Drugstore.com's sales climb, but so do its costs

Chain Drug Review, Nov 24, 2008

BELLEVUE, Wash. -- Red ink from continuing operations widened during the third quarter at drugstore.com, as escalating expenses countered solid sales growth and expanded gross margins. Adjusted EBITDA, however, soared nearly 76% and, in announcing the results, management forecast a modest profit for the fourth quarter (see accompanying story).

The loss from ongoing lines for the three months ended September 28 expanded 18.5% to $4.72 million from $3.98 million in the prior-year period.

In September drugstore.com restructured and expanded its agreement with Rite Aid Corp. to include a Rite Aid online over-the-counter products store that will be powered by drugstore.com. As a result, the company has transferred its local-pickup pharmacy operation (prescriptions ordered online for pickup at a Rite Aid store) to Rite Aid and classified it as a discontinued line.

In return, drugstore.com receives about $10 million in 10 monthly installments from Rite Aid. In line with that change, the company booked $1.1 million in income from discontinued operations, a 31.5% drop from $1.61 million in the prior-year quarter, exacerbating a net loss that swelled 52.4% to $3.62 million, or 4 cents per share, from $2.37 million, or 2 cents per share, a year ago.

The loss from ongoing lines, meanwhile, was heightened by a fourfold jump in amortization of noncash marketing costs to $2.29 million and a 56.8% surge in depreciation to $3.04 million. Factoring out those and certain other items, adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) soared 75.5% to $3.63 million from $2.07 million.

The top line for the online retailer of health, beauty, vision and pharmacy products advanced 8.5% to $87.8 million from $81 million, driven by a 12.1% advance in net O-T-C sales to $61.2 million. Vision sales, meanwhile, gained 4.9% to $15.6 million, but mail-order pharmacy sales fell 4% to $11 million.

Taking a closer look at sales trends, the average transaction for the quarter was $69, while the average net sales per O-T-C order were $58. The average vision order expanded about 13% to $114 while the average mail-order prescription ticket grew 7% to $161. According to management, drugstore.com served about 325,000 new customers, up 6% over the prior-year period, as total orders increased approximately 7% to 1.3 million.

"We posted a solid third quarter, with strong beauty growth, record gross margins and adjusted EBITDA improvement of 76% over the prior-year period to surpass $3.6 million," said chairman and chief executive officer Dawn Lepore. "Overall beauty revenues increased over 20% from the prior-year period, aided by 32% growth in our Beauty.com business.

"Importantly, we are also continuing to see the benefits from our focus on our profitability initiatives as O-T-C margins improved 230 basis points to 31.6%, year over year."

Consolidated gross margin leapt 189 basis points to 28.6%, but total operating costs--which include order processing and fulfillment, marketing and sales, technology and content, general and administrative items, and amortization of intangible assets--more than kept pace, exploding 193 basis points to 34.13% of net sales, reflecting a 15 % dollar increase to $30 million. As a result, the operating loss deepened 9.6% to $4.86 million.

Although its impact was slight, interest income tumbled 70.2% to $137,000.

The company's loss from ongoing operations for the three quarters edged up 1.5% to $13.6 million despite a 9.9% hike in net sales to $272.6 million.

Year-to-date income from discontinued lines jumped 18.7% to $5.01 million from $4.22 million, helping trim the net loss by 6.4% to $8.58 million from $9.17 million in the fiscal 2007 span.

Adjusted EBITDA for the nine months skyrocketed 69.1% to $8.68 million.

Gross margin for the year to date expanded 150 basis points to 27.9%, outpacing growth of the operating expense ratio, which added 76 basis points to reach 32.31% of sales.

With that, the company's operating loss narrowed by 3.8% to $14.1 million.