PetMed Express, Inc. (PETS) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining the PetMed Express 2023 Analyst Call. My name is Rob, the operator for today's call. I would now like to pass the conference over to our host, Mr. Brian Prenoveau, Investor Relations. Sir, the floor is now yours.

Thank you, operator. And I'd like to welcome everybody today to the PetMed Express 2023 Analyst Call. I would also 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 during this call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and the Securities Exchange Act of 1934 as amended, 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 results could differ materially from those projected. There can be no assurance that any forward-looking results will occur or be realized and nothing contained in this presentation is or should be relied upon as a representation or warranty as to any future matter including any matter in respect to the operations or business or financial condition of PetMeds. PetMeds undertakes no obligation to update publicly these forward-looking statements based on subsequent events except as may be required by applicable law, regulation or other competent legal authority. 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. Now let me introduce our CEO and President, Matt Hulett. Matt?

Thank you, Brian. Thank you for making the time today to participate in this investor presentation. The PetMeds management team felt that the recent deal activity necessitated a special communication to our current and future stakeholders. First, I'd like to make today's presentation simple and impactful. If you take away nothing else from the presentation, I'd like you to remember this. PetMed is poised to be a growth company. Earlier this week, we announced a definitive agreement to acquire PetCareRx. A leading supplier of pet medications, food and supplies. And today, we will be sharing some of the key aspects of the deal, including the overall strategic rationale. Our strong belief is that this forum will provide a great opportunity to provide further details on the acquisition while providing a big picture overview of our business and how this acquisition fits into our larger world view. I am joined today by Christine Chambers, PetMed's CFO. During today's presentation, we are going to cover the following: one, PetMeds 1.0, the legacy business and where I started on the turnaround road. Two, progress on our focus of being the pet health expert strategy; three, our overview of the market opportunity and the strategies we are focused on; four, an overview of our recent announcement to acquire a leading pet care retailer, PetCareRx; and five, an overview of our current financial status before we open up the call to questions. On Slide 5, let's first start with the PetMeds business. PetMed has a long history in the pet medication space. It is a phenomenal company that delivers exceptional service to our pet parents and pets. This is evidenced by our NPS scores that have consistently been over 80, which puts us in the upper quartile alongside some of the most beloved brands in the world. The business was built with a strong balance sheet focused on delivering a high dividend yield to investors. In fact, PetMeds today is the only small cap stock in the e-commerce industry that is profitable and issues a dividend. However, over time, growth slowed due in part to some lack of innovation and product assortment as well as increased competition. However, the business and the brand have several key assets that we can and will leverage as we pivot to a growth-oriented business. Our brand is both widely known and trusted. Our own market research indicates that 55% of U.S. pet parents are aware of the PetMeds brand. Having a strong brand takes years to develop, and our customers tell us they look at PetMed as their trusted pharmacy and pet medication expert. We have over 26 years of experience as a pure-play pet pharmacy, fully licensed or authorized as a pet pharmacy to conduct business in all 50 states, delivering outstanding service and value. Our long-standing domain expertise in pharmacy is in what I would call the most complicated part of the pet ecosystem, which makes our progression into the other segments much easier, this expertise as a pharmacy has also enabled us to establish very deep roots in the pet health care industry and our decades-long experience with the vet community is a significant -- have advantage. We have one of the largest direct-to-consumer vet networks in the online retail space with over 70,000 veterinarians we have worked with over the company's history. Because of our industry-leading service relationships with Vets, our prescription medication authorization rates are the highest they have ever been, which speaks volumes to the level of veterinarian cooperation we receive on a daily basis. Our customers love our brand and our service. We provide a 100% satisfaction guarantee to our customers, and we go the extra mile for our customers with generally empathetic and excellent service. We don't just have a transactional interaction with our customers. We have built trusting genuine relationships. Our customers view PetMeds as a trusted pet health expert, and we take that responsibility seriously. Over a year ago, we set out to develop a new strategy, including bringing on a new experienced and transformational executive team and revitalizing the PetMeds brand and product offering in an effort to attract new customers, grow sales and leverage the brand many assets to take advantage of the opportunities we saw in the market. Recently, we have been able to stabilize the business with flattish year-over-year revenues from double-digit declines. This has been accomplished during a number of foundational changes that have taken place in the last 12 months. We brought on a new experienced management team introduced and shifted to a new holistic strategy, your trusted pet health expert, grew essential nascent AutoShip sales to a current level of almost 40% of our business. Placed a strategic investment and partnership investor, an exclusive deal and a minority ownership of a company that unlocks pet telemedicine to the masses. We're the only online retailer to our knowledge that is live with pet telemedicine. And now we're here just 9 months later with another transformational opportunity that vastly increases our addressable market and provides immediate upside to PetMed. Turning to Slide 7. We have discussed over many quarters what that strategy is and what it will be. PetMed is shifting from being simply a leading pet medication retailer to being the pet health experts, a market leader in pet health care expertise. We want to be every pet parents go-to destination for holistic health and wellness from nose to tail. Our focus is not to be all things to all people. At PetMeds, we have a unique perspective. We established relationships with pet parents through pet medication prescriptions first. We think this has been an entry way to further goods and services, including prescription food, Allivet services, supplements and pet assurance, among others. The 4 points of our paw print are medication, care, nutrition and wellness. We view these points as being key to building a differentiated brand and experience to pet parents everywhere. As we all know, pets are really our family members. Becoming the go-to place for your pet health needs is not only honorable from a social perspective, but also from an investment -- investor perspective. We recognize the shifts that are occurring in the regulatory landscape, which led us to our first big bet, Pet Telemedicine. Our investment and partnership investor enabled PetMed to become what we think was the first pet retailer to offer pet telemedicine to pet parents at scale. This is a strategic bet that will continue to develop as regulation changes as well as consumer education and awareness develops. We see the virtualization of vet services as being a key pillar to the pets business and a differentiator in the pet space. Turning to Slide 8. We are making significant progress in a relatively short amount of time. As previously mentioned, recurring subscription revenue has increased significantly and now represents about 40% of our revenue base. We believe that number could still grow. Until recently, PetMed hasn't provided the full selection of non-medication products that our customers are looking for. And we have been hinting at our expansion into premium food and other consumables for a while now. With this week's announcement, we will now have a broader catalog of premium prescription and nonprescription pet foods and supplies that should further expand our customer base, customer retention, increased basket size and subscription revenue. And as mentioned, the addition of pet telemedicine rounds out our holistic health and wellness strategy, delivering unique and differentiated services to our customer base. Before discussing further details of the acquisition, I want to provide a high-level overview of the pet market, how we intersect in areas of focus. This should be useful as we discuss the rationale for our interest in acquiring PetCareRx and how this perfectly fits into the serviceable, addressable market we are pursuing. The overall pet market continues to grow. In 2021, it was almost $123 billion in annual sales. Third-party research expects us to continue to grow at a 9% annual CAGR in the next 5 years. That's an impressive rate for an industry already $123 billion in sales. That translates to an extra $70 billion in annual pet spendings in the next 5 years and a huge opportunity for PetMeds. It is our intent to grow within our niche of being your trusted pet health expert by focusing on total wellness, we can offer products and services to pet parents that are diet and health focused in the areas of pet medication, premium prescription and nonprescription food, supplements, insurance and televet services. Even within this targeted subsegment of the overall pet market, we believe this is a multibillion-dollar opportunity. We believe that we are participating in some of the fastest-growing areas of the pet market. Internet sales of pet medication are expected to grow 16% annually over the next 5 years and take more market share when compared to sales at veterinarian offices or traditional brick-and-mortar establishments. Similarly, more people are buying their pet food and treats online versus in-store. In 2021, online sales were approximately 30% of total spend. That is expected to increase to almost half of all pet food and treat spend in 5 years. Online pet food and treat spend is forecast to grow 17% annually over that time compared to 4% growth in brick-and-mortar spending. I will now turn the call over to our CFO, Christine Chambers, to discuss the PetCareRx acquisition in more detail. Christine?

Thanks, Matt. Earlier this week, we announced our intent to acquire a leading pet care provider, PetCareRx in an all-cash transaction for $36 million. Other high-level details at PetCareRx include its trailing 12-month revenue of about $42 million, 200,000 customers, more than 10,000 brands and product SKUs, about 80 employees and a headquarters and distribution center located in Long Island, New York and gross margins approximately the same as PetMeds. PetCareRx has been operating as a business almost as long as PetMed. Their culture and mission are closely aligned with our own. This is critical since acquisitions are more successful when values align. In fact, they are sort of a mini version of PetMed, which makes the combination immediately synergistic. We expect the deal to close this quarter. While the PetCareRx brand will continue to operate independently as part of PetMed's wellness and consumables business, it is expected to immediately deliver double-digit topline growth for our business. Over time, we expect it to be bottom line accretive as we leverage synergies and streamline infrastructure. In short, the headline for the deal rationale is that the acquisition expands the addressable market for PetMeds while providing immediate upside. Instead of providing just a sliver of our customers' needs, PetMeds can now deliver on what we call a full nose-to-tail solution for our customers. That includes medication, specialty food and diet products, vet services and soon to follow new wellness services. Here are additional benefits and rationale for the acquisition. Firstly, it expands our addressable market. Today, PetMed participates in the medication market, which is approximately a $12 billion market out of $123 billion pet market in the United States. With the acquisition of PetCareRx, we are now participating in a much larger addressable market. PetCareRx not only carries an extensive list of medications, they also made the investment to expand their addressable market by curating over 13,000 of the best non-medication health and wellness products in the market, including foods, supplements and other similar products. They also bring incremental distribution center capability outside of core medication distribution. Secondly, almost half of PetCareRx's revenue is derived from nonmedication products. We will rapidly be moving the relationships and products from the PetCareRx portfolio over to PetMeds over the next several quarters. We are confident that we will see similar expansion of buying behavior with our PetMeds customers. Finally, more wallet share for pet customers and higher LTV. If you think about it, PetMeds has only serviced a small portion of our customers' overall needs for their pet. Medication is purchased on a much less frequent basis than the more common consumable pet products. With the acquisition of PetCareRx, PetMeds will be selling more products on a more regular basis to its customers. Matt will summarize the benefits of the announced acquisition.

We are extremely excited about the PetCareRX acquisition and where the PetMeds business is going from here. We believe we are just getting started on our growth objectives. Our product expansion is a key element to opening up new potential customers in offering existing customers more product rep. In April of last year, we announced an exclusive partnership with the fastest-growing and industry-leading telemedicine platform, Vetster. We believe we are enabling the first mainstream pet telemedicine platform and the one that will prove to be an accelerator of widespread adoption of pet telemedicine. We now have the PetMeds platform integrated into the Vetster platform, and we recently introduced PetMed's very own pet telemedicine service called VetLive in October of last year. PetCareRx has built a unique customer offering, a membership model where customers pay an upfront membership fee in order to receive discounts and free shipping. PetCareRx's broad catalog is a perfect complement to our medication expertise. Prescription medication is among the most complex fulfillment items in the pet market. We have carved a large niche in being the experts for prescription medication refills. With the expanded catalog of PetCareRx products, we will have much more frequent touch points, expanding the potential for cross-selling, increasing customer stickiness and ultimately lowering our acquisition cost. They have strong relationships with their suppliers, especially premium food brands. Christine will now walk us through the financial status and why we believe we are well positioned to take advantage of a growing market.

Thanks, Matt. Let's turn to Slide 17. As Matt mentioned, we have started to see the revenue decline slowdown as we turn the corner and stabilize the core business. We have believe we have laid out a strategy and begun to execute on that strategy to jump start revenue growth and recapture market share. Pet Health and wellness is a growing market and we believe our product and service focus is among the fastest-growing segments of the overall pet market. To take advantage of further opportunities we think we are ideally poised to accelerate growth. As of September 30, 2022, we had just under $100 million of cash and no debt. We've generated over $30 million of EBITDA in the previous 12 months. As a high cash flow producing business, we want to be mindful and diligent about how we allocate that cash. Our balance sheet provides us with the financial flexibility and liquidity to be opportunistic with future opportunities. We view capital allocation as 3 legs on a stool, organic growth, inorganic growth and returning capital to shareholders. Our business, including the integration of PetCareRx has minimal CapEx requirements and we manage a moderate working capital balance in support of inventory fluctuations and seasonality. The second leg of the stool is acquisition opportunities and investments in partnerships. We just announced the recent acquisition that we believe adds to the overall product portfolio and increases our customer count. In April 2022, we announced an investment in Vetster, a leading pet telemedicine offering. We continue to look at opportunities, but we'll maintain strict discipline around future acquisitions and partnerships. As Matt mentioned earlier, PetMeds doesn't want to be all things to all parents. We want to maintain a focus on pet health and wellness through any acquisition, partnership or additional investments would have to fit within the framework and be complementary or additive to our existing business. Returning cash to shareholders, PetMeds has been a consistent dividend payer for several years. As a growing business, we want to balance the best use of our cash, given the opportunities that are in front of us. We will continue to strategically review and analytically assess the use of cash for the dividend and in support of organic and inorganic growth. In a way we believe can drive total shareholder value in the long term. Over the next few years, we believe we're in a great position to succeed on our strategic goals. The acquisition of PetCareRx gives us an immediate revenue boost, and we believe we can expand on that growth through the expanded product catalog and differentiated services. Through operational synergies and other initiatives such as expanding customer wallet share, we are working to expand EBITDA margins and improve overall profitability. We intend to do this by utilizing the existing cash flow of the business to further expand our products, customers and overall offerings. I'll now turn the call back to Matt to provide a recap of today's Analyst Day before opening the call up to questions. Matt?

Thanks, Christine. The PetCareRX transaction marks PetMed's second transaction in the last 9 months since the introduction of the new management team of business strategy. The first transaction was a combined investment business relationship with Vetster in April 2022, which introduced VetLive, a one-of-a-kind offering for pet parents in the pet telemedicine space. PetMeds continues to evaluate incremental growth through acquisitions, partnerships and investments. There is a massive total addressable market for PetMeds and we want to focus on overall pet health and wellness. That serviceable market remains a significant multibillion-dollar opportunity as well. Our unique perspective and offering focused on total wellness should inspire greater loyalty and customer retention with pet parents across the spectrum. Lastly, we think that we have the financial health and stability to accomplish these goals. With significant cash on hand, a business that generates significant cash flow and a strong balance sheet, we think we have ample flexibility to assess growth opportunities and focus on the most meaningful and best opportunities for us. Let's summarize today's call and highlights by turning to the next slide. With over 2 million unique customers and a valued brand name, we believe we are well positioned to take advantage of the multitude of opportunities in front of us. Our plan is to expand our overall customer base, provide more products and create unique and differentiated services for pet parents across the country. Our new management team, along with the hundreds of dedicated employees, have never been as excited to make the lives of pets healthier and happier. Of course, this is not the end of transformation. Expect more progress on our growth initiatives to bolster our pet health expert strategy. Lastly, I would like to welcome the PetCareRx team to the PetMeds pack. Together, we look forward to improving the lives of even more pets and pet parents as we share a common ethos around our vision that every pet deserves to live a happy, healthy life. We will be announcing our earnings date very soon and look forward to discussing our performance this quarter. Thank you, and we are now prepared to take your questions.

[Operator Instructions] Our first question comes from the line of Anthony Lebiedzinski with Sidoti.

So first, just on the PetCareRx deal. Can you talk about what have been their revenue trends over the last few years and also talk to the new customer -- I'm sorry, just a total number of customers. I know it's 200,000 right now, but can you give us a sense as to how that's progressed last few years and whether all of these customers are incremental actually to PetMed Express? And I know, Christine, you touched on the gross margins, but maybe if you could just also talk about the operating margins also for PetCareRx, that would be very helpful.

Yes, Christine, I'll take the first part if you can take the second part. Thanks, Anthony for your questions. It's great to hear from you. On the first part, in terms of revenue growth trends, and again, one of the interesting components to pick our Rx is when we said on the call that they were sort of a mini version of PetMeds, PetCareRx did a really successful migration from a prescription-only business to more of a balanced portfolio products with prescriptions as kind of the main reason why customers have gone to that brand with selling other products like premium prescription food, we're certainly a revenue accelerator. I don't think we're going to cover their kind of growth rate trends. I can say that they were a growth company. They were growing their business and both on new customers as well as topline revenue. Other than that, I don't think we're going to give a lot of trends related to their business, but the adjunct of their expanded catalog was certainly an accelerator for their business, which, again, as we mentioned on the call, long -- mid- to long term, we are excited to integrate more of those products on top of PetMed since we're so medication centric. So Christine, do you want to answer the last couple?

Yes. And thanks, Anthony, for the questions. In terms of the margins, like I said, the gross margins, we expect to be similar to that of PetMeds and in terms of operating margins, PetCareRx is not accretive on a stand-alone basis today. But after we close the acquisition, we'll be working on operating synergies that we believe will drive improved margins going forward. The businesses are very similar. And so there are natural synergies to be had and the PetCareRx business, even though a smaller business and some of the higher fixed cost that we see as an opportunity going forward. We also believe that through the growth in the industry and as we grow our overall revenue through the expanded catalog that, that will add overall profitability to the combined businesses as we move forward as well.

Got it. Okay. And then just wondering whether PetCareRx will need any material CapEx spending as you go through that process? Have you assessed that yet?

Christine, do you want to take that?

Yes, yes, absolutely. So we are continuing to assess as we're not yet closed, but we don't believe that there is a huge incremental CapEx requirement for the integration. As we've mentioned, we very much believe on managing the brands independently at this stage. And yes, we don't expect it to be any large or significant CapEx investments.

Got it. Okay. And then the last question for me, and I'll let others jump with their own questions. But given that you're now increasing your cash usage for acquisitions, do you have any updated thoughts on the dividend? Or is that too early.