PETS - NASDAQ

Good afternoon, everyone, and thank you for joining the PetMed Express third quarter preliminary financial results conference call. My name is Shamali, the operator for today's call. I would now like to pass the conference over to our host, Mr. Brian Prenoveau, Investor Relations.

Thank you, operator, and I'd like to welcome everybody here today to the PetMed Express fiscal third quarter preliminary financial results conference call. 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 a warranty as to any future matter, including any matter in respect of 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 to everyone for making the time today to participate in today's conference call. Today's call will follow a slightly different format than recent calls. As many of today's listeners likely saw, this afternoon, we filed an 8-K and issued a press release announcing a planned restatement of certain previously issued financial statements due to errors in accounting for certain tax-related matters. Please reference those documents for additional information regarding those factors that may affect the restatement of our financial statements. Additionally, due to the administrative burden and the process required for a multiyear restatement, our 10-Q for fiscal year 2024's third quarter ended December 31, 2023, will be delayed. The restatement and the delay in this quarter's 10-Q filing are due to errors in the accounting treatment related to certain previously reported tax-related items. As you recall, our Chief Financial Officer, Christine Chambers, first discussed the identification of the need for a sales tax accrual in the second fiscal quarter of last year and provided an update on the fiscal fourth quarter call. The restatement pertains in part to the recording of this sales tax accrual. I want to stress a few things. Number one, we're working together with all of our relevant partners and consultants to finalize the accounting treatment and complete the restatement as quickly as possible. Number two, the restatement has no impact on our day-to-day business operations or on our strategy. And number three, the restatement is a matter of accounting for tax-related items, and there is no impact on our current cash balance. Christine will be discussing this accounting issue in more detail during her portion of the call. We would like to spend the remainder of the time on today's call discussing progress made in the business and sharing some high-level specifics from the fiscal third quarter. For the quarter ending December 31, 2023, PetMeds delivered sales of $65.3 million compared to sales of $58.9 million in the prior year, an increase of 11% year-over-year, including from our recent acquisition of PetCareRx. We reported a gross margin of 27.4%, which was in line with our expectations. This reflects a balance between promotional activities intended to introduce food to our customers and a regimented focus on maintaining our historical gross margin as an overall business. Returning customers accounted for sales of $57.7 million during the quarter, reflecting a growth of 8% year-over-year related to the addition of the PetCareRx business. In terms of our initiatives to offer more products and provide more value to our existing pet parent customers, we've focused intensely on raising awareness about our food catalog at both the category and brand levels. Additionally, we're enhancing our cross-sell initiatives through our e-mail CRM, call center and website. Along those lines, we are excited to announce the addition of another major food brand of PetMeds in the coming months. We have entered into a partnership with Hill's Pet Nutrition and are launching Hill's Science Diet this quarter, a premium category known for its tailor-made nutrition that promotes healthy skin, coat and immune system in pets. Hill's Science Diet will start to roll out as early as next month. Premium food brands are important relationships for PetMeds, and this expansion was accelerated in part due to our acquisition of PetCareRx. Prescription and premium food are important categories for PetMed as our pet parents are very health and wellness focused. Simply put, our customers want premium food and prescription food options. And we'll be leaning in heavily on this brand as well as new ones as we continue to go to market in the pet food category. We believe these additional food options provide us the ability to interact with our customers more often, increase the average order size and enhance the lifetime value of each customer. Let's turn to our operational advancements and initiatives. We have talked about our key performance indicators for the transformation of the business: successfully providing more product offerings to our current customers, increasing our recurring customer base and driving recurring revenues. A key business model driver for the PetMeds business is to expand the number and types of products our core prescription customer base buys from us or will buy from us on a recurring basis. We believe that our new AutoShip platform, which was recently launched, will help facilitate the long-term compounded benefit and expanded customer loyalty by delivering exceptional value. This new AutoShip & Save capability enhances our current capabilities to include more pet parent control over their ordering experience, including activities like controlling the subscription duration, pausing or accelerating a subscription and adding additional products. We have also integrated our VetLive functionality, which connects pet parents to licensed veterinarians over a digital connection 24/7, which is now available for all of our AutoShip & Save customers on a complementary basis. We believe the more products a pet parent uses on our AutoShip program, the more loyal they become. Our AutoShip & Save and PetPlus programs grew to 52% of our revenue during this last fiscal quarter, a substantial increase from 42% of revenue for the same time last year. I will now turn the call over to our CFO, Christine Chambers, to provide an overview of the quarter's financials.

Thanks, Matt. I want to first address the restatement announced in the 8-K earlier this afternoon, and then I will address selected preliminary third quarter results for fiscal year 2024. In our previously issued annual financial statement for fiscal year 2023, we determined that an accrual for sales tax was required, so we recorded a sales tax accrual in the period based on a determination that the sales tax liability was probable and estimable and that it was in accordance with what we believe to be the appropriate guidance from GAAP. In the third quarter of fiscal year 2024, the company reviewed, in conjunction with our auditors, RSM, the accounting treatment related to the previously reported sales tax accruals as well as the accounting treatment related to the deferred tax asset associated with the company's acquisition of PetCareRx in April 2023. As a result of the review, the Audit Committee of our Board has concluded, based on management's determination, that the company misapplied GAAP as it relates to the sales tax liability for prior periods included in the second quarter and fourth quarter of fiscal year 2023 and the deferred tax asset reported in the first and second quarter of fiscal year 2024. The company expects the impact of the restatement to affect multiple periods. The most significant impact to the income statement is expected to be a decrease in general and administrative expense for fiscal year 2023 in the range of $6 million to $8 million and the corresponding increase in net income for the same period. This amount was originally recorded as a sales tax liability based on a probable and estimable approach in fiscal year 2023 rather than the correct legal liability approach, under which the maximum potential sales liability would have been recorded beginning in fiscal year 2020. The restatement is expected to require the company to revise and record a sales tax liability of approximately $14 million to $20 million as of March 31, 2020. Because this liability gets adjusted in subsequent periods, as of March 31, 2023, we expect to record a maximum potential sales tax liability of approximately $16 million to $23 million. In addition, the accounting related to the valuation of the carried forward net operating loss resulting in an overstated deferred tax asset reported at June 30 and September 30, 2023, related to the PetCareRx acquisition will also be revised. This will increase goodwill and decrease the deferred tax asset on the balance sheet. This revision is the result of a technical tax matter surrounding a limitation adjustment to the net operating losses acquired. The company believes that this fairly represents the expected impact of the restatement on the company's prior financial statements. However, further adjustments may arise. It is important to note that, while unfortunate, the restatement is not expected to have an impact on the company's fiscal year 2024 revenue or cost of sales sold and does not impact our current cash balance. The restatement is not expected to impact our day-to-day business operations or strategic priorities. As a result of the level of administrative effort and time associated with completing the restatement, the company will experience a delay in the filing of its quarterly report on Form 10-Q for the quarter ended December 31, 2023, and expects to file a notification of late filing with the SEC. To reiterate, this quarter, due to the restatement process, we cannot comment on numbers below the gross profit line as the restatement could potentially impact G&A. Today, I will report our selected preliminary third quarter fiscal 2024 results for the quarter ended December 31, 2023. As a reminder, this will be the third quarter of combined results including the acquisition of PetCareRx compared to results for PetMeds only for fiscal year 2023. Third quarter sales was $65.3 million, compared to sales of $58.9 million in the same period last year, representing growth of 11% year-over-year. The growth was due to incremental sales from the acquisition of PetCareRx, partially offset by declines in PetMeds legacy new order and reorder sales. We continue to experience a single-digit decline in PetMeds legacy reorder sales. We welcomed approximately 67,000 new pet parents this quarter compared to nearly 72,000 in the prior year. The decline year-over-year is primarily due to a onetime promotion in the same period last year that we tested and intentionally did not repeat as they did not attract high order value customers. Reorder sales were $57.7 million for the quarter, an increase of 8% compared to reorder sales of $53.3 million in the same period last year. We've continued to grow our recurring revenue, including AutoShip & Save sales and PetCareRx membership sales as a percentage of total sales. This drives greater engagement and strengthens our recurring sales base. Recurring sales as a percentage of total sales was 52% in the quarter, up sequentially from 51% in the prior quarter and up from 42% for the same period last year. Gross profit for the quarter as a percentage of sales was 27.4% compared to 25.9% in the same quarter last year and 28.3% in the prior quarter. The increase year-over-year was due to lower promotions compared to the prior year. As of December 31, 2023, we had approximately $49.4 million of cash and equivalents on hand and no debt. Now I will turn the call back to Matt for some concluding remarks.

Thanks, Christine. As the CEO of this company, I've always promised to lead with full transparency. Providing financial statements that can be relied upon is fundamental and paramount to running a public company. In an effort to provide complete and accurate financial statements, we've recorded an additional sales tax accrual during fiscal 2023 and, unfortunately, later determined that GAAP was misapplied in doing so. Despite having to correct this, I want to reiterate that our focus remains on operating the business and on executing our strategy. Our pet health care strategy revolves around 4 key pillars: medication, care, nutrition and wellness. PetMeds is focused on executing our initiatives to operate a broader range of products and services to our core PetMeds customer base on a recurring basis. The announcement of adding a new premium food brand, along with a major upgrade to our AutoShip & Save infrastructure represent significant milestones in the journey to transform PetMeds into a trusted pet health expert. This will deliver more value to new pet parents as well as our existing 2 million customers. With these statements, we conclude our prepared remarks for today. Operator, we are now prepared to take questions. Thank you.

[Operator Instructions] Our first question comes from the line of Ryan Meyers with Lake Street Capital Markets.

First one for me, just a couple on the actual restatement itself. Can you just discuss or explain what actually happened with the sales tax accrual and essentially how this error happened?

Ryan, it's Christine, and I'm glad you asked the question, thank you. There are 3 really important things that need to be taken away. And first thing I'll start with is this is the same issue that I identified and discussed last year related to our historical -- these are prior period sales tax and an exposure related to that. The difference is surrounded by the accounting treatment. So just to reiterate, this is not the result of any new facts or new analysis. It's about the accounting treatment. So secondly, let me just talk about the accounting treatment. There are 2 different ways to account for prior period sales tax liabilities. You can apply ASC 450, which is based on, as I mentioned, this probable and estimable approach. The other way that you can look at this is by applying ASC 405, which is based on a legal liability approach. This adopts a more strict interpretation and it accrues -- what's important, this accrues to the maximum legal liability. Now we believe that 405 is better than 450. And again, when you're looking at ASC and you're look at accounting applications, they're often about judgment. Historically, there has been diversity of practice applied to this issue. But we just reiterated that we believe now 405 is applicable versus 450. Thirdly, the last thing I want you to -- yes. Just to reiterate as well just the third thing. Yes. While having to restate is really disappointing, we are, as Matt and I have mentioned, committed to operating with the highest standard of transparency and making sure that we provide transparency and integrity. And we proactively identified the issue late in the third quarter and have begun working with our partners immediately to resolve. So we're working on this as quickly as possible, and we'll get more out as soon as we can.

Got it. That's helpful. I understand. And then you talked previously the accrual would be originally estimated about $6 million to $8 million. Now it sounds like it's obviously going to be quite a bit more than that. Does that mean you guys will be paying much more in that sales tax once those accruals go through? Or how should we be thinking about the taxes once you're able to revise this issue?

Yes. Thank you. Another great question. Again, no change, Ryan, to our approach or strategy in resolving sales tax issues with the states. We've demonstrated a history of most settlements with states, and again, our analysis of what is probable and estimable has not changed. So no change to our tax strategy with resolving these sales tax matters, just an accounting change.

Okay. Got it. And then just kind of switching gears here to the actual fundamentals of the business. Just wondering if you can comment on if you've seen further stabilization of the core PetMeds business or maybe a little bit more commentary on what you're seeing there?

Yes. I can take that, Christine. Ryan, thanks for the question. Yes, I think in the call, you obviously noted that the returning core PetMeds customer base, we noted, is declining relatively at the same rate from previous quarters. And really, the big comment there, I would say, is the core returning base of customers to PetMeds and the answer that we've really been focused on as a company is getting more of our customers on the AutoShip because our AutoShip business is growing and those customers churn less; and then 2, in parallel, upgrading that platform, which I noted on the call. And I've mentioned this on several calls, but just to add a little bit more color to that. The AutoShip & Save infrastructure was sitting on a very legacy-old platform. We spent about a year getting ready to do 2 things: one, to adopt that order management system that enables us to really build brains around distributing products, interacting with drop shippers, interacting with different warehouses; and then also, an order subscription platform that enables the consumer as well as us as the back end to have a much more flexible system. The old system was not really what I'd call industrial grade. And we think that this new platform that we just released just several weeks ago is going to be a really good answer to stabilizing the returning customer base with PetMeds. We've noted in our AutoShip sales as a percent of overall sales around 50%. We'd like to be a lot higher than that. Our original goal was 50%. We know that other direct-to-consumer brands have a much higher percent. And we couldn't have done that unless we made this investment about a year ago to upgrade the system. So in a long-winded way, more customers on AutoShip buying more products from PetMeds, including food. And this AutoShip & Save platform, we think, is going to be a key future unlock to really stabilize that base because it's a much more stable platform.

Got it. And then last question for me. Just wondering if you can comment on the food business. I know that's obviously a newer piece of the business. But any sort of contribution you guys saw there during the quarter or how we should think about that business is trending?

Yes. Thanks for that. Well, the answer there is 2 parts. One is getting food brands signed that our customers want, and I'll add a little bit of color on that. And then 2 is executing on getting more products that our customers want in the AutoShip program. So on the first part, we are currently expanding our relationships with many of the top prescription and premium food brands. We just announced that we'll be launching Hill's this quarter, Hill's Science Diet. And we'll be launching and announcing new deeper partnerships with these premium brands in the future. And that's a huge deal for our customers. Our customers are very health conscious. They go to the vet a lot. They want premium food and prescription products, given our prescription medication background. Getting those types of brands online is large because we know definitively how many of our customers use those brands. So that's the first unlock. Get the brands and get them signed. The second is executing on that. And we've seen a large growth in our food sales as a percentage of sales, which is very low. It's our fastest-growing category. And so as we get better at go-to-market, as we get better at marketing the right brands to our customers, that should continue to be a really good trend for the business.

And we have reached the end of the question-and-answer session. I'll now turn the call back over to Mathew Hulett for closing remarks.

Yes. Thanks, everybody, for joining us today. Although it was unfortunate news today regarding the tax liability issues and the accounting change, we hope that, that doesn't overshadow our excitement as a management team about the future of PetMeds as we transform from a single category pet medication business to a broader pet health expert business. We're excited about continuing to articulate our milestones along this journey. And thank you very much for your time and attention today. Thank you. Operator, we're all done here. Thank you very much.