 10-K on 28-May-2013All Recent SEC Filings

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Form 10-K for PETMED EXPRESS INC


28-May-2013

Annual Report


ITEM 7. 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 television, online, and direct mail/print 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 77% of all sales were generated via the Internet in fiscal 2013, compared to 75% in fiscal 2012. The Company's sales consist of products sold mainly to retail consumers. The twelve-month average purchase was approximately $73 and $76 per order for the fiscal years ended March 31, 2013 and 2012, respectively.

Critical Accounting Policies

Our discussion and analysis of our financial condition and the results of our operations are based upon our Consolidated Financial Statements and the data used to prepare them. The Company's 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, long term investments, 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 medication products 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. At both March 31, 2013 and 2012 the allowance for doubtful accounts was approximately $5,000.

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 $79,000 and $66,000 as of March 31, 2013 and 2012, respectively.

Advertising

The Company's advertising expense consists primarily of television advertising, Internet marketing, and direct mail/print advertising. Television advertising costs are expensed as the advertisements are televised. 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 the 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 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 Consolidated Statements of Income and Comprehensive Income:

                                                    Fiscal Year Ended March 31,

                                                   2013           2012        2011

     Sales                                           100.0 %       100.0 %     100.0 %
     Cost of sales                                    66.1          66.3        63.8

     Gross profit                                     33.9          33.7        36.2

     Operating expenses:
     General and administrative                        9.5           9.4         9.6
     Advertising                                      12.0          12.8        11.8
     Depreciation                                      0.5           0.6         0.6
     Total operating expenses                         22.0          22.8        22.0

     Income from operations                           11.9          10.9        14.2

     Total other income                                0.1           0.2         0.2

     Income before provision for income taxes         12.0          11.1        14.4

     Provision for income taxes                        4.5           4.1         5.4

     Net income                                        7.5 %         7.0 %       9.0 %

Fiscal 2013 Compared to Fiscal 2012

Sales

Sales decreased by approximately $10.5 million, or 4.4%, to approximately $227.8 million for the fiscal year ended March 31, 2013, from approximately $238.3 million for the fiscal year ended March 31, 2012. The reduction in sales for the fiscal year ended March 31, 2013 can be attributed to a reduction in new order sales, due to reduced advertising spending, and reorder sales. Our sales were negatively impacted because of the unavailability of Novartis brands during the year due to the manufacturer's suspended production. Our sales were also down because of a decline in average order size, which was due to a change in product mix to lower priced items, including generics, additional discounts given, and increased competition. The Company acquired approximately 630,000 new customers for the year ended March 31, 2013, compared to approximately 722,000 new customers for the same period the prior year.


The following chart illustrates sales by various sales classifications:

                                             Year Ended March 31,
Sales (In thousands)      2013            %           2012            %          $ Variance       % Variance

Reorder Sales           $ 184,814          81.1 %   $ 186,991          78.5 %   $     (2,177 )           -1.2 %
New Order Sales         $  43,015          18.9 %   $  51,259          21.5 %   $     (8,244 )          -16.1 %
Total Net Sales         $ 227,829         100.0 %   $ 238,250         100.0 %   $    (10,421 )           -4.4 %
Internet Sales          $ 175,984          77.2 %   $ 178,758          75.0 %   $     (2,774 )           -1.6 %
Contact Center Sales    $  51,845          22.8 %   $  59,492          25.0 %   $     (7,647 )          -12.9 %
Total Net Sales         $ 227,829         100.0 %   $ 238,250         100.0 %   $    (10,421 )           -4.4 %

Sales may be adversely affected in fiscal 2014 due to increased competition and consumers giving more consideration to price and trading down to less expensive brands, including generics. In response to these trends, the Company will focus on advertising efficiency to improve new order sales and shifting sales to higher margin items, including generics, combined with expanding our product offerings. No guarantees can be made that the Company's efforts will be successful, or that sales will grow in the future. The majority of our product sales were 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 2013, the Company's sales were approximately 30%, 26%, 22%, and 22%, respectively. For the quarters ended June 30, September 30, December 31, and March 31 of Fiscal 2012, the Company's sales were approximately 31%, 24%, 21%, and 24%, respectively. Sales in the March quarter of fiscal 2013 were negatively impacted by the colder than normal weather compared to the warmer than normal weather in the March quarter of fiscal 2012.

Cost of sales

Cost of sales decreased by $7.4 million, or 4.7%, to $150.7 million for the fiscal year ended March 31, 2013, from $158.1 million for the fiscal year ended March 31, 2012. The decrease in cost of sales is directly related to decreased sales. As a percentage of sales, cost of sales was 66.1% in fiscal 2013, as compared to 66.3% in fiscal 2012. The cost of sales percentage decrease can be related to a change in product mix to lower cost items, which includes generics.

Gross profit

Gross profit decreased by $3.1 million, or 3.8%, to $77.1 million for the fiscal year ended March 31, 2013, from $80.2 million for the fiscal year ended March 31, 2012. Gross profit as a percentage of sales for fiscal 2013 was 33.9% compared to 33.7%, for fiscal 2012. The gross profit percentage increase can be mainly attributed to a change in product mix to higher margin items, which includes generics.

General and administrative expenses

General and administrative expenses decreased by $771,000, or 3.4%, to $21.6 million for the fiscal year ended March 31, 2013 from $22.4 million for the fiscal year ended March 31, 2012. The decrease in general and administrative expenses for the fiscal year ended March 31, 2013 was primarily due to the following: a $543,000 decrease in bank service fees due to a reduction in credit card fees; a $293,000 reduction in payroll expenses related primarily to a decrease in stock compensation expense; a $147,000 decrease in professional fees, with the majority of the decrease relating to legal and accounting fees; and a $95,000 decrease in telephone expenses. Offsetting the decrease was an $111,000 increase in property expenses related to our website, an $110,000 increase in licenses and fees, and an $86,000 net increase in other expenses including office expense and insurance expense. General and administrative expenses as a percentage of sales was 9.5% compared to 9.4% for the fiscal years ended March 31, 2013 and 2012, respectively. The increase in general and administrative expenses as a percentage of sales can mainly be attributed to a reduction in sales in fiscal 2013.


Advertising expenses

Advertising expenses decreased by approximately $3.0 million, or 9.7%, to approximately $27.4 million for the year ended March 31, 2013, from approximately $30.4 million for the year ended March 31, 2012. The decrease in advertising expenses for fiscal 2013 can be mainly attributed to reduced advertising due to the unavailability of television remnant space inventory. The advertising costs of acquiring a new customer, defined as total advertising costs divided by new customers acquired, was $44 for the fiscal year ended March 31, 2013, compared to $42 for the fiscal year ended March 31, 2012. Advertising cost of acquiring a new customer can be impacted by the advertising environment, the effectiveness of our advertising creative, increased 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 12.0 % and 12.8% for the fiscal years ended March 31, 2013 and 2012, respectively. The decrease in advertising expense as a percentage of total sales for the fiscal year ended March 31, 2013 can be attributed to a reduction in advertising expense, due to the unavailability of television remnant space inventory. The Company currently anticipates advertising as a percentage of sales to be approximately 13% for fiscal 2014. However, the advertising percentage will fluctuate quarter to quarter due to seasonality and advertising availability. For the fiscal year ended March 31, 2013, quarterly advertising expenses as a percentage of sales ranged between 9% and 14%.

Depreciation

Depreciation decreased by approximately $320,000, to approximately $1.1 million for the year ended March 31, 2013, from approximately $1.4 million for the year ended March 31, 2012. This decrease to depreciation for the year ended March 31, 2013 can be attributed to a reduction in new property and equipment additions, and an increase in fully depreciated fixed assets.

Other income

Other income decreased by approximately $48,000, to approximately $301,000 for the year ended March 31, 2013 from approximately $349,000 for the year ended March 31, 2012. The decrease to other income for the year ended March 31, 2013 can be attributed to a reduction in advertising 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 March 31, 2013, on any quarterly dividend payment, or on its operating activities.

Provision for income taxes

For the fiscal years ended March 31, 2013 and 2012, the Company recorded an income tax provision for approximately $10.1 million and $9.7 million, respectively. The effective tax rate for the fiscal years ended March 31, 2013 and 2012 were 37.1% and 36.8%, respectively. The effective tax rate increase for the fiscal year ended March 31, 2013, was due to a one-time charge related to a fiscal 2012 income tax under-accrual, which was recognized in the quarter ended December 31, 2012. The Company estimates its effective tax rate will be approximately 37.0% for fiscal 2014.

Net income

Net income increased by approximately $506,000, or 3.0%, to approximately $17.2 million for the fiscal year ended March 31, 2013 from approximately $16.7 million for the fiscal year ended March 31, 2012. The increase was primarily due to a decrease in operating expenses offset by a decrease in gross profit in fiscal 2013..

Fiscal 2012 Compared to Fiscal 2011

Sales

Sales increased by approximately $6.7 million, or 2.9%, to approximately $238.3 million for the fiscal year ended March 31, 2012, from approximately $231.6 million for the fiscal year ended March 31, 2011. The increase in sales for the fiscal year ended March 31, 2012 was primarily due to increased new order and reorder sales. The increase in new order sales may be attributed to increased advertising expenses, with flat customer acquisition costs. The Company acquired approximately 722,000 new customers for the year ended March 31, 2012, compared to approximately 645,000 new customers for the same period the prior year.


The following chart illustrates sales by various sales classifications:

                                             Year Ended March 31,
Sales (In thousands)      2012            %           2011            %          $ Variance       % Variance

Reorder Sales           $ 186,991          78.5 %   $ 184,341          79.6 %   $      2,650              1.4 %
New Order Sales         $  51,259          21.5 %   $  47,301          20.4 %   $      3,958              8.4 %
Total Net Sales         $ 238,250         100.0 %   $ 231,642         100.0 %   $      6,608              2.9 %
Internet Sales          $ 178,758          75.0 %   $ 165,473          71.4 %   $     13,285              8.0 %
Contact Center Sales    $  59,492          25.0 %   $  66,169          28.6 %   $     (6,677 )          -10.1 %
Total Net Sales         $ 238,250         100.0 %   $ 231,642         100.0 %   $      6,608              2.9 %

Sales may be adversely affected in fiscal 2013 due to increased competition and consumers giving more consideration to price and trading down to less expensive brands, including generics. In response to these trends, the Company will maintain a more aggressive advertising and pricing strategy combined with expanding our product offerings to pet supplies and generics. This more aggressive pricing strategy has resulted in a decrease to gross profit margins, and no guarantees can be made that the Company's efforts will be successful, or that sales will 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 2012, the Company's sales were approximately 31%, 24%, 21%, and 24%, respectively.

In January 2012, the manufacturer Novartis Consumer Health, Inc. announced that it halted production of their animal health products, including the following brands: Sentinel®, Interceptor®, Program®, Deramaxx®, and Clomicalm®. This disruption is industry wide, and at this time, there is no expected date for production to resume. We are currently asking prescribing veterinarians to prescribe alternate brands as we run out of inventory. This disruption in production has negatively impacted our sales, and if the disruption is prolonged it may negatively impact future sales.

Cost of sales

Cost of sales increased by $10.4 million, or 7.0%, to $158.1 million for the fiscal year ended March 31, 2012, from $147.7 million for the fiscal year ended March 31, 2011. The increase in cost of sales is directly related to increased sales and increased product costs. As a percentage of sales, cost of sales was 66.3% in fiscal 2012, as compared to 63.8% in fiscal 2011. The cost of sales percentage increase can be mainly attributed to more aggressive sales pricing and increases in our product costs.

Gross profit

Gross profit decreased by $3.8 million, or 4.5%, to $80.2 million for the fiscal year ended March 31, 2012, from $84.0 million for the fiscal year ended March 31, 2011. Gross profit as a percentage of sales for fiscal 2012 and 2011 was 33.7% and 36.2%, respectively. The gross profit percentage decrease can be mainly attributed to more aggressive sales promotions and increases in our product costs.

General and administrative expenses

General and administrative expenses increased by $163,000, or 0.7%, to $22.4 million for the fiscal year ended March 31, 2012 from $22.2 million for the fiscal year ended March 31, 2011. The increase in general and administrative expenses for the fiscal year ended March 31, 2012 was primarily due to the following: a $307,000 increase in payroll expenses relating to the customer care and pharmacy departments and a $220,000 increase in property expenses which was primarily related to our website. Offsetting the increase was a $220,000 decrease in professional fees, with the majority of the decrease relating to investor relations and pharmacy fees, a $98,000 decrease in bank service fees due to a reduction in credit card fees, and a $46,000 net decrease in other expenses including telephone, office expenses, and licenses. General and administrative expenses as a percentage of sales was 9.4% compared to 9.6% for the fiscal years ended March 31, 2012 and 2011, respectively. The decrease in general and administrative expenses as a percentage of sales can mainly be attributed to a reduction in bank service fees and professional fees in fiscal 2012.


Advertising expenses

Advertising expenses increased by approximately $3.0 million, or 11.0%, to approximately $30.4 million for the year ended March 31, 2012, from approximately $27.4 million for the year ended March 31, 2011. The increase in advertising expenses for fiscal 2012 can be mainly attributed to a more aggressive advertising strategy during the year. The advertising costs of acquiring a new customer, defined as total advertising costs divided by new customers acquired, was $42 for both the fiscal years ended March 31, 2012 and 2011. Advertising cost of acquiring a new customer can be impacted by the advertising environment, the effectiveness of our advertising creative, increased 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 12.8 % and 11.8% for the fiscal years ended March 31, 2012 and 2011, respectively. The increase in advertising expense as a percentage of total sales for the fiscal year ended March 31, 2012 can be attributed to a more aggressive advertising strategy during fiscal 2012. The Company currently anticipates advertising as a percentage of sales to be approximately 13% for fiscal 2013. However, the advertising percentage will fluctuate quarter to quarter due to seasonality and advertising availability. For the fiscal year ended March 31, 2012, quarterly advertising expenses as a percentage of sales ranged between 11% and 14%.

Depreciation

Depreciation increased by approximately $36,000, to approximately $1.4 million for the year ended March 31, 2012, from approximately $1.4 million for the year ended March 31, 2011. This increase to depreciation for the year ended March 31, 2012 can be attributed to new property and equipment additions relating to the warehouse, pharmacy, and customer call center over the past 2 fiscal years.

Other income

Other income increased by approximately $96,000, to approximately $349,000 for the year ended March 31, 2012 from approximately $253,000 for the year ended March 31, 2011. The increase to other income for the year ended March 31, 2012 can be attributed to the recognition of a federal tax penalty in fiscal 2011. Interest income may decrease in the future as the Company utilizes its cash balances on its share repurchase plan, with approximately $14.0 million remaining as of March 31, 2012, on any quarterly dividend payment, or on its operating activities.

Provision for income taxes

For the fiscal years ended March 31, 2012 and 2011, the Company recorded an income tax provision for approximately $9.7 million and $12.4 million, respectively. The effective tax rate for the fiscal years ended March 31, 2012 and 2011 were 36.8% and 37.3%, respectively. The effective tax rate decrease for the fiscal year ended March 31, 2012, was due to a one-time $280,000 tax adjustment, which was recognized in fiscal 2011, to reconcile the remaining net operating loss carryforward. The Company estimates its effective tax rate will be approximately 37.0% for fiscal 2013.

Net income

Net income decreased by approximately $4.2 million, or 20.2%, to approximately $16.7 million for the fiscal year ended March 31, 2012 from approximately $20.9 million for the fiscal year ended March 31, 2011. The decrease was primarily due to a decrease in gross profit margins as a result of more aggressive pricing, and an increase in advertising spending to revitalize sales in fiscal 2012.


Liquidity and Capital Resources

The Company's working capital at March 31, 2013 and 2012 was approximately $61.2 million and approximately $78.2 million, respectively. The $17.0 million decrease in working capital was primarily attributable the special dividend issued in December 2012, along with share repurchases and quarterly dividends paid during fiscal 2013, offset by cash flow generated from operations. Net cash provided by operating activities was $13.3 million and $20.4 million for the fiscal years ended March 31, 2013 and 2012, respectively. This change can be attributed to a significant increase in the Company's inventory balance due to buying opportunities during fiscal 2013, along with an increase to prepaid expenses and other current assets. Net cash used in investing activities was $5.8 million for the year ended March 31, 2013, compared to net cash provided by investing activities of $11.6 million for the year ended March 31, 2012. This change can be attributed to the redemption of the Company's long term investments balance during fiscal 2012, compared to the purchasing of short term investments during fiscal 2013. Net cash used in financing activities was $36.1 million and $34.9 million for the years ended March 31, 2013 and 2012, respectively. This change was primarily due to the Company paying $32.0 million in dividends in fiscal 2013, compared to paying $11.0 million in dividends in fiscal 2012, and repurchasing approximately 397,000 shares of its common stock for approximately $3.9 million in fiscal 2013, compared to repurchasing approximately 2.1 million shares of its common stock for approximately $23.7 million in fiscal 2012.

As of March 31, 2013 the Company had approximately $10.2 million remaining under the Company's share repurchase plan. Subsequent to March 31, 2013, the Company's Board of Directors declared a $0.15 per share dividend on May 3, 2013. The Board established a May 15, 2013 record date and a May 24, 2013 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 quarterly dividends, or on its operating activities.

As of both March 31, 2013 and 2012 the Company had no outstanding lease commitments except for the lease for its 65,300 square foot facility. 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 $1.5 million forecasted for capital expenditures in fiscal 2014 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 as of March 31, 2013.

Contractual Obligations and Commitments (In thousands)

                                                 Less than                                        More than
                                    Total         1 year        1-2 years       3-5 Years          5 years
. . .
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