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. Presently, the Company's product line includes approximately 750 of the most popular pet medications and other health products for dogs, cats, and horses.

The Company markets its products through national television, online, and direct mail/print advertising campaigns which direct consumers to order by phone or on the Internet, and aim to increase the recognition of the "1-800-PetMeds" brand name, and "PetMeds" family of trademarks. Approximately 65% of all sales were generated via the Internet in both fiscal 2009 and fiscal 2008.

The Company's sales consist of products sold mainly to retail consumers and minimally to wholesale customers. Typically, the Company's customers pay by credit card or check at the time the order is shipped. The Company usually receives cash settlement in two to three banking days for sales paid by credit cards, which minimizes the accounts receivable balances relative to the Company's sales. The Company's sales returns average was approximately 1.5% of sales for both the fiscal years ended March 31, 2009 and 2008. The twelve-month average purchase was approximately $82 and $80 per order for the fiscal years ended March 31, 2009 and 2008, 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, 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 and health products, and pet supplies primarily to retail consumers and minimally to wholesale customers.
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 March 31, 2009 and 2008 the allowance for doubtful accounts was approximately $59,000 and $32,000, respectively.

Valuation of inventory

Inventories consist of prescription and non-prescription pet medications, health products, 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 $202,000 and $135,000 for the fiscal years ended March 31, 2009 and 2008, respectively.

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 SFAS No. 109, 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 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:

                                                   Fiscal Year Ended March 31,

                                                   2009         2008       2007
     Sales                                         100.0  %     100.0  %  100.0  %
     Cost of sales                                  61.1         60.6      60.2

     Gross profit                                   38.9         39.4      39.8

     Operating expenses:
       General and administrative                    9.8         10.8      10.6
       Advertising                                  13.1         13.4      15.6
       Depreciation and amortization                 0.4          0.3       0.3
     Total operating expenses                       23.3         24.5      26.5

     Income from operations                         15.6         14.9      13.3

     Total other income (expense)                    0.7          1.2       1.0

     Income before provision for income taxes       16.3         16.1      14.3

     Provision for income taxes                      5.8          5.5       5.4

     Net income                                     10.5  %      10.6  %    8.9  %

Fiscal 2009 Compared to Fiscal 2008

Sales

Sales increased by approximately $31,076,000, or 16.5%, to approximately $219,412,000 for the fiscal year ended March 31, 2009, from approximately $188,336,000 for the fiscal year ended March 31, 2008. The increase in sales for the fiscal year ended March 31, 2009 was primarily due to increased retail reorders and new orders. The Company has committed certain dollar amounts specifically designated towards television, direct mail/print, and online advertising to stimulate sales, create brand awareness, and acquire new customers. The Company acquired approximately 802,000 new customers for the year ended March 31, 2009, compared to approximately 710,000 new customers for the same period the prior year. There can be no assurances that this growth trend will continue, due to increasing competition from veterinarians and traditional and online retailers.

                                             Year Ended March 31,
                    2009              %             2008              %          $ Variance       % Variance

Reorder Sales  $  156,781,000      71.5  %     $  134,349,000      71.3  %     $  22,432,000         16.7  %
New Order
Sales          $   62,478,000      28.5  %     $   53,766,000      28.6  %     $   8,712,000         16.2  %
Wholesale
Sales          $      153,000         -  %     $      221,000       0.1  %     $     (68,000)       -30.8  %

Total Net
Sales          $  219,412,000     100.0  %     $  188,336,000     100.0  %     $  31,076,000         16.5  %

Internet Sales $  143,284,000      65.3  %     $  122,484,000      65.0  %     $  20,800,000         17.0  %
Contact Center
Sales          $   76,128,000      34.7  %     $   65,852,000      35.0  %     $  10,276,000         15.6  %

Total Net
Sales          $  219,412,000     100.0  %     $  188,336,000     100.0  %     $  31,076,000         16.5  %

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 2009, the Company's sales were approximately 31%, 27%, 20%, and 22%, respectively.

Cost of sales

Cost of sales increased by $19,963,000, or 17.5%, to $134,085,000 for the fiscal year ended March 31, 2009, from $114,122,000 for the fiscal year ended March 31, 2008. The increase in cost of sales is directly related to the increase in sales in fiscal 2009 as compared to fiscal 2008. As a percent of sales, the cost of sales was 61.1% in fiscal 2009, as compared to 60.6% in fiscal 2008.
The percentage increase can be mainly attributed to increases in our product costs, offset by a reduction in freight expenses due to a shift from priority to standard shipping.

Gross profit

Gross profit increased by $11,114,000, or 15.0%, to $85,328,000 for the fiscal year ended March 31, 2009, from $74,214,000 for the fiscal year ended March 31, 2008. Gross profit as a percentage of sales for fiscal 2009 and 2008 was 38.9% and 39.4%, respectively. The gross profit percentage decrease can be mainly attributed to increases in our product costs, offset by a reduction in freight expenses due to a shift from priority to standard shipping.

General and administrative expenses

General and administrative expenses increased by $1,238,000, or 6.1%, to $21,605,000 for the fiscal year ended March 31, 2009 from $20,367,000 for the fiscal year ended March 31, 2008. General and administrative expenses as a percentage of sales was 9.8% compared to 10.8% for the fiscal years ended March 31, 2009 and 2008, respectively. The increase in general and administrative expenses for the fiscal year ended March 31, 2009 was primarily due to the following: a $754,000 increase in payroll expenses which can be attributed to the addition of new employees in the customer care and pharmacy departments enabling the Company to sustain its growth; a $619,000 increase in credit card and bank service fees which is directly attributable to increased sales in the fiscal year; a $367,000 increase in professional fees, with the majority of the increase related to increased legal fees; a $212,000 increase in property expenses which can be directly attributed to increased rent due to the 15,000 square feet warehouse and pharmacy expansion; a $82,000 increase in telephone expenses which can be directly attributed to increased sales; and a $56,000 net increase in bad debt, license, travel, and insurance expenses. Offsetting the increase was a $466,000 reduction in office expenses, a portion of which was due to a change in our shipping policy, a shift from priority to standard shipping, enacted in fiscal 2009. Shipping expenses formerly chargeable as general and administrative expenses are now qualified as cost of sales. Also, offsetting the increase was a $386,000 one-time state/county sales tax charge which was booked in fiscal 2008, relating to state/county sales tax which was not collected on behalf of our customers.

Advertising expenses

Advertising expenses increased by approximately $3,446,000, or approximately 13.6%, to approximately $28,707,000 for the fiscal year ended March 31, 2009 from approximately $25,261,000 for the fiscal year ended March 31, 2008. The increase in advertising expenses for the fiscal year ended March 31, 2009 was due to the Company's plan to commit certain amounts specifically designated towards television, direct mail/print, and online advertising to stimulate sales, create brand awareness, and acquire new customers. The advertising cost of acquiring a new customer, defined as total advertising cost divided by new customers acquired, was $36 for both the fiscal years ended March 31, 2009 and 2008. 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 from veterinarians and other retailers of pet medications. 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 13.1% in fiscal 2009, as compared to 13.4% in fiscal 2008. The decrease in advertising expense as a percentage of total sales for fiscal 2009 can be attributed to increased sales with new customer acquisition costs remaining relatively flat. The Company currently anticipates advertising as a percentage of sales to range from approximately 12.0% to 13.0% in fiscal 2010. However, the advertising percentage will fluctuate quarter to quarter due to seasonality and advertising availability.
For the fiscal year ended March 31, 2009, quarterly advertising expenses as a percentage of sales ranged between 11% and 15%.

Depreciation and amortization

Depreciation and amortization increased by approximately $225,000, or 38.1%, to approximately $815,000 for the fiscal year ended March 31, 2009 from approximately $590,000 for the fiscal year ended March 31, 2008. This increase to depreciation and amortization expense for fiscal 2009 can be attributed to an increase in new property and equipment additions relating to the warehouse, pharmacy and customer care call centers expansion in fiscal 2009.

Other income

Other income decreased by approximately $960,000, or 39.7%, to approximately $1,456,000 for the fiscal year ended March 31, 2009, from approximately $2,416,000 for the fiscal year ended March 31, 2008. The decrease to other income can be primarily attributed to decreased interest income due to a reduction in interest rates and a reduced cash balance due to the Company's share repurchase plan. The decrease can also be attributed to a reduction in advertising revenue generated from our website. Also, during fiscal 2009, the Company booked a charge of $140,000 in interest and penalties due to a late payment of federal income taxes. Interest income may decrease in the future due to a reduction in interest rates and also as the Company utilizes its cash balances on its $20,000,000 share repurchase plan, with approximately $9,952,000 remaining as of May 29, 2009, or on its operating activities.

Provision for income taxes

For the fiscal years ended March 31, 2009 and 2008, the Company recorded an income tax provision for approximately $12,680,000 and $10,389,000, respectively. The effective tax rate for the fiscal years ended March 31, 2009 and 2008 were 35.6% and 34.2%, respectively. The effective tax rate increase can be attributed to an income tax benefit of approximately $308,000 that was recognized in fiscal 2008, which relates to an income tax over-accrual for the fiscal year ended March 31, 2007. During the first quarter of fiscal 2008, it was determined that the Company was no longer a full tax payer in the state of Florida, due to the fact that it established nexus in another state. This event triggered a lower effective tax rate in fiscal 2008. The Company estimates its effective tax rate to be approximately 36.0% in fiscal 2010.

Net income

Net income increased by approximately $2,954,000, or 14.8%, to approximately $22,976,000 for the fiscal year ended March 31, 2009 from approximately $20,022,000 for the fiscal year ended March 31, 2008. The increase was mainly attributable to the Company's sales growth and our success in leveraging our operating and advertising expenses.

Fiscal 2008 Compared to Fiscal 2007

Sales

Sales increased by approximately $26,090,000, or 16.1%, to approximately $188,336,000 for the fiscal year ended March 31, 2008, from approximately $162,246,000 for the fiscal year ended March 31, 2007. The increase in sales for the fiscal year ended March 31, 2008 was primarily due to increased retail reorders and new orders, offset by decreased wholesale sales. The Company has committed certain dollar amounts specifically designated towards television, direct mail/print, and online advertising to stimulate sales, create brand awareness, and acquire new customers. The Company acquired approximately 710,000 new customers for the year ended March 31, 2008, compared to approximately 681,000 new customers for the same period the prior year. There can be no assurances that this growth trend will continue, due to increased price competition from veterinarians and traditional and online retailers.

The following chart illustrates sales by various sales classifications:

                                               Year Ended March 31,
                          2008              %             2007              %          $ Variance       % Variance

Reorder Sales        $  134,349,000      71.3  %     $  110,540,000      68.1  %     $  23,809,000         21.5  %
New Order Sales      $   53,766,000      28.6  %     $   51,096,000      31.5  %     $   2,670,000          5.2  %
Wholesale Sales      $      221,000       0.1  %     $      610,000       0.4  %     $    (389,000)       -63.6  %

Total Net Sales      $  188,336,000     100.0  %     $  162,246,000     100.0  %     $  26,090,000         16.1  %

Internet Sales       $  122,484,000      65.0  %     $  100,916,000      62.2  %     $  21,568,000         21.4  %
Contact Center Sales $   65,852,000      35.0  %     $   61,330,000      37.8  %     $   4,522,000          7.4  %

Total Net Sales      $  188,336,000     100.0  %     $  162,246,000     100.0  %     $  26,090,000         16.1  %

Leading up to the 2004 presidential election we experienced an increase in the advertising cost of acquiring a new customer and a decrease in new customer sales, which may have been attributed to a shortage of television advertising inventory. There can be no assurances that the 2008 presidential election will not have a similar impact on the advertising cost of acquiring a new customer and new customer sales.

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 2008, the Company's sales were approximately 31%, 27%, 20%, and 22%, respectively.

Cost of sales

Cost of sales increased by $16,442,000, or 16.8%, to $114,122,000 for the fiscal year ended March 31, 2008, from $97,680,000 for the fiscal year ended March 31, 2007. The increase in cost of sales is directly related to the increase in retail sales in fiscal 2008 as compared to fiscal 2007. As a percent of sales, the cost of sales was 60.6% in fiscal 2008, as compared to 60.2% in fiscal 2007.
The percentage increase can be mainly attributed to increases in our product and freight costs offset by a shift in our product mix to higher margin items.

Gross profit

Gross profit increased by $9,648,000, or 14.9%, to $74,214,000 for the fiscal year ended March 31, 2008, from $64,566,000 for the fiscal year ended March 31, 2007. Gross profit as a percentage of sales for fiscal 2008 and 2007 was 39.4% and 39.8%, respectively. The gross profit percentage decrease can be mainly attributed to increases in our product and freight costs offset by a shift in our product mix to higher margin items.

General and administrative expenses increased by $3,074,000, or 17.8%, to $20,367,000 for the fiscal year ended March 31, 2008 from $17,293,000 for the fiscal year ended March 31, 2007. General and administrative expenses as a percentage of sales was 10.8% compared to 10.6% for the fiscal years ended March 31, 2008 and 2007, respectively. The increase in general and administrative expenses for the fiscal year ended March 31, 2008 was primarily due to the following: a $1,981,000 increase in payroll expenses, with $584,000 of the increase due to the recognition of additional stock based compensation expense during the fiscal year relating to the issuance of restricted stock and stock options, with $295,000 of the increase due to withholding tax expense relating to restricted stock issuances in fiscal 2007 and 2008, and the remaining amount attributed to the addition of new employees in the customer care and pharmacy departments enabling the Company to sustain its growth; a $692,000 increase in credit card and bank service fees which is directly attributable to increased sales in the fiscal year; a $386,000 one-time charge due to the fact that nexus was established in another state, relating to state/county sales tax which was not collected on behalf of our customers in fiscal 2007; a $175,000 increase in office expenses which can be directly attributed to increased sales; and a $97,000 increase in property expenses which can be directly attributed to increased sales; with a $78,000 decrease in license fees; a $65,000 decrease in professional fees; a $55,000 decrease in telephone expense; a $41,000 decrease in insurance expense; and a $18,000 decrease in other expenses, including travel and bad debt expenses, offsetting the increase.

Advertising expenses

Advertising expenses increased by approximately $18,000, or approximately 0.1%, to approximately $25,261,000 for the fiscal year ended March 31, 2008 from approximately $25,243,000 for the fiscal year ended March 31, 2007. The slight increase in advertising expenses for the fiscal year ended March 31, 2008 was due to the Company's plan to commit certain amounts specifically designated towards television, direct mail/print, and online advertising to stimulate sales, create brand awareness, and acquire new customers.

The advertising cost of acquiring a new customer, defined as total advertising cost divided by new customers acquired, for the fiscal year ended March 31, 2008 was $36, compared to $37 for the same period the prior year. 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 from veterinarians and other retailers of pet medications.
Historically, the advertising environment fluctuates due to supply and demand. A less favorable advertising environment may negatively impact future new order sales. As a percentage of sales, advertising expense was 13.4% in fiscal 2008, as compared to 15.6% in fiscal 2007. The decrease in advertising expense as a percentage of total sales for fiscal 2008 can be attributed to increased sales with a slight improvement in new customer acquisition costs during the year.
The Company currently anticipates advertising as a percentage of sales to range from approximately 13.0% to 14.0% in fiscal 2009. However, the advertising percentage will fluctuate quarter to quarter due to seasonality and advertising availability. For the fiscal year ended March 31, 2008, quarterly advertising expenses as a percentage of sales ranged between 11% and 16%.

Depreciation and amortization

Depreciation and amortization increased by approximately $60,000, or 11.2%, to approximately $590,000 for the fiscal year ended March 31, 2008 from approximately $530,000 for the fiscal year ended March 31, 2007. This increase to depreciation and amortization expense for fiscal 2008 can be attributed to an increase in new property and equipment additions in fiscal 2008.

Other income

Other income increased by approximately $715,000, or 42.0%, to approximately $2,416,000 for the fiscal year ended March 31, 2008, from approximately $1,701,000 for the fiscal year ended March 31, 2007. The increase to other income can be primarily attributed to increased interest income due to increases in the Company's cash balance, which is swept into an interest-bearing overnight account, and a tax-free investment account. The increase can also be attributed to additional advertising revenue generated from our website. Interest income may decrease in the future due to a reduction in interest rates and also as the Company utilizes its cash balances on its $20,000,000 share repurchase plan, with approximately $8,399,000 remaining, or on its operating activities.

For the fiscal years ended March 31, 2008 and 2007, the Company recorded an income tax provision for approximately $10,389,000 and $8,757,000, respectively.
The income tax provision for fiscal 2008 includes a tax benefit of approximately $308,000 which relates to an income tax over-accrual for the fiscal year ended March 31, 2007. During the first quarter of fiscal 2008, it was determined that the Company was no longer a full tax payer in the state of Florida, due to the fact that it established nexus in another state. This event triggered a lower effective tax rate in fiscal 2008. The Company also recognized a $155,000 income tax benefit due to the disqualifying disposition of certain incentive stock option exercises during fiscal 2008. These events resulted in an effective tax rate of 34.2% for the year ended March 31, 2008, compared to an effective tax rate of 37.7% for the year ended March 31, 2007.
The Company estimates its effective tax rate to be approximately 36.0% in fiscal 2009.

Net income

Net income increased by approximately $5,578,000, or 38.6%, to approximately $20,022,000 for the fiscal year ended March 31, 2008 from approximately $14,444,000 for the fiscal year ended March 31, 2007. The increase was mainly attributable to the Company's sales growth and our success in leveraging our operating expenses.

Liquidity and Capital Resources

The Company's working capital at March 31, 2009 and 2008 was approximately $54,630,000 and approximately $38,804,000, respectively. The $15,826,000 increase in working capital was primarily attributable to redemptions of long term investments, cash flow generated from operations, interest income earned on investments, and the exercise of stock options, offset by the repurchase of shares pursuant to the Company's stock repurchase plan. Net cash provided by operating activities was $14,966,000 and $19,380,000 for the fiscal years ended March 31, 2009 and 2008, respectively. Net cash provided by investing activities was $11,179,000 and $9,102,000 for the fiscal years ended March 31, 2009 and 2008, respectively. This change can be attributed to an increased amount of property and equipment purchases for our warehouse, pharmacy and customer care departments, the redemption of short and long term investments, and the acquisition of a $485,000 intangible asset in fiscal 2009. Net cash used in financing activities was $16,287,000 and $8,531,000 for fiscal 2009 and 2008, respectively. This change was primarily due to the Company repurchasing 1,347,000 shares of its common stock for approximately $18,448,000 during fiscal 2009, compared to the Company repurchasing 952,000 shares of its common stock for approximately $11,601,000 during fiscal 2008, offset by the exercise of . . .