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We have reaffirmed our Neutral recommendation on PetMed Express (PETS - Analyst Report), following its second-quarter fiscal 2013 results.

PetMed reported earnings per share (EPS) of 20 cents in the quarter, a penny ahead of the year-ago quarter and also above the Zacks Consensus Estimate of 17cents per share. Net sales remained almost unchanged at $58.1 million, but surpassed the Zacks Consensus Estimate of $57 million.

Despite the several recent headwinds like the unavailability of the Novartis (NVS - Analyst Report) brands leading to a decline in average order value and a change in product mix to lower-margin items, we are encouraged to note that the company is working on these issues.

PetMed is currently asking veterinarians to prescribe additional brands that have made almost 60% pet owners to shift from the Novartis brands. In the reported quarter, the company added 177,000 new customers compared with 184,000 in the year-ago period. The company is also working on improving the effectiveness of its campaigns. It has been quite successful in pushing its sales via the Internet, which is reflected in the 2.9% increase in online sales. Approximately 77% of the company’s orders were generated on the website compared with 74% in the corresponding year-ago quarter.

Despite an improving top line, gross margin continued to languish and dropped 90 basis points to 33.3% during the quarter with the average order size declining 5% to $72. This reduction was primarily due to the additional discounts as well as a shift to lower-priced product mix, mainly generics. Increase in freight costs was also responsible for the lower margin. Although the company is undertaking several initiatives to revive its top line, any benefit in the near term can be ruled out.

Meanwhile, PetMed operates in a highly competitive and fragmented pet medications market with peers like PetSmart (PETM - Snapshot Report). However, we are impressed with the fact that PetMed is striving to expand its portfolio to drive top line and is targeting every possible means to shift customers from the Novartis brand.

Currently the stock retains a Zacks #3 Rank (Hold) in the short term.

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