PETMED EXPRESS INC - Annual Report: 2010 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Commission File Number 000-28827

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PETMED EXPRESS, INC.

(Exact name of registrant as specified in its charter)

___________________________

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes £ No S

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes £ No S

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes S No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceeding12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £  No £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  S

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £ No S

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of September 30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, was $419,319,000 based on the closing sales price of the registrant’s Common Stock on that date, as reported on the NASDAQ Global Select Market.

The number of shares of the registrant’s Common Stock outstanding as of May 28, 2010 was 23,018,702.

DOCUMENTS INCORPORATED BY REFERENCE

Information to be set forth in our Proxy Statement relating to our 2010 Annual Meeting of Stockholders to be held on July 30, 2010 is incorporated by reference in Items 10, 11, 12, 13, and 14 of Part III of this report.

PETMED EXPRESS, INC.

2010 Annual Report on Form 10-K

TABLE OF CONTENTS

PART I

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

Certain information in this Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  You can identify these forward-looking statements by the words "believes," "intends," "expects," "may," "will," "should," "plan," "projects," "contemplates," "intends," "budgets," "predicts," "estimates," "anticipates," or similar expressions.  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 future results may differ significantly from the results discussed in the forward-looking statements.  A reader, whether investing in our common stock or not, should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report.

When used in this Annual Report on Form 10-K, "PetMed Express," "1-800-PetMeds," “PetMeds,” "PetMed," “PetMeds.com,” "PetMed Express.com," "the Company,"  "we," "our," and "us" refer to PetMed Express, Inc. and our wholly-owned subsidiaries.

ITEM 1.

BUSINESS

General

PetMed Express, Inc. and subsidiaries, d/b/a 1-800-PetMeds, is a leading nationwide pet pharmacy.  The Company markets prescription and non-prescription pet medications, and other health products for dogs, cats, and horses direct to the consumer.  The Company offers consumers an attractive alternative for obtaining pet medications in terms of convenience, price, and speed of delivery.

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.  Our fiscal year end is March 31, our executive offices are located at 1441 S.W. 29^th Avenue, Pompano Beach, Florida 33069, and our telephone number is (954) 979-5995.  

Our Products

We offer a broad selection of products for dogs, cats, and horses.  Our current product line contains approximately 750 SKUS.  These products include a majority of the well-known brands of medication, such as Frontline Plus®, K9 Advantix®, Advantage®, Heartgard Plus®, Sentinel®, Interceptor®, Program®, Revolution®, Deramaxx®, and Rimadyl®.  Generally, our prices are competitive with the prices for medications charged by veterinarians and retailers.

We research new products, and regularly select new products or the latest generation of existing products to become part of our product selection.  In addition, we also refine our current products to respond to changing consumer-purchasing habits.  Our website is designed to give us the flexibility to change featured products or promotions.  Our product line provides customers with a wide variety of selections across the most popular health categories for dogs, cats, and horses.  Our current products include:

Non-Prescription Medications (OTC): Flea and tick control products, bone and joint care products, vitamins and nutritional supplements, and hygiene products.

Prescription Medications (Rx): Heartworm preventatives, arthritis, thyroid, diabetes, and pain medications, antibiotics, and other specialty medications, as well as generic substitutes.

In March 2010 the Company started offering for sale additional pet supplies on our website, which will be drop shipped to our customers by third parties.  These pet supplies include: beds, crates, stairs, strollers, and other popular pet supplies.

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Sales

The following table provides a breakdown of the percentage of our total sales by each category during the indicated periods:

We offer our products through three main sales channels: Internet through our website, telephone contact center through our toll-free number, and direct mail/print through 1-800-PetMeds catalogs, brochures, and postcards.  We have designed our catalogs and website to provide a convenient, cost-effective, and informative shopping experience that encourages consumers to purchase products important for a pet’s health and quality of life.  We believe that these multiple channels allow us to increase the visibility of our brand name and provide our customers with increased shopping flexibility and excellent service.

Internet

We seek to combine our product selection and pet health information with the shopping ease of the Internet to deliver a convenient and personalized shopping experience.  Our website offers health and nutritional product selections for dogs, cats, and horses, and relevant editorial and easily obtainable or retrievable resource information.  From our home page, customers can search our website for products and access resources on a variety of information on dogs, cats, and horses.  Customers can shop at our website by category, product line, individual product, or symptom.  We attracted approximately 17 million visitors to our website during fiscal 2010, approximately 13% of those visitors placed an order, and our website generated approximately 68% of our total sales for the same time period.

In February 2006, we began sponsorship of a website called "PetHealth101" which is located at www.PetHealth101.com.  In PetHealth101, pet owners have access to health information covering pets’ behavior and illnesses, and natural and pharmaceutical remedies specifically for a pet’s problems. PetHealth101 is periodically updated with the latest research for pet owners.  

Telephone Contact Center

Our customer care representatives receive and process inbound and outbound customer calls, facilitate our live web chat, and process customer e-mails.  Our telephone system is equipped with certain features including pop-up screens and call blending capabilities that give us the ability to efficiently utilize our customer care representatives’ time, providing excellent customer care, service, and support.  Our customer care representatives receive a base salary and are rewarded with commissions for sales, and bonuses and other awards for achieving certain quality goals.

Direct Mail/Print

The 1-800-PetMeds catalog is a full-color catalog that features our most popular products.  The catalog is produced by a combination of in-house writers, production artists, and independent contractors.  We mail catalogs, brochures, and postcards in response to requests generated from our advertising and as part of direct mail campaigns to our customers.

Our Customers

Approximately 2,600,000 customers have purchased from us within the last two years.  We attracted approximately 815,000 and 802,000 new customers in fiscal 2010 and 2009, respectively.  Our customers are located throughout the United States, with approximately 50% of customers residing in California, Florida, Texas, New York, Pennsylvania, Virginia, North Carolina, and Georgia.  Our primary focus has been on retail customers and the average purchase was approximately $80 for fiscal 2010 compared to $82 for fiscal 2009.

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Marketing

The goal of our marketing strategy is to build brand recognition, increase customer traffic, add new customers, build strong customer loyalty, maximize reorders, and develop incremental revenue opportunities.  We have an integrated marketing campaign that includes television advertising, direct mail/print and e-mail, and online marketing.

Television Advertising

Our television advertising is designed to build brand equity, create brand awareness, and generate initial purchases of products via the telephone and the Internet.  We have used :30 and :15 second television commercials to attract new customer orders.  Our television commercials typically focus on our ability to rapidly deliver to customers the same medications offered by veterinarians, but at reduced prices.  We generally purchase advertising on national cable channels to target our key demographic group – women, ages 30 to 65.  We believe that television advertising is particularly effective and instrumental in building brand awareness.  

Direct Mail/Print and E-mail

We use direct mail/print and e-mail to acquire new customers and to remind our existing customers to reorder.   

Online Marketing

We supplement our traditional advertising with online advertising and marketing efforts.  We make our brand available to Internet consumers by purchasing targeted keywords and achieving prominent placement on the top search engines and search engine networks, including Google, Microsoft Network (bing™), and Yahoo®.  We utilize Internet banner advertisements and we are also members of the LinkShare Network, which is an affiliate program with merchant clients and affiliate websites.  This network is designed to develop and build a long-term, branded affiliate program in order to increase online sales and establish an Internet presence.  The LinkShare Network enables us to establish link arrangements with other websites.

Operations

Order Processing

We provide our customers with toll-free telephone access to our customer care representatives.  Our call center generally operates from 8:00 AM to 11:00 PM Monday through Thursday, 8:00 AM to 9:00 PM on Friday, 9:00 AM to 6:00 PM on Saturday, and 10:00 AM to 5:00 PM on Sunday, Eastern Time.  The process of customers purchasing products from 1-800-PetMeds consists of a few simple steps.  A customer first places a call to our toll-free telephone number or visits our website.  The following information is needed to process prescription orders: pet information, prescription information, and the veterinarian’s name and phone number.  This information is entered into our computer system.  Then our pharmacists and pharmacy technicians verify all prescriptions.  The order process system checks for the verification for prescription medication orders and a valid payment method for all orders.  An invoice is generated and printed in our fulfillment center, where items are picked for shipping.  The product(s) in the customer’s order are then selected from the Company's inventory and shipped via United States Postal Service or Federal Express.  Our customers enjoy the convenience of rapid home delivery, with approximately 75% of all orders being shipped within 24 hours of ordering.  Our website allows customers to easily browse and purchase all of our products online.  Our website is designed to be fast, secure, and easy to use with order and shipping confirmations, and with online order tracking capabilities.

Customer Care and Support

We believe that a high level of customer care and support is critical in retaining and expanding our customer base.  Customer care representatives participate in ongoing training programs under the supervision of our training managers.  These training sessions include a variety of topics such as product knowledge, computer usage, customer service tips, and the relationship between our Company and veterinarians.  Our customer care representatives respond to customers’ e-mails and calls that are related to products, order status, prices, and shipping.  Our customer care representatives also respond to customers through our live web chat.  We believe our customer care representatives are a valuable source of feedback regarding customer satisfaction.  Our customer returns and credits average approximately 1.5% of total sales.

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Warehousing and Shipping

We inventory our products and fill most customer orders from our corporate headquarters in Pompano Beach, Florida.  We have an in-house fulfillment and distribution operation, which is used to manage the entire supply chain, beginning with the placement of the order, continuing through order processing, and then fulfilling and shipping of the product to the customer.  We offer a variety of shipping options, including next day delivery.  We ship to anywhere in the United States served by the United States Postal Service or Federal Express.  Priority orders are expedited in our fulfillment process.  Our goal is to ship the products the same day that the order is received.  For prescription medications, our goal is to ship the product immediately after the prescription has been authorized by the customer’s veterinarian.

Purchasing

We purchase our products from a variety of sources, including certain manufacturers, domestic distributors, and wholesalers.  We have multiple suppliers for each of our products to obtain the lowest cost.  There are currently five suppliers from whom we purchased approximately 50% of all products in fiscal 2010.  We purchase the majority of our health and nutritional supplements directly from manufacturers.  We believe having strong relationships with product manufacturers will ensure the availability of an adequate volume of products ordered by our customers, and will enable us to provide more and better product information.  Historically, substantially all the major manufacturers of prescription and non-prescription medications have declined to sell these products to direct marketing companies, such as our Company.  (See Risk Factors.)  Part of our growth strategy includes developing direct relationships with the leading pharmaceutical manufacturers of the more popular prescription and non-prescription medications.  In March 2010 Bayer started making their products available directly to pet specialty retailers and internet sites, including our Company.

Technology

We utilize integrated technologies in our call centers, e-commerce, order entry, and inventory control/fulfillment operations.  Our systems are custom configured by the Company to optimize our computer telephone integration and mail-order processing.  The systems are designed to maintain a large database of specialized information and process a large volume of orders efficiently and effectively.  Our systems provide our customer care representatives, and our customers on our website, with real time product availability information and updated customer information to enhance our customer care.  We also have an integrated direct connection for processing credit cards to ensure that a valid credit card number and authorization have been received at the same time our customer care representatives are on the phone with the customer or when a customer submits an order on our website.  Our information systems provide our customer care representatives with records of all prior contact with a customer, including the customer’s address, phone number, e-mail address, prescription information, order history, payment history, and notes.

Competition

The pet medications market is competitive and highly fragmented.  Our competitors consist of veterinarians, traditional and online retailers.  We believe that the following are the principal competitive factors in our market:

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Product selection and availability, including the availability of prescription and non-prescription medications;

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Brand recognition;

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Reliability and speed of delivery;

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Personalized service and convenience;

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Price; and

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Quality of website content.

We compete with veterinarians for the sale of prescription and non-prescription pet medications and other health products.  Many pet owners may prefer the convenience of purchasing their pet medications or other health products at the time of a veterinarian visit, or may be hesitant to offend their veterinarian by not purchasing these products from the veterinarian.  In order to effectively compete with veterinarians, we must continue to educate pet owners about the service, convenience, and savings offered by our Company.

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According to the American Pet Products Manufacturers Association, pet spending in the United States increased 5% to $45.5 billion in 2009.  Pet supplies and medications represented $10.4 billion, or 22% of the total spending on pets in the United States.  The pet medication market that we participate in is estimated to be approximately $3.7 billion, with veterinarians having the majority of the market share.  The dog and cat population is approximately 171 million, with approximately 62% of all households owning a pet.

We believe that the following are the main competitive strengths that differentiate 1-800-PetMeds from the competition:

·

“1-800-PetMeds” brand name;

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Exceptional customer care and support;

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Consumer benefit structure of savings and convenience; and

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Licensed pharmacy to conduct business in 50 states, and awarded Vet-VIPPS (Veterinary-Verified Internet Pharmacy Practice Site) accreditation by the National Association of Boards of Pharmacy.

Intellectual Property

We conduct our business under the trade name “1-800-PetMeds” and use a family of names all containing the term “PetMeds” or “PetMed” in some form.   We believe this name, which is also our toll-free telephone number, and the “PetMeds” family of trademarks, have added significant value and are an important factor in the marketing of our products. We have also obtained the right to use and control the Internet addresses www.1800petmeds.com, www.1888petmeds.com, www.petmedexpress.com, www.petmed.com, and www.petmeds.com.   We do not expect to lose the ability to use the Internet addresses; however, there can be no assurance in this regard and the loss of these addresses may have a material adverse effect on our financial position and results of operations.  We are the exclusive owners of United States Trademark Registrations for “PetMed Express and Design®,” “1888PetMeds and Design®,” “1-800-PetMeds and Design®,” 1-800-PetMeds®,” and “PetMeds®.”

Government Regulation

Dispensing prescription medications is governed at the state level by the Board of Pharmacy, or similar regulatory agencies, of each state where prescription medications are dispensed.  We are subject to regulation by the State of Florida and are licensed as a community pharmacy by the Florida Board of Pharmacy.  Our current license is valid until February 28, 2011, and prior to that date a renewal application will be submitted to the Board of Pharmacy.  Our pharmacy practice is also licensed and/or regulated by 49 other state pharmacy boards and, with respect to our products, by other regulatory authorities including, but not necessarily limited to, the United States Food and Drug Administration (“FDA”) and the United States Environmental Protection Agency.  As a licensed pharmacy in the State of Florida, we are subject to the Florida Pharmacy Act and regulations promulgated thereunder.  To the extent that we are unable to maintain our license as a community pharmacy with the Florida Board of Pharmacy, or if we do not maintain the licenses granted by other state pharmacy boards, or if we become subject to actions by the FDA, or other enforcement regulators, our distribution of prescription medications to pet owners could cease, which could have a material adverse effect on our financial condition and results of operations.

Employees

We currently have 227 full time employees, including: 133 in customer care and marketing; 34 in fulfillment and purchasing; 45 in our pharmacy; 4 in information technology; 4 in administrative positions; and 7 in management.  None of our employees are represented by a labor union, or governed by any collective bargaining agreements.  We consider relations with our employees to be satisfactory.

Available Information

We file annual, quarterly, and current reports, proxy statements, and other information with the Securities and Exchange Commission ("SEC").  Our SEC filings, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act are available to the public free of charge over the Internet at our website at www.1800petmeds.com or at the SEC's web site at www.sec.gov.  Our SEC filings will be available through our website as soon as reasonably practicable after we have electronically filed or furnished them to the SEC. Information contained on our website is not incorporated by reference into this annual report on Form 10-K.  

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You may also read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Room 1580, Washington D.C. 20549.  You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330 or on the Internet at www.sec.gov/info/edgar/prrrules.htm.  The Company’s Code of Business Conduct and Ethics and the charters for each of our committees of the Board of Directors may be found in our 2004 Proxy which was filed on June 30, 2004.  You may also obtain a copy of our Code of Business Conduct and Ethics and the charters for each of our committees of the Board of Directors free of charge by contacting Investor Relations at 1-800-738-6337.

ITEM 1A.

RISK FACTORS

You should carefully consider the risks and uncertainties described below, and all the other information included in this Annual Report before you decide to invest in our common stock.  Any of the following risks could materially adversely affect our business, financial condition, or operating results and could result in a loss of your investment.

We may inadvertently fail to comply with various state regulations covering the dispensing of prescription pet medications which may subject us to reprimands, sanctions, probations, fines, suspensions, or the loss of one or more of our pharmacy licenses.

The sale and delivery of prescription pet medications is generally governed by state laws and state regulations.  Since our pharmacy is located in the State of Florida, the Company is governed by the laws and regulations of the State of Florida.  Each prescription pet medication sale we make is likely also to be covered by the laws of the state where the customer is located.  The laws and regulations relating to the sale and delivery of prescription pet medications vary from state to state, but generally require that prescription pet medications be dispensed with the authorization from a prescribing veterinarian.  To the extent that we are unable to maintain our license as a community pharmacy with the Florida Board of Pharmacy, or if we do not maintain the licenses granted by other state boards, or if we become subject to actions by the FDA, or other enforcement regulators, our distribution of prescription medications to pet owners could cease, which could have a material adverse effect on our operations.

The Company is a party to routine litigation and administrative complaints incidental to its business.  Management does not believe that the resolution of any or all of such routine litigation and administrative complaints is likely to have a material adverse effect on the Company’s financial condition or results of operations.  While we make every effort to fully comply with all applicable state rules, laws, and regulations, from time to time we have been the subject of administrative complaints regarding the authorization of prescriptions prior to shipment.  We cannot assure you that we will not continue to be the subject of administrative complaints in the future.  We cannot guarantee you that we will not be subject to reprimands, sanctions, probations, or fines, or that one or more of our pharmacy licenses will not be suspended or revoked.  If we were unable to maintain our license as a community pharmacy in the State of Florida, or if we are not granted licensure in a state that begins to require licensure, or if one or more of the licenses granted by other state boards should be suspended or revoked, our ability to continue to sell prescription medications and to continue our business as it is presently conducted could be in jeopardy.

We currently purchase a portion of our prescription and non-prescription medications from third party distributors and we are not an authorized distributor of these products.  We do not have any guaranteed supply of medications at any pre-established prices.

The majority of our sales were attributable to sales of prescription and non-prescription medications.  Historically, substantially all the major pharmaceutical manufacturers have declined to sell prescription and non-prescription pet medications directly to us.  In order to assure a supply of these products, we purchase medications from various secondary sources, including a variety of domestic distributors.  Our business strategy includes seeking to establish direct purchasing arrangements with major pet pharmaceutical manufacturing companies.  If we are not successful in achieving this goal, we will continue to rely upon secondary sources.

We cannot guarantee that if we continue to purchase prescription and non-prescription pet medications from secondary sources that we will be able to purchase an adequate supply to meet our customers’ demands, or that we will be able to purchase these products at competitive prices.  As these products represent a significant portion of our sales, our failure to fill customer orders for these products could adversely impact our sales.  If we are forced to pay higher prices for these products to ensure an adequate supply, we cannot guarantee that we will be able to pass along to our customers any increases in the prices we pay for these medications.  This inability to pass along increased prices could materially adversely affect our financial condition and results of operations.

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Our failure to properly manage our inventory may result in excessive inventory carrying costs, or inadequate supply of products, which could materially adversely affect our financial condition and results of operations.

Our current product line contains approximately 750 SKUs.  A significant portion of our sales is attributable to products representing approximately 90 SKUs, including the most popular flea and tick, and heartworm preventative brands.  We need to properly manage our inventory to provide an adequate supply of these products and avoid excessive inventory of the products representing the balance of the SKUs.  We generally place orders for products with our suppliers based upon our internal estimates of the amounts of inventory we will need to fill future orders.  These estimates may be significantly different from the actual orders we receive.  

In the event that subsequent orders fall short of original estimates, we may be left with excess inventory.  Significant excess inventory could result in price discounts and increased inventory carrying costs.  Similarly, if we fail to have an adequate supply of some SKUs, we may lose sales opportunities.  We cannot guarantee that we will maintain appropriate inventory levels.  Any failure on our part to maintain appropriate inventory levels may have a material adverse effect on our financial condition and results of operations.

Resistance from veterinarians to authorize prescriptions, or attempts/efforts on their part to discourage pet owners to purchase from internet mail-order pharmacies could cause our sales to decrease and could materially adversely affect our financial condition and results of operations.

Since we began our operations some veterinarians have resisted providing our customers with a copy of their pet’s prescription or authorizing the prescription to our pharmacy staff, thereby effectively preventing us from filling such prescriptions under state law.  We have also been informed by customers and consumers that veterinarians have tried to discourage pet owners from purchasing from internet mail-order pharmacies.  Sales of prescription medications represented approximately 35% of our sales for the fiscal year.  Although veterinarians in some states are required by law to provide a pet owner with a prescription if medically appropriate, if the number of veterinarians who refuse to authorize prescriptions should increase, or if veterinarians are successful in discouraging pet owners from purchasing from internet mail-order pharmacies, our sales could decrease and our financial condition and results of operations may be materially adversely affected.

Significant portions of our sales are made to residents of eight states.  If we should lose our pharmacy license in one or more of these states, our financial condition and results of operations would be materially adversely affected.

While we ship pet medications to customers in all 50 states, approximately 50% of our sales for the fiscal year ended March 31, 2010 were made to customers located in the states of California, Florida, Texas, New York, Pennsylvania, Virginia, North Carolina, and Georgia.   If for any reason our license to operate a pharmacy in one or more of those states should be suspended or revoked, or if it is not granted or renewed, our ability to sell prescription medications to residents of those states would cease and our financial condition and results of operations in future periods would be materially adversely affected.  

We face significant competition from veterinarians and online and traditional retailers and may not be able to compete profitably with them.

We compete directly and indirectly with veterinarians for the sale of pet medications and other health products.  Veterinarians hold a competitive advantage over us because many pet owners may find it more convenient or preferable to purchase these products directly from their veterinarians at the time of an office visit.  We also compete directly and indirectly with both online and traditional retailers.  Both online and traditional retailers may hold a competitive advantage over us because of longer operating histories, established brand names, greater resources, and/or an established customer base.  Online retailers may have a competitive advantage over us because of established affiliate relationships to drive traffic to their website.  Traditional retailers may hold a competitive advantage over us because pet owners may prefer to purchase these products from a store instead of online or through catalog or telephone methods.  In order to effectively compete in the future, we may be required to offer promotions and other incentives, which may result in lower operating margins or adversely affect the results of operations.

We also face a significant challenge from our competitors forming alliances with each other, such as those between online and traditional retailers. These relationships may enable both their retail and online stores to negotiate better pricing and better terms from suppliers by aggregating the demand for products and negotiating volume discounts, which could be a competitive disadvantage to us.

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The content of our website could expose us to various kinds of liability, which, if prosecuted successfully, could negatively impact our business.

Because we post product and pet health information and other content on our website, we face potential liability for negligence, copyright infringement, patent infringement, trademark infringement, defamation, and/or other claims based on the nature and content of the materials we post.  Various claims have been brought, and sometimes successfully prosecuted, against Internet content distributors.  We could be exposed to liability with respect to the unauthorized duplication of content or unauthorized use of other parties’ proprietary technology.  Although we maintain general liability insurance, our insurance may not cover potential claims of this type, or may not be adequate to indemnify us for all liability that may be imposed.  Any imposition of liability that is not covered by insurance, or is in excess of insurance coverage, could materially adversely affect our financial condition and results of operations.

We may not be able to protect our intellectual property rights, and/or we may be found to infringe on the proprietary rights of others.

We rely on a combination of trademarks, trade secrets, copyright laws, and contractual restrictions to protect our intellectual property rights.  These afford only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy our non-prescription private label generic equivalents, when and if developed, as well as aspects of our sales formats, or to obtain and use information that we regard as proprietary, including the technology used to operate our website and our content, and our trademarks.  Litigation or proceedings before the United States Patent and Trademark Office or other bodies may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets and domain names, or to determine the validity and scope of the proprietary rights of others.  Any litigation or adverse proceeding could result in substantial costs and diversion of resources, and could seriously harm our business and operating results.  Third parties may also claim infringement by us with respect to past, current, or future technologies.  We expect that participants in our market will be increasingly involved in infringement claims as the number of services and competitors in our industry segment grows.  Any claim, whether meritorious or not, could be time-consuming, result in costly litigation, cause service upgrade delays, or require us to enter into royalty or licensing agreements.  These royalty or licensing agreements might not be available on terms acceptable to us or at all.  

If we are unable to protect our Internet addresses or to prevent others from using Internet addresses that are confusingly similar, our business may be adversely impacted.

Our Internet addresses, www.1800petmeds.com, www.1888petmeds.com, www.petmedexpress.com, www.petmed.com, and www.petmeds.com are critical to our brand recognition and our overall success.  If we are unable to protect these Internet addresses, our competitors could capitalize on our brand recognition.  There may be similar Internet addresses used by competitors.  Governmental agencies and their designees generally regulate the acquisition and maintenance of Internet addresses.  The regulation of Internet addresses in the United States and in foreign countries has changed, and may undergo further change in the near future.  Furthermore, the relationship between regulations governing Internet addresses and laws protecting trademarks and similar proprietary rights is unclear.  Therefore, we may not be able to protect our own Internet addresses, or prevent third parties from acquiring Internet addresses that are confusingly similar to, infringe upon, or otherwise decrease the value of our Internet addresses.

Since all of our operations are housed in a single location, we are more susceptible to business interruption in the event of damage to or disruptions in our facility.

Our headquarters and distribution center are located in two buildings in one location in South Florida, and all of our shipments of products to our customers are made from this sole distribution center.  We have no present plans to establish any additional distribution centers or offices.  Because we consolidate our operations in one location, we are more susceptible to power and equipment failures, and business interruptions in the event of fires, floods, and other natural disasters than if we had additional locations.  Furthermore, because we are located in South Florida, which is a hurricane-sensitive area, we are particularly susceptible to the risk of damage to, or total destruction of, our headquarters and distribution center and surrounding transportation infrastructure caused by a hurricane.  We cannot assure you that we are adequately insured to cover the amount of any losses relating to any of these potential events, business interruptions resulting from damage to or destruction of our headquarters and distribution center, or power and equipment failures relating to our call center or websites, or interruptions or disruptions to major transportation infrastructure, or other events that do not occur on our premises.  The occurrence of one or more of these events could adversely impact our ability to generate revenues in future periods.

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A portion of our sales are seasonal and our operating results are difficult to predict and may fluctuate.

Because our operating results are difficult to predict, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance.  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, 2009, September 30, 2009, December 31, 2009, and March 31, 2010, Company sales were 33%, 26%, 20%, and 21%, respectively.  In addition to the seasonality of our sales, our annual and quarterly operating results have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are out of our control.  Factors that may cause our operating results to fluctuate include:

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Our ability to obtain new customers at a reasonable cost, retain existing customers, or encourage reorders;

·

Our ability to increase the number of visitors to our website, or our ability to convert visitors to our website into customers;

·

The mix of medications and other pet products sold by us;

·

Our ability to manage inventory levels or obtain an adequate supply of products;

·

Our ability to adequately maintain, upgrade, and develop our website, the systems that we use to process customers’ orders and payments, or our computer network;

·

Increased competition within our market niche;

·

Price competition;

·

Increases in the cost of advertising;

·

The amount and timing of operating costs and capital expenditures relating to expansion of our product line or operations; and

·

Disruption of our toll-free telephone service, technical difficulties, or systems and Internet outages or slowdowns.

Any change in one or more of these factors could materially adversely affect our financial condition and results of operations in future periods.

Our stock price fluctuates from time to time and may fall below expectations of securities analysts and investors, and could subject us to litigation, which may result in you suffering a loss on your investment.

The market price of our common stock may fluctuate significantly in response to a number of factors, many of which are out of our control.  These factors include: quarterly variations in operating results; changes in accounting treatments or principles; announcements by us or our competitors of new products and services offerings; significant contracts, acquisitions, or strategic relationships; additions or departures of key personnel; any future sales of our common stock or other securities; stock market price and volume fluctuations of publicly-traded companies; and general political, economic, and market conditions.

In some future quarter our operating results may fall below the expectations of securities analysts and investors, which could result in a decrease in the trading price of our common stock.  In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities.  We may be the target of similar litigation in the future.  Securities litigation could result in substantial costs and divert management's attention and resources, which could seriously harm our business and operating results.

We may issue additional shares of preferred stock that could defer a change of control or dilute the interests of our common stockholders.  Our charter documents could defer a takeover effort which could inhibit your ability to receive an acquisition premium for your shares.

Our charter permits our Board of Directors to issue up to 5,000,000 shares of preferred stock without stockholder approval.  Currently there are 2,500 shares of our Convertible Preferred Stock issued and outstanding.  This leaves 4,997,500 shares of preferred stock available for issuance at the discretion of our Board of Directors.  These shares, if issued, could contain dividend, liquidation, conversion, voting, or other rights which could adversely affect the rights of our common stockholders and which could also be utilized, under some circumstances, as a method of discouraging, delaying, or preventing a change in control.  Provisions of our articles of incorporation, bylaws and Florida law could make it more difficult for a third party to acquire us, even if many of our stockholders believe it is in their best interest.

9

Our investments in auction rate securities are subject to risks which may adversely affect our liquidity.

The Company has $12.5 million (par) invested in auction rate securities (“ARS”) which were classified as long term investments in our financial statements as of March 31, 2010.  Our ARS investments are not mortgage-backed based but are municipal-based and the securities underlying the ARS are currently rated AAA, the highest rating available by a rating agency.  Our ARS consist of closed-end fund preferred ARS, whose interest rates are reset, typically every seven to twenty-eight days.  Liquidity for our ARS historically has been provided by an auction process which has allowed us the opportunity to sell the securities at each auction date, and for those securities not sold, resets the applicable interest rate every seven or twenty-eight days.  Although auctions had been successful for periods immediately subsequent to February 2008, auctions for our ARS have failed, which therefore has eliminated our ability to sell these securities through the standard auction process. Currently there is no liquid market for these securities. There is no assurance that future auctions in our ARS will succeed.  An auction failure means that the parties wishing to sell their securities cannot be matched with an adequate volume of buyers. In the event that there is a failed auction the indenture governing the security requires the issuer to pay interest at a contractually defined rate which may or may not correspond to market rates for other types of similar short-term instruments. Our securities for which auctions have failed will continue to accrue interest at the contractual rate and be subject to the auction process every seven or twenty-eight days until the auction succeeds, the issuer redeems the securities, or the security matures. As a result, our ability to liquidate our investment in these securities and use the cash proceeds in the near term may be limited.

In fiscal 2010 the fair value of our ARS was based upon a valuation assessment by an outside third party.  As of March 31, 2010, the Company held $12.5 million (par) in ARS, which were classified as long term investments and the Company recorded an unrealized impairment loss of $107,875, in the fourth quarter of fiscal 2010, within accumulated other comprehensive income (loss), based upon an assessment of the fair value of these ARS.  The $107,875 impairment was recorded as temporary due to the fact that the Company has both the ability and intent to hold these securities until anticipated recovery or maturity.  However, it could take until the final maturity or issuer refinancing of the underlying debt for us to realize the recorded value of our investments in these securities.  If the issuers of our ARS are unable to successfully close future auctions or redeem or refinance the securities and their credit ratings deteriorate, we may in the future be required to record an additional impairment charge on these investments, or may need to sell these securities on a secondary market.  Although we believe we will be able to liquidate our investments in these securities without any significant loss, the timing and financial impact of such an outcome is uncertain.  Based on our expected cash expenditures, our cash and cash equivalents balance, and other potential sources of cash, we do not anticipate that the potential lack of liquidity of these investments in the near term will adversely affect our ability to execute our current business plan.

The United States Environmental Protection Agency (“EPA”) has announced its intention to increase restrictions on flea and tick products and to caution consumers to use these products with extra care.  The Company’s sales and profits in future periods could be adversely impacted if sales for these products decline.

The EPA is taking a series of actions to increase the safety of spot-on pesticide products for flea and tick control for cats and dogs.  In 2008 the EPA received 44,000 complaints about certain “spot-on” pest prevention products, including some flea and tick control products that the Company currently sells.  The complaints reported adverse reactions ranging from mild effects such as skin irritations to more serious effects such as seizures and, in some cases, death of the pet.  Since that time, the EPA received additional information from the pet spot-on pesticide registrants and others and began an intensive evaluation of these products. Among immediate actions that the EPA is going to pursue are: requiring manufacturers of spot-on pesticide products to improve labeling, making instructions clearer to prevent product misuse; requiring more precise label instructions to ensure proper dosage per pet weight; requiring clear markings to differentiate between dog and cat products, and disallowing similar brand names for dog and cat products. There can be no assurances that this action by the EPA will not adversely affect our future sales and profits.

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ITEM 1B.  

UNRESOLVED STAFF COMMENTS

None

ITEM 2.

PROPERTIES

Our facilities, including our principal executive offices, are located at 1441 S.W. 29^th Avenue and 2900 Gateway Drive, Pompano Beach, Florida 33069.  The Company leases its 50,000 square foot executive offices and warehouse facility and its 15,300 square foot customer service and pharmacy contact centers under a non-cancelable operating lease, through May 31, 2015.  This lease also includes a one-year option that expires on January 29, 2011, which will allow the Company to extend the lease until May 31, 2016.  The Company is responsible for certain maintenance costs, taxes, and insurance under this lease.  The future minimum annual lease payments are as follows: $723,000 for fiscal 2011, $745,000 for fiscal 2012, $767,000 for fiscal 2013, $784,000 for fiscal 2014, $794,000 for fiscal 2015, and $133,000 for fiscal 2016, and total $3,946,000.  Rent expense was $703,000, $641,000, and $500,000 for the years ended March 31, 2010, 2009 and 2008, respectively.

ITEM 3.  

LEGAL PROCEEDINGS

In October 2009, the Company was notified that it was named as a defendant in a multi-defendant lawsuit, filed in the United States District Court for the Eastern District of Texas, Marshall Division, seeking declaratory, injunctive, and monetary relief styled Charles E. Hill & Associates, Inc. v. ABT Electronics, Inc., et al, Cause No. 2:09-CV-313.  The lawsuit alleges that the Company is infringing on patents related to electronic catalog systems.  The Company notified the vendor that provides it with Internet software that it was seeking indemnification, and at this time, subject to a reservation of rights set forth in the Master Licensing Agreement between the parties, and to a further assessment of the role of the vendor’s software in the matter, the vendor is supplying legal counsel at their expense.  However, at this stage it is difficult to assess the outcome or estimate any potential loss in the event of an adverse outcome.

The Company has settled complaints that had been filed with various states’ pharmacy boards in the past.  There can be no assurances made that other states will not attempt to take similar actions against the Company in the future.  The Company initiates litigation to protect its trade or service marks.  There can be no assurance that the Company will be successful in protecting its trade or service marks.  Legal costs related to the above matters are expensed as incurred.

ITEM 4.

REMOVED AND RESERVED

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PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock, par value $.001 per share, began trading publicly in 1997.  Our common stock is currently traded on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “PETS.”  The prices set forth below reflect the range of high and low closing sale prices per share in each of the quarters of fiscal 2010 and 2009 as reported by the NASDAQ.  

There were 90 holders of record of our common stock at May 28, 2010, and we estimate there were approximately 17,000 beneficial stockholders on that date.

Dividend Policy

On August 3, 2009, the Company’s Board of Directors declared its first quarterly dividend of $0.10 per share on its common stock.  The Company intends to continue to pay regular quarterly dividends; however the declaration and payment of future dividends is discretionary and will be subject to a determination by the Board of Directors each quarter following its review of the Company’s financial performance.

During fiscal 2010, our Board of Directors declared the following dividends:

On May 3, 2010, the Company’s Board of Directors declared a quarterly dividend of $0.10 per share on its common stock.  The dividend was paid on May 28, 2010, to shareholders of record at the close of business on May 14, 2010.

Share Repurchase Plan

On November 8, 2006, the Company announced that the Board of Directors authorized the repurchase of up to $20.0 million of the Company’s common stock.  On October 31, 2008 the Company’s Board of Directors approved a second share repurchase program of up to $20.0 million.  This plan is intended to be implemented through purchases made from time to time in either the open market or through private transactions at the Company's discretion, subject to market conditions and other factors, in accordance with Securities and Exchange Commission requirements.  

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There can be no assurances as to the precise number of shares that will be repurchased under the share repurchase plan, and the Company may discontinue the share repurchase plan at any time subject to compliance with applicable regulatory requirements.  Shares purchased pursuant to the share repurchase plan will either be retired or held in the Company's treasury.  Any share repurchase would reduce our available cash.  During fiscal 2010 no shares of our outstanding common stock were repurchased.  During fiscal 2009 we repurchased approximately 1.3 million shares of our outstanding common stock for approximately $18.4 million, averaging approximately $13.70 per share.  All shares repurchased in fiscal 2009 were subsequently retired.

Since the inception of the share repurchase plans, approximately 2.3 million shares have been repurchased under the plan for approximately $30.0 million, and approximately $10.0 million remains available for repurchase, as of May 28, 2010.  

Securities Authorized for Issuance under Equity Compensation Plans

The following table sets forth securities authorized for issuance under equity compensation plans, including individual compensation arrangements, by us under our 1998 Stock Option Plan, 2006 Employee Equity Compensation Restricted Stock Plan, and 2006 Outside Director Equity Compensation Restricted Stock Plan as of March 31, 2010:

(1) The 1998 Stock Option Plan expired on July 31, 2008.

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Performance Graph

Set forth below is a graph comparing the five year cumulative performance of our Common Stock with the Standard & Poor’s Composite-500 Stock Index (the “S&P 500”), the Nasdaq Composite, and the Russell 2000, from March 31, 2005 to March 31, 2010.  The graph assumes that $100 was invested on March 31, 2005 in each of our Common Stock, the S&P 500, the Nasdaq Composite, and the Russell 2000 and that all dividends were reinvested.  The performance graph and related information below shall not be deemed “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.

Performance graph data:

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ITEM 6.  SELECTED FINANCIAL DATA

The following selected financial data should be read together with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Consolidated Financial Statements and notes thereto, and other financial information included elsewhere in this Annual Report on Form 10-K.  The Consolidated Statements of Income data set forth below for the fiscal years ended March 31, 2010, 2009, and 2008 and the Consolidated Balance Sheet data as of March 31, 2010 and 2009 have been derived from our audited Consolidated Financial Statements which are included elsewhere in this Annual Report on Form 10-K.  The Consolidated Statements of Income data set forth below for the fiscal years ended March 31, 2007 and 2006 and the Consolidated Balance Sheet data as of March 31, 2008, 2007 and 2006 have been derived from our audited Consolidated Financial Statements which are not included in this Annual Report on Form 10-K.

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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.  Presently, the Company’s product line includes approximately 750 of the most popular pet medications and other health products for dogs, cats, and horses. In March 2010 the Company started offering for sale additional pet supplies on our website, which will be drop shipped to our customers by third parties.  These pet supplies include: beds, crates, stairs, strollers, and other popular pet supplies.

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 68% of all sales were generated via the Internet in fiscal 2010, compared to 65% in fiscal 2009.  The Company’s sales consist of products sold mainly to retail consumers.  The Company’s sales returns average was approximately 1.5% of sales for both the fiscal years ended March 31, 2010 and 2009.  The twelve-month average purchase was approximately $80 and $82 per order for the fiscal years ended March 31, 2010 and 2009, 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 prescription and non-prescription pet medications 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 March 31, 2010 and 2009 the allowance for doubtful accounts was approximately $5,000 and $59,000, respectively.

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 $73,000 and $202,000 for the fiscal years ended March 31, 2010 and 2009, 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.

16

Accounting for income taxes

The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes (ASC Topic 740), 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 2010 Compared to Fiscal 2009

Sales

Sales increased by approximately $18.9 million, or 8.6%, to approximately $238.3 million for the fiscal year ended March 31, 2010, from approximately $219.4 million for the fiscal year ended March 31, 2009.  The increase in sales for the fiscal year ended March 31, 2010 was primarily due to increased reorder sales offset by a decrease in new order sales.  The decrease in new order sales may be attributed to a reduction in advertising spending for the fiscal year, along with a reduction in the average order size.  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.  There can be no assurances that this growth trend will continue, due to increasing competition from veterinarians and traditional and online retailers, and a reduction in our average order size.  The Company acquired approximately 815,000 new customers for the year ended March 31, 2010, compared to approximately 802,000 new customers for the same period the prior year.    

17

The following chart illustrates sales by various sales classifications:

Sales may be adversely affected in fiscal 2011 due to increased retail and on-line competition and the lack of television remnant space availability at affordable prices. Television advertising has been the Company’s predominant marketing method for several years.  Historically, there has been a direct correlation between the amount of television advertising done by the Company and its sales.  Sales may also be affected by consumers giving more consideration to price and trading down to less expensive retail brands, which we may not carry.  In response to these trends, the Company is currently attempting to shift some advertising dollars from television to both on-line and print campaigns, and offer more promotions to our existing database to encourage reorders and reactivate inactive customers.  However, there can be no assurances that the alternative advertising strategies to television will have the same impact on our sales and more aggressive sales promotions could also result in a decrease to gross profit margins.  No guarantees can be made that the Company’s efforts will be successful, or that sales will continue to grow.

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 2010, the Company’s sales were approximately 33%, 26%, 20%, and 21%, respectively.

Cost of sales

Cost of sales increased by $12.3 million, or 9.2%, to $146.4 million for the fiscal year ended March 31, 2010, from $134.1 million for the fiscal year ended March 31, 2009.  The increase in cost of sales is directly related to the increase in sales in fiscal 2010 as compared to fiscal 2009.  As a percentage of sales, cost of sales was 61.4% in fiscal 2010, as compared to 61.1% in fiscal 2009.  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 $6.6 million, or 7.7%, to $91.9 million for the fiscal year ended March 31, 2010, from $85.3 million for the fiscal year ended March 31, 2009.  Gross profit as a percentage of sales for fiscal 2010 and 2009 was 38.6% and 38.9%, 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 $736,000, or 3.4%, to $22.3 million for the fiscal year ended March 31, 2010 from $21.6 million for the fiscal year ended March 31, 2009.  The increase in general and administrative expenses for the fiscal year ended March 31, 2010 was primarily due to the following: a $513,000 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 $384,000 increase in credit card and bank service fees which is directly attributable to increased sales in the fiscal year; a $211,000 increase in property expenses which can be directly attributed to increased rent due to the 15,000 square feet warehouse and pharmacy expansion; and a $88,000 increase in license expenses which can be directly attributed to increased fees associated with the state of Ohio.  Offsetting the increase was a $283,000 reduction in professional fees, with the majority of the decrease relating to legal and pharmacy fees; a $61,000 decrease in telephone expenses, a $56,000 decrease in bad debt expense, and a $60,000 decrease in other expenses including office and

18

insurance expenses.  General and administrative expenses as a percentage of sales was 9.4% compared to 9.8% for the fiscal years ended March 31, 2010 and 2009, respectively.  The decrease in general and administrative expenses as a percentage of sales can mainly be attributed to efficiencies in payroll expenses and a reduction of professional fees.    

Advertising expenses

Advertising expenses decreased by approximately $1.0 million, or 3.7%, to approximately $27.7 million for the year ended March 31, 2010, from approximately $28.7 million for the year ended March 31, 2009.  The decrease in advertising expenses for the year can be mainly attributed to a shortage in the remnant television advertising inventory.  During the year the Company planned 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 costs of acquiring a new customer, defined as total advertising costs divided by new customers acquired, was $34 for the year ended March 31, 2010, compared to $36 for the year ended March 31, 2009.  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 11.6% and 13.1% for the years ended March 31, 2010 and 2009, respectively.  The decrease in advertising expense as a percentage of total sales for the year ended March 31, 2010 can be attributed to increased sales with declining new customer acquisition costs and a reduction in advertising spending.  The Company currently anticipates advertising as a percentage of sales to range between approximately 11.0% and 12.0% for fiscal 2011.  However, the advertising percentage will fluctuate quarter to quarter due to seasonality and advertising availability.  For the fiscal year ended March 31, 2010, quarterly advertising expenses as a percentage of sales ranged between 10% and 13%.

Depreciation and amortization expenses

Depreciation and amortization expenses increased by approximately $507,000, or 62%, to approximately $1.3 million for the year ended March 31, 2010, from approximately $815,000 for the year ended March 31, 2009.  This increase to depreciation and amortization expense for the year ended March 31, 2010 can be attributed to an increase in new property and equipment additions relating to the warehouse, pharmacy, and customer call center expansion in fiscal 2009.

Other income

Other income decreased by approximately $1.3 million, or 86%, to approximately $201,000 for the year ended March 31, 2010 from approximately $1.5 million for the year ended March 31, 2009.  The decrease to other income can be primarily attributed to decreased interest income due to a reduction in interest rates.  The decrease can also be attributed to a reduction in 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 $20.0 million share repurchase plan, with approximately $10.0 million remaining as of March 31, 2010, on any quarterly dividend payment, or on its operating activities.

Provision for income taxes

For the fiscal years ended March 31, 2010 and 2009, the Company recorded an income tax provision for approximately $14.7 and $12.7 million, respectively.  The effective tax rate for the fiscal years ended March 31, 2010 and 2009 were 36.2% and 35.6%, respectively.  The effective tax rate increase was due to less tax-free interest income for the year compared to the same period the prior year.  The Company estimates its effective tax rate will range between approximately 36.5% and 37.0% for fiscal 2011.

Net income

Net income increased by approximately $3.0 million, or 13.2%, to approximately $26.0 million for the fiscal year ended March 31, 2010 from approximately $23.0 million for the fiscal year ended March 31, 2009.  The increase was mainly attributable to the Company’s sales growth and our success in leveraging our operating expenses.

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Fiscal 2009 Compared to Fiscal 2008

Sales

Sales increased by approximately $31.1 million, or 16.5%, to approximately $219.4 million for the fiscal year ended March 31, 2009, from approximately $188.3 million 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.

The following chart illustrates sales by various sales classifications:

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 $20.0 million, or 17.5%, to $134.1 million for the fiscal year ended March 31, 2009, from $114.1 million 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 $11.1 million, or 15.0%, to $85.3 million for the fiscal year ended March 31, 2009, from $74.2 million 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 $1.2 million, or 6.1%, to $21.6 million for the fiscal year ended March 31, 2009 from $20.4 million 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

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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 $3.4 million, or approximately 13.6%, to approximately $28.7 million for the fiscal year ended March 31, 2009 from approximately $25.3 million 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 $1.5 million for the fiscal year ended March 31, 2009, from approximately $2.4 million 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 $20.0 million share repurchase plan, with approximately $10.0 million 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 $12.7 million and $10.4 million, 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.

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Net income

Net income increased by approximately $3.0 million, or 14.8%, to approximately $23.0 million for the fiscal year ended March 31, 2009 from approximately $20.0 million 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.

Liquidity and Capital Resources

The Company’s working capital at March 31, 2010 and 2009 was approximately $79.4 million and approximately $54.6 million, respectively.  The $24.8 million increase in working capital was primarily attributable to cash flow generated from operations and a $2.2 million redemption of our auction rate securities (“ARS”) investments.  Net cash provided by operating activities was $27.7 million and $15.0 million for the fiscal years ended March 31, 2010 and 2009, respectively.  Net cash provided by investing activities was $1.1 million and $11.2 million for the fiscal years ended March 31, 2010 and 2009, respectively.  This change can be mainly attributed to an increased amount of investment redemptions during fiscal 2009, offset by a decrease in property and equipment and intangible asset purchases in fiscal 2010 compared to the prior fiscal year.  Net cash used in financing activities was $5.8 million and $16.3 million for fiscal 2010 and 2009, respectively.  This decrease was primarily due to the Company paying approximately $6.8 million in dividends for the year ended March 31, 2010, which was offset in the prior year by the Company repurchasing its common stock for approximately $18.5 million during the year ended March 31, 2009.  The Company also received approximately $735,000 in proceeds from the exercise of stock options for the year ended March 31, 2010 compared to proceeds of approximately $1.9 million for the year ended March 31, 2009.  The Company did not repurchase any of its common shares during fiscal 2010.  As of March 31, 2010 the Company had approximately $10.0 million remaining under the Company’s share repurchase plan.  On May 3, 2010 our Board of Directors declared a $0.10 per share dividend.  The Board established a May 14, 2010 record date and a May 28, 2010 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, or on quarterly dividends.

The Company had $12.5 million, at par, invested in ARS which were classified as long term investments in our financial statements as of March 31, 2010.  Our ARS investments are not mortgage-backed based but are municipal-based and the securities underlying the ARS are currently rated AAA, the highest rating available by a rating agency.  Our ARS consist of closed-end fund preferred ARS, whose interest rates are reset, typically every seven to twenty-eight days. In fiscal 2010, the fair value of investments was based upon a valuation assessment by an outside third party.  As of March 31, 2009, the Company held $14.7 million, at par, in ARS, which were classified as long term investments and the Company recorded an unrealized impairment loss of $219,750, in the fourth quarter of fiscal 2009, within accumulated other comprehensive loss, based upon an assessment of the fair value of these ARS.  During the quarter ended September 30, 2009 the Company was able to liquidate approximately $2.2 million of its ARS investments, at par.  As of March 31, 2010, the Company held $12.5 million in ARS, at par, which were classified as long term investments.  The Company reduced the unrealized impairment loss to $107,875, in the fourth quarter of fiscal 2010, within accumulated other comprehensive loss, based upon an assessment of the fair value of these ARS.  The $107,875 impairment was recorded as temporary due to the fact that the Company has both the ability and intent to hold these securities until anticipated recovery or maturity.  However, it could take until the final maturity or issuer refinancing of the underlying debt for us to realize the recorded value of our investments in these securities.  If the issuers of our ARS are unable to successfully close future auctions or redeem or refinance the securities and their credit ratings deteriorate, we may in the future be required to record an additional impairment charge on these investments, or may need to sell these securities on a secondary market.  Although we believe we will be able to liquidate our investments in these securities without any significant loss, the timing and financial impact of such an outcome is uncertain.  Based on our expected cash expenditures, our cash and cash equivalents balance, and other potential sources of cash, we do not anticipate that the potential lack of liquidity of these investments in the near term will adversely affect our ability to execute our current business plan.

The Company leases its 65,300 square foot facility which houses its executive offices, warehouse, and customer service and pharmacy contact centers under a non-cancelable operating lease, through May 31, 2015.  On January 29, 2010, the Company signed a sixth addendum to its existing lease extending the terms of the lease until May 31, 2015.  This addendum also includes a one-year option that expires on January 29, 2011, which will allow the Company to extend the lease until May 31, 2016.  The future minimum annual lease payments are as follows: $723,000 for fiscal 2011, $745,000 for fiscal 2012, $767,000 for fiscal 2013, $784,000 for fiscal 2014, $794,000 for fiscal 2015, and $133,000 for fiscal 2016.  The Company is responsible for certain maintenance costs, taxes, and insurance under this lease.

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As of March 31, 2010 and 2009 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 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 $750,000 forecasted for capital expenditures to further support and maintain the Company’s growth in fiscal 2011 which will be funded through cash from operations.  The Company’s source of working capital includes cash from operations and the exercise of stock options.  The Company presently has no need for alternative sources of working capital, and has no commitments or plans to obtain additional capital.

Contractual Obligations and Commitments (In thousands)

Off-Balance Sheet Arrangements

The Company had no off-balance sheet arrangements as of March 31, 2010.

Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board ("FASB") established the Accounting Standards Codification (“the Codification” or “ASC”).  The FASB issued Accounting Standards Update (“ASU”) No. 2009-01 “Generally Accepted Accounting Principles” (ASC Topic 105) which establishes the FASB Accounting Standards Codification as the official single source of authoritative U.S. generally accepted accounting principles (“GAAP”). All existing accounting standards are superseded and all other accounting guidance not included in the Codification will be considered non-authoritative. The Codification also includes all relevant Securities and Exchange Commission guidance organized using the same topical structure in separate sections within the Codification.  Following the Codification, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts. Instead, it will issue the ASU which will serve to update the Codification, provide background information about the guidance, and provide the basis for conclusions on the changes to the Codification.  The Codification is not intended to change GAAP, but it will change the way GAAP is organized and presented.  The Codification was effective for the quarter ended September 30, 2009 financial statements and the principal impact on our financial statements is limited to disclosures as all future references to authoritative accounting literature will be referenced in accordance with the Codification.  In order to ease the transition to the Codification, we are providing the Codification cross-references alongside the references to the standards issued and adopted prior to the adoption of the Codification.

The Company does not believe that any recently issued, but not yet effective, accounting standards, if currently adopted, will have a material effect on the Company’s consolidated financial position, results of operations, or cash flows.

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ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk generally represents the risk that losses may occur in the value of financial instruments as a result of movements in interest rates, foreign currency exchange rates, and commodity prices.  Our financial instruments include cash and cash equivalents, short and long term investments, accounts receivable, and accounts payable.  The book values of cash equivalents, short and long term investments, accounts receivable, and accounts payable are considered to be representative of fair value because of the short maturity of these instruments.  Interest rates affect our return on excess cash and investments.  As of March 31, 2010, we had $53.0 million in cash and cash equivalents, and $12.4 million in long term investments.  A majority of our cash and cash equivalents and investments generate interest income based on prevailing interest rates.  

A significant change in interest rates would impact the amount of interest income generated from our excess cash and investments.  It would also impact the market value of our investments.  Our investments are subject to market risk, primarily interest rate and credit risk.  Our investments are managed by a limited number of outside professional managers within investment guidelines set by our Board of Directors.  Such guidelines include security type, credit quality, and maturity, and are intended to limit market risk by restricting our investments to high-quality debt instruments with both short and long term maturities.  We do not hold any derivative financial instruments that could expose us to significant market risk.  At March 31, 2010, we had no debt obligations.

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ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

PETMED EXPRESS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

PetMed Express, Inc. and Subsidiaries

We have audited the consolidated balance sheets of PetMed Express, Inc. and Subsidiaries as of March 31, 2010 and 2009, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended March 31, 2010.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PetMed Express, Inc. and Subsidiaries as of March 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2010, in conformity with U.S. generally accepted accounting principles. 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), PetMed Express, Inc. and Subsidiaries' internal control over financial reporting as of March 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 28, 2010 expressed an unqualified opinion on the effectiveness of PetMed Express, Inc. and Subsidiaries’ internal control over financial reporting.

/s/ McGladrey & Pullen, LLP

McGladrey & Pullen, LLP

New York, New York

May 28, 2010

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