ITEM 2. 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. In March 2010, the Company started offering for sale additional pet supplies on its website, and these items are drop shipped to customers by third party vendors. Presently, the Company’s product line includes approximately 3,000 of the most popular pet medications, health products, and supplies for dogs and cats.
The Company markets its products through national 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 85% of all sales were generated via the Internet for the quarter ended September 30, 2018, compared to 84% for the quarter ended September 30, 2017. The Company’s sales consist of products sold mainly to retail consumers. The three-month average purchase was approximately $87 and $85 per order for the quarters ended September 30, 2018 and 2017, respectively, and the six-month average purchase was approximately $89 and $86 per order for the six months ended September 30, 2018 and 2017, respectively.
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, and income taxes. We base our estimates and judgments on our historical experience, knowledge of current conditions, and our beliefs of what could occur in the future considering available information. Actual results may differ from these estimates under different assumptions or conditions. Our estimates are guided by observing the following critical accounting policies.
Revenue recognition
The Company generates revenue by selling pet medication products and pet supplies. Certain pet supplies offered on the Company’s website are drop shipped to customers. The Company considers itself the principal in the arrangement because the Company controls the specified good before it is transferred to the customer. Revenue contracts contain one performance obligation, which is delivery of the product; customer care and support is deemed not to be a material right to the contract. The transaction price is adjusted at the date of sale for any applicable sales discounts and an estimate of product returns, which are estimated based on historical patterns, however this is not considered a key judgment. There are no amounts excluded from variable consideration. Revenue is recognized when control transfers to the customer at the point in time in which shipment of the product occurs. This key judgment is determined as the shipping point represents the point in time in which the Company has a present right to payment, title has transferred to the customer, and the customer has assumed the risks and rewards of ownership.
Outbound shipping and handling fees are an accounting policy election, and are included in sales as the Company considers itself the principal in the arrangement given responsibility for supplier selection and discretion over pricing. Shipping costs associated with outbound freight after control over a product has transferred to a customer are an accounting policy election and are accounted for as fulfillment costs and 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. The allowance for doubtful accounts was approximately $37,000 at September 30, 2018 compared to $35,000 at March 31, 2018.
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 $72,000 at September 30, 2018 compared to $58,000 at March 31, 2018.
Advertising
The Company's advertising expense consists primarily of Internet marketing and direct mail/print advertising. Internet costs are expensed in the month incurred and direct mail/print advertising costs are expensed when the related catalogs, brochures, and postcards are produced, distributed, or superseded.
Accounting for income taxes
The Company accounts for income taxes under the provisions of ASC Topic 740 (“
Accounting for Income Taxes
”), which generally requires recognition of deferred tax assets and liabilities for the expected future tax benefits or consequences of events that have been included in the Consolidated Financial Statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting carrying values and the tax bases of assets and liabilities, and are measured by applying enacted tax rates and laws for the taxable years in which those differences are expected to reverse.
Results of Operations
The following should be read in conjunction with the Company’s Condensed 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 Condensed Consolidated Statements of Comprehensive Income:
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Three Months Ended
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Six Months Ended
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September 30,
|
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|
September 30,
|
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|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of sales
|
|
|
64.6
|
|
|
|
64.8
|
|
|
|
65.2
|
|
|
|
65.2
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
35.4
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|
|
|
35.2
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|
|
|
34.8
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|
|
|
34.8
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|
|
|
|
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|
|
|
|
|
|
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|
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|
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Operating expenses:
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|
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|
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|
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|
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General and administrative
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|
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8.7
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|
|
|
9.3
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|
|
|
8.3
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|
|
|
8.5
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Advertising
|
|
|
7.4
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|
|
|
6.8
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|
|
|
7.6
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|
|
|
7.4
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|
Depreciation
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|
|
0.8
|
|
|
|
0.8
|
|
|
|
0.7
|
|
|
|
0.7
|
|
Total operating expenses
|
|
|
16.9
|
|
|
|
16.9
|
|
|
|
16.6
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|
|
|
16.6
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Income from operations
|
|
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18.5
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|
|
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18.3
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|
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18.2
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|
|
18.2
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
Total other income
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|
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1.0
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|
|
|
0.6
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|
|
|
0.9
|
|
|
|
0.5
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Income before provision for income taxes
|
|
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19.5
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|
|
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18.9
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|
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19.1
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|
|
|
18.7
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Provision for income taxes
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|
|
4.4
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|
|
|
5.8
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|
|
|
4.4
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|
|
|
6.4
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|
|
|
|
|
|
|
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|
|
|
|
|
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Net income
|
|
|
15.1
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%
|
|
|
13.1
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%
|
|
|
14.7
|
%
|
|
|
12.3
|
%
|
Three Months Ended September 30, 2018 Compared With Three Months Ended September 30, 2017, and Six Months Ended September 30, 2018 Compared With Six Months Ended September 30, 2017
Sales
Sales increased by approximately $4.7 million, or 7.0%, to approximately $71.4 million for the quarter ended September 30, 2018, from approximately $66.7 million for the quarter ended September 30, 2017. For the six months ended September 30, 2018, sales increased by approximately $12.4 million, or 8.5%, to approximately $158.8 million compared to $146.4 million for the six months ended September 30, 2017. The increase in sales for the three and six months ended September 30, 2018 was primarily due to increased reorder sales. The Company acquired approximately 117,000 new customers for the quarter ended September 30, 2018, compared to approximately 134,000 new customers for the same period the prior year. For the six months ended September 30, 2018 the Company acquired approximately 286,000 new customers, compared to 302,000 new customers for the six months ended September 30, 2017. The following chart illustrates sales by various sales classifications:
Three Months Ended September 30,
|
|
Sales (In thousands)
|
|
2018
|
|
|
%
|
|
|
2017
|
|
|
%
|
|
|
$ Variance
|
|
|
% Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reorder Sales
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|
$
|
60,979
|
|
|
|
85.4
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%
|
|
$
|
55,065
|
|
|
|
82.5
|
%
|
|
$
|
5,914
|
|
|
|
10.7
|
%
|
New Order Sales
|
|
|
10,417
|
|
|
|
14.6
|
%
|
|
|
11,646
|
|
|
|
17.5
|
%
|
|
|
(1,229
|
)
|
|
|
-10.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Sales
|
|
$
|
71,396
|
|
|
|
100.0
|
%
|
|
$
|
66,711
|
|
|
|
100.0
|
%
|
|
$
|
4,685
|
|
|
|
7.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet Sales
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|
$
|
60,306
|
|
|
|
84.5
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%
|
|
$
|
56,169
|
|
|
|
84.2
|
%
|
|
$
|
4,137
|
|
|
|
7.4
|
%
|
Contact Center Sales
|
|
|
11,090
|
|
|
|
15.5
|
%
|
|
|
10,542
|
|
|
|
15.8
|
%
|
|
|
548
|
|
|
|
5.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Sales
|
|
$
|
71,396
|
|
|
|
100.0
|
%
|
|
$
|
66,711
|
|
|
|
100.0
|
%
|
|
$
|
4,685
|
|
|
|
7.0
|
%
|
Six Months Ended September 30,
|
|
Sales (In thousands)
|
|
2018
|
|
|
%
|
|
|
2017
|
|
|
%
|
|
|
$ Variance
|
|
|
% Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reorder Sales
|
|
$
|
132,493
|
|
|
|
83.4
|
%
|
|
$
|
119,532
|
|
|
|
81.7
|
%
|
|
$
|
12,961
|
|
|
|
10.8
|
%
|
New Order Sales
|
|
|
26,293
|
|
|
|
16.6
|
%
|
|
|
26,836
|
|
|
|
18.3
|
%
|
|
|
(543
|
)
|
|
|
-2.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Sales
|
|
$
|
158,786
|
|
|
|
100.0
|
%
|
|
$
|
146,368
|
|
|
|
100.0
|
%
|
|
$
|
12,418
|
|
|
|
8.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internet Sales
|
|
$
|
134,625
|
|
|
|
84.8
|
%
|
|
$
|
122,817
|
|
|
|
83.9
|
%
|
|
$
|
11,808
|
|
|
|
9.6
|
%
|
Contact Center Sales
|
|
|
24,161
|
|
|
|
15.2
|
%
|
|
|
23,551
|
|
|
|
16.1
|
%
|
|
|
610
|
|
|
|
2.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Net Sales
|
|
$
|
158,786
|
|
|
|
100.0
|
%
|
|
$
|
146,368
|
|
|
|
100.0
|
%
|
|
$
|
12,418
|
|
|
|
8.5
|
%
|
Going forward sales may be adversely affected due to increased competition and consumers giving more consideration to price. No guarantees can be made that sales will continue to grow in the future. 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 2018, the Company’s sales were approximately 29%, 24%, 22%, and 25%, respectively.
Cost of sales
Cost of sales increased by approximately $2.9 million, or 6.7%, to approximately $46.1 million for the quarter ended September 30, 2018, from approximately $43.2 million for the quarter ended September 30, 2017. For the six months ended September 30, 2018, cost of sales increased by approximately $8.2 million, or 8.5%, to approximately $103.6 million compared to $95.4 million for the same period in the prior year. The increase in cost of sales is directly related to the increase in sales during the quarter and six months ended September 30, 2018. Cost of sales as a percent of sales was 64.6% and 64.8% for the quarters ended September 30, 2018 and 2017, respectively, and for both the six months ended September 30, 2018 and 2017 the cost of sales as a percent was 65.2%. The cost of sales percentage decrease for the quarter ended September 30, 2018 is mainly attributed to a product mix shift to higher margin items, offset by additional discounts given to customers to increase sales during the quarter ended September 30, 2018.
Gross profit
Gross profit increased by approximately $1.8 million, or 7.6%, to approximately $25.3 million for the quarter ended September 30, 2018, from approximately $23.5 million for the quarter ended September 30, 2017. For the six months ended September 30, 2018 gross profit increased by approximately $4.3 million, or 8.4%, to approximately $55.2 million, compared to $50.9 million for the same period in the prior year. The increase in gross profit is directly related to an increase in sales during the quarter and six months ended September 30, 2018. Gross profit as a percentage of sales was 35.4% and 35.2% for the three months ended September 30, 2018 and 2017, respectively, and for both the six months ended September 30, 2018 and 2017, gross profit was 34.8%. The gross profit percentage increase for the quarter ended September 30, 2018 is mainly attributed to a product mix shift to higher margin items, offset by additional discounts given to customers to increase sales during the quarter.
General and administrative expenses
General and administrative expenses for both quarters ended September 30, 2018 and 2017 was $6.2 million. General and administrative expenses as a percentage of sales was 8.7% and 9.3% for the quarters ended September 30, 2018 and 2017, respectively. The percentage decrease for the quarter ended September 30, 2018 can be attributed to an increase to sales. For the six months ended September 30, 2018 general and administrative expenses increased by $730,000, or 5.9%, to approximately $13.1 million from approximately $12.4 million for the six months ended September 30, 2017. The increase in general and administrative expenses for the six months ended September 30, 2018 was primarily due to the following: a $349,000 increase in payroll expenses related to increased sales and increased stock compensation expense; a $273,000 increase in bank service fees; a $85,000 increase in property expenses; and a $23,000 net increase in other expenses, which included professional fees, licenses, and travel expenses.
Advertising expenses
Advertising expenses increased by approximately $774,000, or 17%, to approximately $5.3 million for the quarter ended September 30, 2018, from approximately $4.5 million for the quarter ended September 30, 2017. For the six months ended September 30, 2018, advertising expenses increased by approximately $1.2 million, or 11%, to approximately $12.0 million compared to advertising expenses of approximately $10.8 million for the six months ended September 30, 2017. The increase in advertising expenses for the three and six months ended September 30, 2018 was intended to stimulate sales and acquire new customers. Increased advertising had a positive impact on reorder revenue. The advertising costs of acquiring a new customer, defined as total advertising costs divided by new customers acquired, increased to $45 for the quarter ended September 30, 2018, compared to $34 for the quarter ended September 30, 2017. For the six months ended September 30, 2018 and 2017 the advertising costs of acquiring a new customer were $42 and $36, respectively. The increases to customer acquisition costs for the quarter and six months ended September 30, 2018 was due to increased advertising costs. Advertising cost of acquiring a new customer can be impacted by the advertising environment, the effectiveness of our advertising creative, advertising spending, and price competition. Historically, the advertising environment fluctuates due to supply and demand. A more favorable advertising environment may positively impact future sales, whereas a less favorable advertising environment may negatively impact future sales.
As a percentage of sales, advertising expense was 7.4% and 6.8% for the quarters ended September 30, 2018 and 2017, respectively, and for the six months ended September 30, 2018 and 2017 advertising expense was 7.6% and 7.4%, respectively. The increase in advertising expense as a percentage of total sales for the quarter and six months ended September 30, 2018 can be attributed to increased advertising spend during the quarter. The Company currently anticipates advertising as a percentage of sales to be between approximately 7.0% and 8.0% for fiscal 2019. However, the advertising percentage will fluctuate quarter to quarter due to seasonality and advertising availability.
Depreciation
Depreciation expense increased by approximately $25,000 to approximately $552,000 for the quarter ended September 30, 2018, from approximately $527,000 for the quarter ended September 30, 2017. For both the six months ended September 30, 2018 and 2017 depreciation expense was approximately $1.1 million. The increase to depreciation expense for the quarter ended September 30, 2018 can be attributed to an increase in new property and equipment additions during the quarter.
Other income
Other income increased by approximately $291,000 to approximately $683,000 for the quarter ended September 30, 2018 from approximately $392,000 for the quarter ended September 30, 2017. For the six months ended September 30, 2018 other income increased by approximately $663,000 to approximately $1.4 million compared to approximately $716,000 for the same period in the prior year. The increase to other income for the quarter and six months ended September 30, 2018 is primarily related to increased interest income, with additional increases to rental and advertising revenue. Interest income may decrease in the future as the Company utilizes its cash balances on its share repurchase plan, with approximately $10.2 million remaining as of September 30, 2018, on any quarterly dividend payment, or on its operating activities.
Provision for income taxes
For the quarters ended September 30, 2018 and 2017, the Company recorded an income tax provision of approximately $3.1 million and $3.9 million, respectively, and for the six months ended September 30, 2018 and 2017, the Company recorded an income tax provision of approximately $7.0 million and $9.3 million, respectively. The effective tax rate for the quarter ended September 30, 2018 was approximately 22.6%, compared to 30.7% for the quarter ended September 30, 2017, and the effective tax rate for the six months ended September 30, 2018 was approximately 23.1% compared to 34.1% for the six months ended September 30, 2017. The decreases to the income tax provision and effective rate for the three and six months ended September 30, 2018, are directly related to a decrease in the federal tax rate from 35.0% to 21.0% pursuant to the Tax Cuts and Jobs Act of 2017. The decrease to the effective rate for three and six months ended September 30, 2018 can also be attributed to a $134,000 income tax benefit related to restricted stock compensation, which was recognized in the September quarter.
Liquidity and Capital Resources
The Company’s working capital at September 30, 2018 and March 31, 2018 was $102.1 million and $87.1 million, respectively. The $15.0 million increase in working capital was primarily attributable to cash flow generated from operations, offset by dividends paid in the period. Net cash provided by operating activities was $20.4 million and $18.3 million for the six months ended September 30, 2018 and 2017, respectively. This increase is mainly attributed to an increase in net income offset by fluctuations in inventory, accounts payable, and income taxes payable during the period. Net cash used in investing activities was $450,000 for the six months ended September 30, 2018, compared to net cash used in investing activities of $350,000 for the six months ended September 30, 2017. This change in investing activities is related to increased property and equipment additions. Net cash used in financing activities was $10.8 million for the six months ended September 30, 2018, compared to $8.2 million for the same period in the prior year, which represented an increase in the dividend paid for the six months ended September 30, 2018.
At September 30, 2018, the Company had approximately $10.2 million remaining under the Company’s share repurchase plan. Subsequent to September 30, 2018, on October 22, 2018 our Board of Directors declared a $0.27 per share dividend. The Board established a November 5, 2018 record date and a November 16, 2018 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, on dividends, or on its operating activities.
At September 30, 2018, the Company had no outstanding lease commitments. We are not currently bound by any long or short term agreements for the purchase or lease of capital expenditures. Any material 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 $600,000 forecasted for capital expenditures for the remainder of fiscal 2019, which will be funded through cash from operations. The Company’s primary source of working capital is cash from operations. The Company presently has no need for alternative sources of working capital, and has no commitments or plans to obtain additional capital.
Off-Balance Sheet Arrangements
The Company had no off-balance sheet arrangements at September 30, 2018.
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," "plans," "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," "PetMeds," "PetMed," "PetMeds.com," “1800PetMeds.com,” "PetMed.com," "PetMed Express.com," "the Company," "we," "our," and "us" refers to PetMed Express, Inc. and our subsidiaries.