UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q (Mark One) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 ------------------ or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _____________ Commission file number: 000-28827 PETMED EXPRESS, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) FLORIDA 65-0680967 - --------------------------------- ------------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 1441 S.W. 29th Avenue, Pompano Beach, Florida 33069 --------------------------------------------------- (Address of principal executive offices) (954) 979-5995 ------------------------------------------------ (Issuer's telephone number, including area code) N/A ---------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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 [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [X] APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 19,633,558 Common Shares, $.001 par value per share at November 7, 2003 PART I - FINANCIAL INFORMATION Item 1. Financial Statements. PETMED EXPRESS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS September 30, March 31, 2003 2003 (Unaudited) ------------- ------------ ASSETS ------ Current assets: Cash and cash equivalents $ 4,693,846 $ 984,169 Accounts receivable, less allowance for doubtful accounts of $15,509 and $16,644, respectively 769,308 651,883 Inventories - finished goods 6,976,984 4,268,146 Prepaid expenses and other current assets 426,011 478,108 ------------- ------------ Total current assets 12,866,149 6,382,306 Property and equipment, net 1,469,244 1,496,979 Deferred income taxes 581,356 581,356 Intangible asset 365,000 365,000 Other assets 21,822 200,155 ------------- ------------ Total assets $ 15,303,571 $ 9,025,796 ============= ============ LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable $ 3,068,508 $ 2,570,459 Income taxes payable 930,946 170,752 Accrued expenses and other current liabilities 686,709 555,012 Current portion of loan obligation 68,442 68,442 ------------- ------------ Total current liabilities 4,754,605 3,364,665 Loan obligation, less current portion 34,221 68,443 ------------- ------------ Total liabilities 4,788,826 3,433,108 ------------- ------------ Commitments and contingencies Shareholders' equity: Preferred stock, $.001 par value, 5,000,000 shares authorized; 2,500 convertible shares issued and outstanding with a liquidation preference of $4 per share 8,898 8,898 Common stock, $.001 par value, 40,000,000 shares authorized; 19,628,892 and 18,460,878 shares issued and outstanding, respectively 19,629 18,461 Additional paid-in capital 8,949,324 7,279,207 Retained earnings (accumulated deficit) 1,536,894 (1,713,878) ------------- ------------ Total shareholders' equity 10,514,745 5,592,688 ------------- ------------ Total liabilities and shareholders' equity $ 15,303,571 $ 9,025,796 ============= ============ See accompanying notes to condensed consolidated financial statements 1 PETMED EXPRESS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Six Months Ended September 30, September 30, ----------------------------- ------------------------------ 2003 2002 2003 2002 ------------ ------------- ------------- ------------- Sales $ 24,969,228 $ 14,229,702 $ 55,356,791 $ 29,060,457 Cost of sales 14,745,824 8,029,410 33,328,504 16,597,663 ------------ ------------- ------------- ------------- Gross profit 10,223,404 6,200,292 22,028,287 12,462,794 ------------ ------------- ------------- ------------- Operating expenses: General and administrative 2,718,371 1,974,189 5,739,625 4,057,612 Advertising 4,443,980 3,832,241 10,952,970 6,639,421 Depreciation and amortization 132,049 86,108 259,400 166,772 ------------ ------------- ------------- ------------- Total operating expenses 7,294,400 5,892,538 16,951,995 10,863,805 ------------ ------------- ------------- ------------- Income from operations 2,929,004 307,754 5,076,292 1,598,989 ------------ ------------- ------------- ------------- Other income (expense): Interest expense (1,526) (4,450) (4,207) (10,040) Interest income 4,705 1,824 6,854 5,957 Other, net 378 952 986 3,287 ------------ ------------- ------------- ------------- Total other income (expense) 3,557 (1,674) 3,633 (796) ------------ ------------- ------------- ------------- Income before provision for income taxes 2,932,561 306,080 5,079,925 1,598,193 Provision for income taxes 1,114,373 101,193 1,829,153 490,977 ------------ ------------- ------------- ------------- Net income $ 1,818,188 $ 204,887 $ 3,250,772 $ 1,107,216 ============ ============= ============= ============= Net income per common share: Basic $ 0.09 $ 0.01 $ 0.17 $ 0.07 ============ ============= ============= ============= Diluted $ 0.08 $ 0.01 $ 0.14 $ 0.05 ============ ============= ============= ============= Weighted average number of common shares outstanding: Basic 19,372,365 17,173,499 19,192,390 16,883,731 ============ ============= ============= ============= Diluted 23,425,269 21,356,196 23,103,919 20,655,407 ============ ============= ============= ============= See accompanying notes to condensed consolidated financial statements 2 PETMED EXPRESS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended September 30, 2003 2002 ------------ ------------ Cash flows from operating activities: Net income $ 3,250,772 $ 1,107,216 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 259,400 166,772 Tax benefit related to stock options exercised 486,151 78,660 Bad debt expense (672) 11,596 (Increase) decrease in operating assets and liabilities: Accounts receivable (116,753) (295,943) Inventory (2,708,838) (1,592,119) Prepaid expenses and other current assets 52,097 (29,175) Other assets 178,333 (150,000) Accounts payable 498,049 971,596 Accrued expenses and other current liabilities 891,891 776,027 ------------ ------------ Net cash provided by operating activities 2,790,430 1,044,630 ------------ ------------ Cash flows from investing activities: Purchases of property and equipment (231,665) (551,338) Purchase of intangible asset - (365,000) ------------ ------------ Net cash used in investing activities (231,665) (916,338) ------------ ------------ Cash flows from financing activities: Proceeds from the exercise of stock options and warrants 1,185,134 393,663 Payments on loan obligation (34,222) (34,221) Payments on line of credit - (141,214) ------------ ------------ Net cash provided by financing activities 1,150,912 218,228 ------------ ------------ Net increase in cash and cash equivalents 3,709,677 346,520 Cash and cash equivalents, at beginning of period 984,169 737,284 ------------ ------------ Cash and cash equivalents, at end of period $ 4,693,846 $ 1,083,804 ============ ============ Supplemental disclosure of cash flow information: Cash paid for interest $ 3,984 $ 10,514 ============ ============ Cash paid for income taxes $ 536,667 $ - ============ ============ See accompanying notes to condensed consolidated financial statements 3 PETMED EXPRESS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1: Summary of Significant Accounting Policies - ------- ------------------------------------------ Organization PetMed Express, Inc. and subsidiaries is a leading nationwide pet pharmacy. The Company markets prescription and non- prescription pet medications along with health and nutritional supplements for cats and dogs 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, on-line and direct mail advertising campaigns, which aim to increase the recognition of the "1-800-PetMeds" brand name, increase traffic on its web site at www.1800PetMeds.com , acquire new customers, and maximize repeat purchases. The Company's executive offices are located in Pompano Beach, Florida. The Company's fiscal year end is March 31, and references herein to fiscal 2004 or 2003 refer to the Company's fiscal years ending March 31, 2004 and 2003, respectively. Basis of Presentation and Consolidation The Company is no longer eligible as a small business filer, as of April 1, 2003 the Company holds the status of a regular Securities Exchange Act filer. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary to present fairly the financial position of the Company, after elimination of intercompany accounts and transactions, at September 30, 2003 and the statements of income for the three and six months ended September 30, 2003 and 2002 and cash flows for the six months ended September 30, 2003 and 2002. The results of operations for the three and six months ended September 30, 2003, are not necessarily indicative of the operating results expected for the fiscal year ending March 31, 2004. These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's annual report on Form 10- KSB for the fiscal year ended March 31, 2003. The condensed consolidated financial statements include the accounts of PetMed Express, Inc. and its wholly owned subsidiaries. All significant intercompany transaction has been eliminated upon consolidation. Use of Estimates The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Note 2: Net Income Per Share - ------- -------------------- In accordance with the provisions of SFAS No. 128, "Earnings Per Share," basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income per share includes the dilutive effect of potential stock options and warrants exercised and the effects of the potential conversion of preferred shares, calculated using the treasury stock method. Outstanding stock options, warrants, and convertible preferred shares issued by the Company represent the only dilutive effect reflected in diluted weighted average shares outstanding. 4 The following is a reconciliation of the numerators and denominators of the basic and diluted net income per share computations for the periods presented: Three Months Ended Six Months Ended September 30 September 30 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Net income (numerator): Net income $ 1,818,188 $ 204,887 $ 3,250,773 $ 1,107,216 ============ ============ ============ ============ Shares (denominator): Weighted average number of common shares outstanding used in basic computation 19,372,365 17,173,499 19,192,390 16,883,731 Common shares issuable upon exercise of stock options and warrants 4,042,779 4,172,572 3,901,404 3,761,551 Common shares issuable upon conversion of preferred shares 10,125 10,125 10,125 10,125 ------------ ------------ ------------ ------------ Shares used in diluted computation 23,425,269 21,356,196 23,103,919 20,655,407 ============ ============ ============ ============ Net income per common share: Basic $ 0.09 $ 0.01 $ 0.17 $ 0.07 ============ ============ ============ ============ Diluted $ 0.08 $ 0.01 $ 0.14 $ 0.05 ============ ============ ============ ============ For the periods ended September 30, 2003 and 2002, 55,000 and 129,600 shares of common stock options and warrants, with a weighted average exercise price of $7.95 and $3.52, respectively, were excluded from the diluted net income per share computation as their exercise prices were greater than the average market price of the common shares for the period. Note 3: Accounting for Stock-Based Compensation The Company accounts for employee stock options using the intrinsic value method as prescribed by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees. The Company follows the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for employee stock options. Had the Company determined employee compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income would have been decreased to the pro forma amounts indicated below: Three Months Ended Six Months Ended September 30 September 30 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Reported net income: $ 1,818,188 $ 204,887 $ 3,250,772 $ 1,107,216 Deduct: total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects 77,070 62,431 121,929 153,721 Pro forma net income: $ 1,741,118 $ 142,456 $ 3,128,843 $ 953,495 ============ ============ ============ ============ Reported basic net income per share: $ 0.09 $ 0.01 $ 0.17 $ 0.07 ============ ============ ============ ============ Pro forma basic net income per share: $ 0.09 $ 0.01 $ 0.16 $ 0.06 ============ ============ ============ ============ Reported diluted net income per share: $ 0.08 $ 0.01 $ 0.14 $ 0.05 ============ ============ ============ ============ Pro forma diluted net income per share: $ 0.08 $ 0.01 $ 0.14 $ 0.05 ============ ============ ============ ============ 5 Note 4: Line of Credit On August 28, 2003, the Company signed an amendment to their existing line of credit agreement, which extended the line of credit from $2,000,000 up to $5,000,000. The Company's $5,000,000 line of credit is effective through August 28, 2004, and the interest rate is at the published thirty day London Interbank Offered Rates ("LIBOR") plus 2.40% (3.52% at September 30, 2003), and contains various financial and operating covenants. At September 30, 2003, there was no outstanding balance under the line of credit agreement. Note 5: Commitments and Contingencies Various complaints had been filed with the Florida Board of Pharmacy. These complaints, the majority of which were filed by veterinarians who are in competition with the Company for the sale of pet prescription-required products, alleged violations of the Pharmacy Practice Act and regulations promulgated there under. The vast majority of the complaints alleged that the Company, through its pharmacists, improperly dispensed prescription-required veterinary medication based on prescriptions verified through the Company's discontinued alternate veterinarian program. The alternate veterinarian program used a veterinarian outside the state of Florida to verify prescriptions for certain pets outside the state of Florida. While the program was not used for pets residing in the state of Florida, the complaints had, for the most part, been filed with the Florida Board of Pharmacy. Other complaints alleged the dispensing of medication without a valid prescription, the sale of non-conforming products and that the Company's pharmacy was operating at the same location as another pharmacy, with which it had a contractual relationship. The Company contested all allegations and continued discussions in an attempt to reach a resolution of these matters. In February 2002, the Company voluntarily ceased the use of its alternate veterinarian program, and in March 2002 a business decision was made to enter into a settlement agreement with the Florida Board of Pharmacy, rather than to proceed with costly and lengthy litigation. In April 2002, the Florida Board of Pharmacy approved the settlement agreement. The Florida Board of Pharmacy did not reach any finding of fact or conclusion of law that the Company committed any wrongdoing or violated any rules or laws governing the practice of pharmacy. According to the settlement agreement, the Company's pharmacy license was placed on probation for a period of three years and the Company, the Company's pharmacists and contracted pharmacy and pharmacist, paid approximately $120,000 in fines and investigative costs, in July 2002. The Company remains licensed with the State of Florida and continues to operate its principal business in Florida. The Company has settled with various states 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. In September 2001, the Company and the EPA entered into a Consent Agreement and Final Order ("CAFO"). The settlement agreement required the Company to pay a civil penalty of $100,000 plus interest, requiring a payment of $56,000, which was paid in September 2002, and $53,000 which was paid in September 2003, a reduction from the previously assessed fine of $445,000. For the purpose of this CAFO, the Company admitted to the jurisdictional allegations set forth, and neither admitted nor denied the alleged violations. On September 28, 2001, the CAFO was approved and ordered by the regional judicial officer. The Company is a defendant in a lawsuit in Texas state district court seeking injunctive and monetary relief styled Texas State Board of Pharmacy and State Board of Veterinary Medical Examiners v. PetMed Express, Inc. Cause No.GN-202514, in the 201st Judicial District Court, Travis County, Texas. The Company in its initial pleading denied the allegations contained therein. The Company will vigorously defend, is confident of its compliance with the applicable law, and finds wrong-on-the-facts the vast majority of the allegations contained in the Plaintiffs' supporting documentation attached to the lawsuit. Discovery has commenced and at this stage of the litigation it is difficult to assess any possible outcome or estimate any potential loss in the event of an adverse outcome. Routine Proceedings The Company is a party to routine litigation and regulatory complaints incidental to its business. The Company's management does not believe that the resolution of any or all of such routine litigation and regulatory complaints are likely to have a material adverse effect on the Company's financial condition or results of operations. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Overview - -------- PetMed Express was incorporated in the state of Florida in January 1996. The Company's common shares are traded on the OTC Bulletin Board ("OTCBB") under the symbol "PETS." The Company began selling pet medications and products in September 1996, and in the fall of 1997 we issued our first catalog. This catalog displayed approximately 1,200 items, including prescription and non-prescription pet medications, pet health and nutritional supplements and pet accessories. In fiscal 2001, the Company focused its product line to approximately 600 of the most popular pet medications and health and nutritional supplements for dogs and cats. The Company also markets products on its web site, where we currently generate approximately 50% of all sales. Since October 1997, the Company has advertised its products on national television, on-line, and through direct mail advertising. The Company's sales consist of products sold to mainly retail consumers and minimal wholesale customers. Typically, the Company's retail customers pay by credit card or check at the time the order is shipped. The Company usually receives cash settlement in two to three banking days for sales paid for by credit cards, which minimizes the accounts receivable balances relative to the Company's sales. Certain wholesale customers are extended credit terms, which usually require payment within 30 days of delivery. For the quarters ended September 30, 2003 and 2002, the Company's sales returns average was approximately 1.5% and 1.8% of sales, respectively, and the twelve month average purchase was approximately $72. Critical Accounting Policies - ---------------------------- Our discussion and analysis of our financial condition and the results of our operations are based upon our condensed consolidated financial statements and the data used to prepare them. The Company's condensed 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, long-lived assets, income taxes, litigation and contingencies. We base our estimates and judgments on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. Actual results may differ from these estimates under different assumptions or conditions. Our estimates are guided by observing the following critical accounting policies. Revenue recognition The Company generates revenue by selling pet medication products primarily to retail consumers and minimally to wholesale customers. The Company's policy is to recognize revenue from product sales upon shipment, when the rights of ownership and risk of loss have passed to the consumer. Outbound shipping and handling fees are included in sales and are billed upon shipment. Shipping and handling 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 our accounts receivable balances relative to our sales. The Company maintains an allowance for doubtful accounts for losses that the Company estimates will arise from the customers' inability to make required payments, arising from either credit card charge-backs or insufficient fund checks. The Company determines its estimates of the uncollectibility of accounts receivable by analyzing historical bad debts and current economic trends. At September 30, 2003 the allowance for doubtful accounts was approximately $16,000. Valuation of inventory Inventories consist of prescription and non-prescription pet medications 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. At September 30, 2003 the inventory reserve was approximately $142,000. Property and equipment Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets. The furniture, fixtures, equipment and computer software are depreciated over periods ranging from three to ten years. Leasehold improvements and assets under capital lease agreements are amortized over the shorter of the underlying lease agreement or the useful life of the asset. 7 Long-lived assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Recoverability of assets is measured by comparison of the carrying amount of the asset to net future cash flows expected to be generated from the asset. Advertising The Company's advertising expense consists primarily of television advertising, internet marketing, and direct mail advertising. Television costs are expensed as the advertisements are televised and direct mail costs are expensed when the related print materials are produced, distributed or superseded. Accounting for income taxes The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes, which generally requires recognition of deferred tax assets and liabilities for the expected future tax benefits or consequences of events that have been included in the condensed 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 condensed consolidated financial statements and the related notes thereto included elsewhere herein. The following table sets forth, as a percentage of sales, certain items appearing in the Company's condensed consolidated statements of operations. Three Months Ended Six Months Ended September 30 September 30 2003 2002 2003 2002 ------------ ------------ ------------ ------------ Sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 59.1 56.4 60.2 57.1 ------------ ------------ ------------ ------------ Gross profit 40.9 43.6 39.8 42.9 ------------ ------------ ------------ ------------ Operating expenses: General and administrative 10.9 13.9 10.3 14.0 Advertising 17.8 26.9 19.8 22.8 Depreciation and amortization 0.5 0.6 0.5 0.6 ------------ ------------ ------------ ------------ Total operating expenses 29.2 41.4 30.6 37.4 ------------ ------------ ------------ ------------ Income from operations 11.7 2.2 9.2 5.5 ------------ ------------ ------------ ------------ Provision for income taxes 4.4 0.8 3.3 1.7 ------------ ------------ ------------ ------------ Net income 7.3 1.4 5.9 3.8 ============ ============ ============ ============ 8 Three Months Ended September 30, 2003 Compared With Three Months Ended September 30, 2002, and Six Months Ended September 30, 2003 Compared With Six Months Ended September 30, 2002 - ----------------------------------------------------------------- Sales - ----- Sales increased by approximately $10,739,000, or 75.5%, to approximately $24,969,000 for the quarter ended September 30, 2003, from approximately $14,230,000 for the quarter ended September 30, 2002. For the six months ended September 30, 2003, sales increased by approximately $26,296,000, or 90.5%, to approximately $55,357,000 compared to sales of $29,061,000 for the six months ended September 30, 2002. The increase to sales for the three and six months ended September 30, 2003 can be primarily attributed to increased retail reorders and the positive effects generated from our advertising campaign. Additionally, the Company's free shipping promotion, which was initiated in March 2003, had a positive impact on sales. The Company has committed certain amounts specifically designated towards television and direct mail advertising to stimulate sales, create brand awareness, and acquire new customers. Retail new order sales have increased by approximately $4,119,000, or 52.6%, to approximately $11,944,000 for the three months ended September 30, 2003, from approximately $7,825,000 for the three months ended September 30, 2002. Retail new order sales have increased by approximately $12,886,000, or 76.6%, to approximately $29,708,000 for the six months ended September 30, 2003, from approximately $16,822,000 for the six months ended September 30, 2002. Retail reorder sales have increased by approximately $6,552,000, or 103.1%, to approximately $12,906,000 for the three months ended September 30, 2003, from approximately $6,354,000 for the three months ended September 30, 2002. Retail reorder sales have increased by approximately $13,290,000, or 109.6%, to approximately $25,415,000 for the six months ended September 30, 2003, from approximately $12,125,000 for the six months ended September 30, 2002.The Company acquired approximately 166,000 new customers for the quarter ended September 30, 2003, compared to approximately 114,000 new customers for the same period prior year. For the six months ended September 30, 2003, the Company acquired approximately 400,000 new customers, compared to 235,000 new customers for the same period in the prior year. The majority of our product sales are affected by the seasons, due to the seasonality of mainly heartworm and flea and tick medications. Industry seasonality trends, according to Fountain Agricounsel LLC, Management Consultants to Agribusiness, are divided into percentage of industry sales by quarter. For the quarters ended March 31, June 30, September 30, and December 31 industry sales are 19%, 37%, 28%, and 16%, respectively. The Company cannot accurately predict future sales; however, based on current circumstances the Company does not expect a significant variance compared to the industry trends in the third quarter of fiscal 2004. Cost of sales - ------------- Cost of sales increased by approximately $6,717,000, or 83.7%, to approximately $14,746,000 for the quarter ended September 30, 2003, from approximately $8,029,000 for the quarter ended September 30, 2002. For the six months ended September 30, 2003, cost of sales increased by approximately $16,731,000, or 100.8%, to approximately $33,329,000 compared to cost of sales of $16,598,000 for the six months ended September 30, 2002. The increase in cost of sales for the three and six months ended September 30, 2003 is directly related to the increase in retail sales. As a percent of sales, the cost of sales was 59.1% for the three months ended September 30, 2003, as compared to 56.4% for the three months ended September 30, 2002. This percentage increase can be directly attributed to the free shipping promotion, with a portion offset by increases in our product pricing. Gross profit - ------------ Gross profit increased by approximately $4,023,000, or 64.9%, to approximately $10,223,000 for the quarter ended September 30, 2003, from approximately $6,200,000 for the quarter ended September 30, 2002. For the six months ended September 30, 2003, gross profit increased by approximately $9,565,000, or 76.8%, to approximately $22,028,000 compared to gross profit of $12,463,000 for the six months ended September 30, 2002. Gross profit as a percentage of sales for second quarter of fiscal 2004 and 2003 was 40.9% and 43.6%, respectively. This percentage decrease can also be attributed to the Company's free shipping promotion, with a portion offset by increases in our product pricing. 9 General and administrative expenses - ----------------------------------- General and administrative expenses increased by approximately $744,000, or 37.7%, to approximately $2,718,000 for the quarter ended September 30, 2003, from approximately $1,974,000 for the quarter ended September 30, 2002. For the six months ended September 30, 2003, general and administrative expenses increased by approximately $1,682,000, or 41.5%, to approximately $5,740,000 compared to general and administrative expenses of $4,058,000 for the six months ended September 30, 2002. General and administrative expense as a percentage of sales was 10.9% and 13.9% for the quarter ended September 30, 2003 and 2002, respectively. The increase in general and administrative expenses for the three months ended September 30, 2003 was primarily due to the following: a $275,000 increase to payroll expenses which can be attributed to the addition of new employees in the customer service and pharmacy departments which enabled the company to sustain its continued growth; a $235,000 increase to bank service and credit card fees; a $147,000 increase to professional fees; a $61,000 increase to telephone expenses which is directly related to the increase in the quarterly sales; and a $26,000 increase in other expenses which includes insurance, property, and office expenses. The increase in general and administrative expenses for the six months ended September 30, 2003 was primarily due to the following: a $681,000 increase to payroll expenses which can be attributed to the addition of new employees in the customer service and pharmacy departments which enabled the company to sustain its continued growth; a $541,000 increase to bank service and credit card fees; a $237,000 increase to professional fees; a $183,000 increase to telephone expenses which is directly related to the increase in the six month sales; and a $40,000 increase in other expenses which includes insurance, property, and office expenses. Advertising expenses - -------------------- Advertising expenses increased by approximately $612,000, or 16.0%, to approximately $4,444,000 for the quarter ended September 30, 2003, from approximately $3,832,000 for the quarter ended September 30, 2002. For the six months ended September 30, 2003, advertising expenses increased by approximately $4,314,000, or 65.0%, to approximately $10,953,000 compared to advertising expenses of $6,639,000 for the six months ended September 30, 2002. The increase in advertising expenses for the three and six months ended September 30, 2003 was due to the Company's plan to commit certain amounts specifically designated towards television and direct mail advertising to stimulate sales, create brand awareness, and acquire new customers. Depreciation and amortization expenses - -------------------------------------- Depreciation and amortization expenses increased by approximately $46,000, or 53.4%, to approximately $132,000 for the quarter ended September 30, 2003, from approximately $86,000 for the quarter ended September 30, 2002. For the six months ended September 30, 2003, depreciation and amortization expenses increased by approximately $92,000, or 55.5%, to approximately $259,000 compared to depreciation and amortization expenses of $167,000 for the six months ended September 30, 2002. This increase to depreciation and amortization expense for three and six months ended September 30, 2003 can be attributed to increased property and equipment additions mainly related to the warehouse expansion, since the first quarter of fiscal 2003. Interest expense - ---------------- Interest expense decreased by approximately $3,000, or 65.7%, to approximately $2,000 for the quarter ended September 30, 2003, from approximately $5,000 for the quarter ended September 30, 2002. For the six months ended September 30, 2003, interest expense decreased by approximately $6,000, or 58.1%, to approximately $4,000 compared to interest expense of $10,000 for the six months ended September 30, 2002. Interest expense may increase slightly in future quarters, due to the Company utilizing its $5,000,000 line of credit to increase inventory levels. Provision for income taxes - -------------------------- The Company had incurred significant net losses since its inception in 1996, through the quarter ended June 30, 2001. These losses have resulted in net operating loss carryforwards, which have been used by the Company to offset its tax liabilities. For the fiscal year ended March 31, 2002, the Company recorded a full valuation allowance against the deferred income tax assets, created by net operating losses, since future utilization of these assets was subject to the Company's ability to generate taxable income. For the fiscal year ended March 31, 2003, the Company recognized a deferred income tax asset of approximately $581,000, due to the fact that the Company had demonstrated the ability to generate taxable income. There are no guarantees that the Company will be able to utilize all future net operating loss carryforwards unless the Company generates taxable income. For the quarters ended September 30, 2003 and 2002, the Company recorded an income tax provision for approximately $1,114,000 and $101,000, respectively; to provide for taxable income as the utilization of net operating loss carryforwards are limited. 10 Liquidity and Capital Resources The Company's working capital at September 30, 2003 and March 31, 2003 was $8,112,000 and $3,018,000, respectively. The $5,094,000 increase in working capital was primarily attributable to cash flow generated from operations and the exercise of stock options. Net cash provided by operating activities was $2,790,000 and $1,045,000 for the six months ended September 30, 2003 and 2002, respectively. Net cash used in investing activities was $232,000 and $916,000 for the six months ended September 30, 2003 and 2002, respectively. Net cash provided by financing was $1,151,000 and $218,000 for the six months ended September 30, 2003 and 2002, respectively. This increase relates directly to the exercise of stock options in the first and second quarter of fiscal 2004. The Company maintains a $5,000,000 line of credit, effective through August 28, 2004. The interest rate is at the published thirty day London Interbank Offered Rates ("LIBOR") plus 2.40% (3.52% at September 30, 2003), and contains various financial and operating covenants. At September 30, 2003, there was no outstanding balance under the line of credit agreement. On July 25, 2003 the Company signed an amendment to its current lease agreement to obtain an additional 8,000 square feet, with an option to add another 3,600 square feet, to its current 32,000 square foot facility, which became available on October 1, 2003. This addition to the warehouse was necessary to increase the Company's capacity to store additional inventory during our peak season. The Company had financed certain equipment acquisitions with capital leases. As of June 30, 2003 the Company had no outstanding lease commitments. The Company's sources of working capital include the line of credit, cash from operations, and the exercise of stock options and warrants. For the remainder of fiscal 2004, the Company has approximately $420,000 planned for capital expenditure commitments to further the Company's growth to add backup computer equipment to sustain business during an outage. These capital expenditures will be funded through cash from operations. The Company presently has no need for other alternative sources of working capital. The Company may seek to raise additional capital through the sale of equity securities. No assurances can be given that the Company will be successful in obtaining additional capital, or that such capital will be available in terms acceptable to the Company. At this time, the Company has no commitments or plans to obtain additional capital. Further, there can be no assurances that even if such additional capital is obtained that the Company will sustain profitability or positive cash flow. Cautionary Statement Regarding Forward-Looking Information Certain information in this Quarterly Report on Form 10-Q 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 quarterly report. When used in this quarterly report on Form 10-Q, "PetMed Express," "1-800-PetMeds," "PetMed," "1-888-PetMeds," "PetMed Express.com," "the Company," "we," "our," and "us" refers to PetMed Express, Inc. and our subsidiaries. 11 Item 3. 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, accounts receivable, accounts payable, line of credit, and debt obligations. The book values of cash equivalents, accounts receivable, and accounts payable are considered to be representative of fair value because of the short maturity of these instruments. We estimate that the fair value of all of our debt obligations approximate $103,000 as of September 30, 2003. We do not utilize financial instruments for trading purposes and we do not hold any derivative financial instruments that could expose us to significant market risk. Our exposure to market risk for changes in interest rates relates primarily to our obligations under our line of credit. As of November 7, 2003, there was no outstanding balance under the line of credit agreement. A ten percent increase in short-term interest rates on the variable rate debts outstanding as of November 7, 2003 would not have a material impact on our quarterly interest expense, assuming the amount of debt outstanding remains constant. The above sensitivity analysis for interest rate risk excludes accounts receivable, accounts payable and accrued liabilities because of the short-term maturity of such instruments. The analysis does not consider the effect this movement may have on other variables including changes in revenue volumes that could be indirectly attributed to changes in interest rates. The actions that management would take in response to such a change are also not considered. If it were possible to quantify this impact, the results could well be different than the sensitivity effects shown above. Item 4. Controls and Procedures. The Company's management, including our Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended) as of the quarter ended September 30, 2003, the end of the period covered by this report (the "Evaluation Date"). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded, that our disclosure controls and procedures are effective for timely gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Securities Exchange Act of 1934, as amended. There have been no significant changes made in our internal controls or in other factors that could significantly affect our internal controls over financial reporting during the period covered by this report. 12 PART II - OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K. (a) The following exhibits are filed as part of this report. 10.10 First Amendment of Business Loan Agreement (Third Line of Credit) with SouthTrust Bank, N.A. (filed herewith). 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, promulgated under the Securities Exchange Act of 1934, as amended (filed herewith to Exhibit 31.1 of the Registrant's Report on Form 10-Q for the quarter ended September 30, 2003, Commission File No. 000-28827). 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, promulgated under the Securities Exchange Act of 1934, as amended (filed herewith to Exhibit 31.2 of the Registrant's Report on Form 10-Q for the quarter ended September 30, 2003, Commission File No. 000-28827). 32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith to Exhibit 32.1 of the Registrant's Report on Form 10-Q for the quarter ended September 30, 2003, Commission File No. 000-28827). 32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith to Exhibit 32.2 of the Registrant's Report on Form 10-Q for the quarter ended September 30, 2003, Commission File No. 000-28827). (b) Reports on Form 8-K during the fiscal quarter ended September 30, 2003 (1) On August 12, 2003 the Company filed a report under Item 5 disclosing the addition of Frank J. Formica to our Board of Directors and the resignation of Guven Kivilcim from our Board of Directors. (2) On August 12, 2003 the Company filed a report under Items 7 and 9 disclosing a quarterly conference call transcript reporting its financial results for the quarter ended June 30, 2003. 13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PETMED EXPRESS, INC. (The "Registrant") Date: November 7, 2003 By: /s/Menderes Akdag --------------------------------- Menderes Akdag Chief Executive Officer (principal executive officer) By: /s/Bruce S. Rosenbloom --------------------------------- Bruce S. Rosenbloom Chief Financial Officer (principal financial and accounting officer) 14 _________________________________________________________________ _________________________________________________________________ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _______________________ PETMED EXPRESS, INC _______________________ FORM 10-Q FOR THE QUARTER ENDED: SEPTEMBER 30, 2003 _______________________ EXHIBITS _______________________ _________________________________________________________________ _________________________________________________________________ EXHIBIT INDEX ------------- Number of Incorporated Pages By Exhibit in Original Reference Number Description Document + First Amendment of Business Loan 10.10 Agreement (Third Line of Credit) 5 ** with SouthTrust Bank, N.A. Certification of Chief Executive 31.1 Officer Pursuant to Section 302 of 1 ** the Sarbanes-Oxley Act of 2002 Certification of Chief Financial 31.2 Officer Pursuant to Section 302 of 1 ** the Sarbanes-Oxley Act of 2002 Certification of Chief Executive 32.1 Officer Pursuant to 18 U.S.C. 1 ** Section 1350 Certification of Chief Financial 32.2 Officer Pursuant to 18 U.S.C. 1 ** Section 1350 ** Filed herewith