UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended October 30, 2011

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: 0-21888

 

 

PetSmart, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		94-3024325
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

19601 N. 27th Avenue
Phoenix, Arizona		85027
(Address of principal executive offices)		(Zip Code)

(623) 580-6100

(Registrant’s telephone number, including area code)

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		x				Accelerated filer		¨
Non-accelerated filer		¨		(Do not check if a smaller reporting company)		Smaller reporting company		¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date:

Common Stock, $.0001 Par Value, 111,624,829 Shares at November 11, 2011

 

 

 

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PetSmart, Inc. and Subsidiaries

INDEX

 

		Page Number
PART I. FINANCIAL INFORMATION (UNAUDITED)
Item 1. Financial Statements
Report of Independent Registered Public Accounting Firm			3
Condensed Consolidated Balance Sheets as of October 30, 2011, January  30, 2011, and October 31, 2010			4
Condensed Consolidated Statements of Income and Comprehensive Income for the thirteen and thirty-nine weeks ended October 30, 2011, and October 31, 2010			5
Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks ended October 30, 2011, and October 31, 2010			6
Notes to the Condensed Consolidated Financial Statements			7
Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			13
Item 3. Quantitative and Qualitative Disclosures About Market Risk			22
Item 4. Controls and Procedures			22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			22
Item 1A. Risk Factors			23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			23
Item 6. Exhibits			23
Signatures			25

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

PetSmart, Inc.

Phoenix, Arizona

We have reviewed the accompanying condensed consolidated balance sheets of PetSmart, Inc. and subsidiaries (the “Company”) as of October 30, 2011 and October 31, 2010, and the related condensed consolidated statements of income and comprehensive income for the thirteen week and thirty-nine week periods then ended, and of cash flows for the thirty-nine week periods then ended. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of PetSmart, Inc. and subsidiaries as of January 30, 2011, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 24, 2011, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of January 30, 2011, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ DELOITTE & TOUCHE LLP

Phoenix, Arizona

November 23, 2011

 

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PetSmart, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands, except par value)

(Unaudited)

 

		October 30, 2011				January 30, 2011				October 31, 2010
ASSETS
Cash and cash equivalents		$	271,252			$	291,949			$	235,407
Short-term investments			19,555				9,708				—
Restricted cash			61,439				61,439				46,515
Receivables, net			65,709				53,971				43,108
Merchandise inventories			707,997				615,841				687,825
Deferred income taxes			44,999				44,999				36,805
Prepaid expenses and other current assets			88,908				46,022				91,822
Total current assets			1,259,859				1,123,929				1,141,482
Property and equipment, net			1,064,993				1,132,435				1,150,286
Equity investment in Banfield			35,082				42,858				38,691
Deferred income taxes			95,426				96,215				86,199
Goodwill			44,266				44,111				43,555
Other noncurrent assets			34,336				30,672				29,140
Total assets		$	2,533,962			$	2,470,220			$	2,489,353
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and bank overdraft		$	228,431			$	168,776			$	201,564
Accrued payroll, bonus and employee benefits			149,032				139,359				125,563
Accrued occupancy expenses and deferred rents			72,563				64,328				67,606
Current maturities of capital lease obligations			52,446				45,277				43,503
Other current liabilities			169,733				156,065				155,655
Total current liabilities			672,205				573,805				593,891
Capital lease obligations			511,984				521,552				528,270
Deferred rents			82,565				86,027				87,479
Other noncurrent liabilities			121,068				118,194				107,078
Total liabilities			1,387,822				1,299,578				1,316,718
Commitments and contingencies
Stockholders’ equity:
Preferred stock; $.0001 par value; 10,000 shares authorized, none issued and outstanding			—				—				—
Common stock; $.0001 par value; 625,000 shares authorized, 164,265, 162,586 and 162,042 shares issued			16				16				16
Additional paid-in capital			1,290,152				1,222,340				1,201,158
Retained earnings			1,420,471				1,277,803				1,201,957
Accumulated other comprehensive income			5,731				5,380				4,478
Less: Treasury stock, at cost, 52,659, 47,094 and 44,543 shares			(1,570,230	)			(1,334,897	)			(1,234,974	)
Total stockholders’ equity			1,146,140				1,170,642				1,172,635
Total liabilities and stockholders’ equity		$	2,533,962			$	2,470,220			$	2,489,353

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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PetSmart, Inc. and Subsidiaries

Condensed Consolidated Statements of Income and Comprehensive Income

(In thousands, except per share data)

(Unaudited)

 

		For the Thirteen Weeks Ended								For the Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010				October 30, 2011				October 31, 2010
Merchandise sales		$	1,326,819			$	1,230,911			$	3,941,641			$	3,681,188
Services sales			161,339				148,282				506,380				466,874
Other revenue			9,399				8,877				27,455				25,701
Net sales			1,497,557				1,388,070				4,475,476				4,173,763
Cost of merchandise sales			940,960				880,556				2,777,172				2,619,624
Cost of services sales			119,038				109,652				364,290				338,866
Cost of other revenue			9,399				8,877				27,455				25,701
Total cost of sales			1,069,397				999,085				3,168,917				2,984,191
Gross profit			428,160				388,985				1,306,559				1,189,572
Operating, general and administrative expenses			326,964				305,345				973,404				910,664
Operating income			101,196				83,640				333,155				278,908
Interest expense, net			(14,038	)			(14,289	)			(42,740	)			(44,222	)
Income before income tax expense and equity in income from Banfield			87,158				69,351				290,415				234,686
Income tax expense			(33,826	)			(26,386	)			(110,356	)			(91,300	)
Equity in income from Banfield			2,826				2,648				8,184				6,205
Net income			56,158				45,613				188,243				149,591
Other comprehensive (loss) income, net of income tax:
Foreign currency translation adjustments			(2,228	)			387				344				2,109
Other			(6	)			—				7				—
Comprehensive income		$	53,924			$	46,000			$	188,594			$	151,700
Earnings per common share:
Basic		$	0.50			$	0.39			$	1.67			$	1.27
Diluted		$	0.50			$	0.38			$	1.65			$	1.25
Weighted average shares outstanding:
Basic			111,330				116,943				112,425				117,333
Diluted			113,081				119,360				114,399				119,771

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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PetSmart, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

		For the Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	188,243			$	149,591
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			177,685				176,221
Loss on disposal of property and equipment			5,137				6,104
Stock-based compensation expense			20,541				21,316
Deferred income taxes			569				7,456
Equity in income from Banfield			(8,184	)			(6,205	)
Dividend received from Banfield			15,960				—
Excess tax benefits from stock-based compensation			(10,235	)			(7,063	)
Non-cash interest expense			622				234
Changes in other operating assets and liabilities:
Merchandise inventories			(92,256	)			(123,503	)
Other assets			(46,832	)			(29,936	)
Accounts payable			34,877				(16,929	)
Accrued payroll, bonus and employee benefits			9,626				20,233
Other liabilities			33,806				15,542
Net cash provided by operating activities			329,559				213,061
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments			(28,151	)			—
Proceeds from maturities of investments			4,830				—
Proceeds from sales of investments			1,804				—
Decrease in restricted cash			—				1,657
Cash paid for property and equipment			(79,550	)			(88,811	)
Proceeds from sales of property and equipment			295				164
Net cash used in investing activities			(100,772	)			(86,990	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from common stock issued under stock incentive plans			41,944				33,810
Minimum statutory withholding requirements			(6,955	)			(5,410	)
Cash paid for treasury stock			(235,333	)			(163,368	)
Payments of capital lease obligations			(40,158	)			(39,663	)
Increase in bank overdraft			24,753				6,081
Excess tax benefits from stock-based compensation			10,235				7,063
Cash dividends paid to stockholders			(44,387	)			(38,716	)
Net cash used in financing activities			(249,901	)			(200,203	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS			417				1,179
DECREASE IN CASH AND CASH EQUIVALENTS			(20,697	)			(72,953	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			291,949				308,360
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	271,252			$	235,407

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1 — GENERAL

PetSmart, Inc., including its wholly owned subsidiaries (the “Company,” “PetSmart” or “we”), is the leading specialty provider of products, services and solutions for the lifetime needs of pets in North America. We offer a broad selection of products for all the life stages of pets, as well as various pet services including professional grooming, training, boarding and day camp. We also offer pet products through an e-commerce site. As of October 30, 2011, we operated 1,210 retail stores and had full-service veterinary hospitals in 792 of our stores. MMI Holdings, Inc., through a wholly owned subsidiary, Medical Management International, Inc., collectively referred to as “Banfield,” operated 784 of the veterinary hospitals under the registered trade name of “Banfield, The Pet Hospital.” The remaining 8 hospitals are operated by other third parties in Canada.

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or “GAAP,” for interim reporting. Accordingly, they do not include all the information and footnotes required by GAAP for annual financial statements. In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments, which are of a normal, recurring nature, necessary for a fair presentation of the interim periods presented. These condensed consolidated financial statements, which are unaudited, should be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended January 30, 2011.

Due to the seasonal nature of our business, the results of operations for the thirteen and thirty-nine weeks ended October 30, 2011, are not necessarily indicative of the results expected for the full year. Our fiscal year consists of 52 or 53 weeks and ends on the Sunday nearest January 31. Fiscal 2011 ends on January 29, 2012, while fiscal 2010 ended on January 30, 2011, both 52 week years. Unless otherwise specified, all references to years in these condensed consolidated financial statements are to fiscal years.

NOTE 2 — RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In September 2011, the Financial Accounting Standards Board, or “FASB,” issued new guidance on testing goodwill for impairment. The guidance permits an entity to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then the entity is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit. If the carrying amount of the reporting unit exceeds its fair value, then the entity is required to perform the second step of the impairment test to measure the amount of the impairment loss, if any. The amendments in this update are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. We do not expect our adoption of the new guidance to impact our consolidated financial statements.

In June 2011, the FASB issued new guidance on the presentation of comprehensive income. The guidance requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. Additionally, the guidance requires that reclassification adjustments between other comprehensive income and net income be presented on the face of the financial statements, except in the case of foreign currency translation adjustments that are not the result of complete or substantially complete liquidation of an investment in a foreign entity. The amendments in this update are to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We do not expect the new guidance to have a material impact on our consolidated financial statements.

In May 2011, the FASB issued new guidance to achieve common fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. This new guidance amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. This new guidance is to be applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. We do not expect our adoption of the new guidance to impact our consolidated financial statements.

 

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NOTE 3 — DERIVATIVE FINANCIAL INSTRUMENTS

We use foreign currency exchange forward contracts, or “Foreign Exchange Contracts,” to manage the impact of foreign currency exchange rate fluctuations related to certain balance sheet accounts. We enter into the Foreign Exchange Contracts in Canada primarily to mitigate risk related to non-functional currency exposures. These Foreign Exchange Contracts are not designated as hedges and are recorded at fair value using quoted prices for similar assets or liabilities in active markets. The changes in the fair value are recognized in operating, general and administrative expenses in the Condensed Consolidated Statements of Income and Comprehensive Income.

At October 30, 2011, we had Foreign Exchange Contracts outstanding with a notional amount of $5.0 million, which represents the amount of foreign currencies to be purchased or sold at maturity and does not represent our exposure on these contracts. The fair value of the liability related to these Foreign Exchange Contracts, included in other current liabilities in the Condensed Consolidated Balance Sheets, was $14 thousand as of October 30, 2011, and October 31, 2010. The fair value of the receivable related to these Foreign Exchange Contracts, included in prepaid expenses and other current assets in the Condensed Consolidated Balance Sheet was $16 thousand as of January 30, 2011. We recorded (gains)/losses of $(0.5) million and $0.1 million on Foreign Exchange Contracts during the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively. We recorded losses of $0.1 million and $0.3 million during the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively.

NOTE 4 — FOREIGN CURRENCY

Foreign currency translation adjustments are included in other comprehensive income and are reported separately in stockholders’ equity in the Condensed Consolidated Balance Sheets. The income tax benefit related to the foreign currency translation adjustments was $1.4 million for the thirteen weeks ended October 30, 2011. The income tax expense related to the foreign currency translation adjustments was $0.2 million for the thirteen weeks ended October 31, 2010. The income tax expense related to foreign currency translation adjustments was $0.2 million and $1.2 million for the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively. The transaction loss/(gain) included in net income was $1.0 million and $(9) thousand for the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively. The transaction loss/(gain) included in net income was $0.7 million and $(0.7) million for the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively.

The impact of foreign currency translation adjustments to the carrying value of goodwill was ($1.2) million and $0.2 million for the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively, and $0.2 million and $1.4 million for the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively.

NOTE 5 — INCOME TAXES

We generally do not materially adjust deferred income taxes as part of our interim income tax provision. During the thirty-nine weeks ended October 30, 2011, changes in deferred income taxes were primarily due to tax benefits related to stock-based compensation, and changes in accumulated other comprehensive income. During the interim periods, we recognize the provision for income taxes in other current liabilities in the Condensed Consolidated Balance Sheets. The provision is calculated based on our estimated annual effective income tax rate applied to pretax income. A reclassification between other current liabilities and deferred income tax assets and liabilities is likely to occur during the fourth quarter of 2011. During the thirty-nine weeks ended October 30, 2011, we recognized a tax benefit of $3.9 million from dividends received from Banfield.

NOTE 6 — INVESTMENTS

We have an investment in Banfield which is accounted for using the equity method of accounting. Our ownership interest in the stock of Banfield was as follows (in thousands):

 

		October 30, 2011								January 30, 2011								October 31, 2010
		Shares				Amount				Shares				Amount				Shares				Amount
Voting common stock and preferred stock			4,693			$	21,675				4,693			$	21,675				4,693			$	21,675
Equity in income from Banfield			—				29,367				—				21,183				—				17,016
Dividend received from Banfield			—				(15,960	)			—				—				—				—
Total equity investment in Banfield			4,693			$	35,082				4,693			$	42,858				4,693			$	38,691

Our investment consisted of voting common stock, comprising 21.4% of all voting stock as of October 30, 2011, January 30, 2011, and October 31, 2010. Our ownership percentage as of October 30, 2011, January 30, 2011, and October 31, 2010, considering all classes of stock (voting and non-voting) was 21.0%.

 

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Banfield’s financial data is summarized as follows (in thousands):

 

		October 30, 2011				January 30, 2011				October 31, 2010
Current assets		$	370,817			$	351,379			$	349,507
Noncurrent assets			136,851				119,175				121,975
Current liabilities			360,326				279,836				301,705
Noncurrent liabilities			8,926				12,367				14,172

 

		Thirteen Weeks Ended								Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010				October 30, 2011				October 31, 2010
Net sales		$	175,675			$	162,011			$	516,961			$	472,665
Income from operations			23,073				21,696				67,992				50,342
Net income			13,456				12,609				38,968				29,549

We recognized license fees and reimbursements for specific operating expenses from Banfield of $9.4 million and $8.9 million during the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively, and $27.5 million and $25.7 million during the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively, in other revenue on the Condensed Consolidated Statements of Income and Comprehensive Income. The related costs are included in cost of other revenue in the Condensed Consolidated Statements of Income and Comprehensive Income. Receivables from Banfield totaled $3.0 million, $2.7 million and $2.9 million at October 30, 2011, January 30, 2011, and October 31, 2010, respectively, and were included in receivables, net in the Condensed Consolidated Balance Sheets.

The master operating agreement also includes a provision for the sharing of profits on the sale of therapeutic pet foods sold in all stores with an operating Banfield hospital. The net sales and gross profit on the sale of therapeutic pet food are not material to our condensed consolidated financial statements.

NOTE 7 — RESERVE FOR CLOSED STORES

The components of the reserve for closed stores were as follows (in thousands):

 

		October 30, 2011				January 30, 2011				October 31, 2010
Total remaining gross occupancy costs		$	30,492			$	34,313			$	35,740
Less:
Expected sublease income			(19,280	)			(22,964	)			(23,916	)
Interest costs			(1,478	)			(1,585	)			(1,708	)
Reserve for closed stores		$	9,734			$	9,764			$	10,116
Current portion, included in other current liabilities		$	2,751			$	3,056			$	3,200
Noncurrent portion, included in other noncurrent liabilities			6,983				6,708				6,916
Reserve for closed stores		$	9,734			$	9,764			$	10,116

The activity related to the reserve for closed stores was as follows (in thousands):

 

		Thirteen Weeks Ended								Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010				October 30, 2011				October 31, 2010
Opening balance		$	10,174			$	10,969			$	9,764			$	8,216
Provision for new store closures			—				155				—				3,706
Changes in sublease assumptions			610				—				3,246				992
Other			169				190				339				521
Charges, net			779				345				3,585				5,219
Payments			(1,219	)			(1,198	)			(3,615	)			(3,319	)
Ending balance		$	9,734			$	10,116			$	9,734			$	10,116

 

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NOTE 8 — EARNINGS PER COMMON SHARE

The following table presents a reconciliation of the weighted average shares outstanding used in the earnings per common share calculations (in thousands):

 

		Thirteen Weeks Ended								Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010				October 30, 2011				October 31, 2010
Basic			111,330				116,943				112,425				117,333
Effect of dilutive securities:
Stock options, restricted stock and performance share units			1,751				2,417				1,974				2,438
Diluted			113,081				119,360				114,399				119,771

Certain stock-based compensation awards representing 2.6 million and 2.5 million shares of common stock in the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively, and 2.4 million and 2.2 million shares of common stock in the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively, were not included in the calculation of diluted earnings per common share because the inclusion of such awards would have been antidilutive for the periods presented.

NOTE 9 — STOCKHOLDERS’ EQUITY

Share Purchase Program

In June 2009, the Board of Directors approved a share purchase program authorizing the purchase of up to $350.0 million of our common stock through January 29, 2012. During the thirteen weeks ended May 2, 2010, we purchased 3.4 million shares of common stock for $107.1 million under this $350.0 million program.

In June 2010, the Board of Directors approved a share purchase program authorizing the purchase of up to $400.0 million of our common stock through January 29, 2012, replacing the $350.0 million program. During the thirteen weeks ended October 31, 2010, we purchased 1.6 million shares of common stock for $56.3 million under the $400.0 million program. We did not purchase any shares of common stock under the $400.0 million program during the thirteen weeks ended August 1, 2010. During the twenty-six weeks ended July 31, 2011, we purchased 3.9 million shares of common stock for $165.4 million under the $400.0 million program.

In June 2011, the Board of Directors approved a share purchase program authorizing the purchase of up to $450.0 million of our common stock through January 31, 2013, replacing the $400.0 million program, effective August 1, 2011. During the thirteen weeks ended October 30, 2011, we purchased 1.7 million shares of common stock for $70.0 million under the $450.0 million program. As of October 30, 2011, $380.1 million remained available under the $450.0 million program.

Dividends

During the thirty-nine weeks ended October 30, 2011, the Board of Directors declared the following dividends:

 

Date Declared		Dividend Amount per Share				Stockholders of Record Date		Payment Date
March 23, 2011		$	0.125			April 29, 2011		May 13, 2011
June 15, 2011		$	0.14			July 29, 2011		August 12, 2011
September 21, 2011		$	0.14			October 28, 2011		November 11, 2011

NOTE 10 — STOCK-BASED COMPENSATION

The stock-based compensation expense, net of forfeitures, and the total income tax benefit recognized in the Condensed Consolidated Statements of Income and Comprehensive Income were as follows (in thousands):

 

		Thirteen Weeks Ended								Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010				October 30, 2011				October 31, 2010
Stock options expense		$	2,856			$	2,533			$	8,573			$	6,965
Restricted stock expense			981				1,837				3,575				4,891
Performance share unit expense			3,077				2,061				8,393				5,576
Stock-based compensation cost – equity awards			6,914				6,431				20,541				17,432
Management equity unit expense			3,028				1,912				7,053				3,884
Total stock-based compensation expense		$	9,942			$	8,343			$	27,594			$	21,316
Tax benefit		$	3,494			$	2,954			$	9,603			$	7,430

 

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At October 30, 2011, the total unrecognized stock-based compensation expense, net of estimated forfeitures, was $46.5 million and is expected to be recognized over a weighted average period of 1.4 years.

NOTE 11 — SUPPLEMENTAL SCHEDULE OF CASH FLOWS

Supplemental cash flow information was as follows (in thousands):

 

		Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010
Interest paid		$	43,362			$	44,177
Income taxes paid, net of refunds			134,707				121,814
Assets acquired using capital lease obligations			35,639				37,331
Accruals and accounts payable for capital expenditures			28,775				28,359
Dividends declared but unpaid			15,624				14,695

NOTE 12 — CREDIT FACILITIES

Effective April 22, 2011, we elected to reduce the aggregate commitment amount under our $350.0 million revolving credit facility, or “Revolving Credit Facility,” to $100.0 million, which allows us to avoid stand-by costs related to the excess commitment amount. This Revolving Credit Facility expires on August 15, 2012. The Revolving Credit Facility also gives us the ability to issue letters of credit, which reduce the amount available under the Revolving Credit Facility.

We had no borrowings and $31.6 million in stand-by letter of credit issuances outstanding under our Revolving Credit Facility as of October 30, 2011, January 30, 2011, and October 31, 2010.

We also have a $100.0 million stand-alone letter of credit facility, or “Stand-alone Letter of Credit Facility,” that expires on August 15, 2012. As of October 30, 2011, and January 30, 2011, we had $61.4 million in outstanding letters of credit under the Stand-alone Letter of Credit Facility and $61.4 million in restricted cash on deposit with the lender. As of October 31, 2010, we had $46.5 million in outstanding letters of credit under the Stand-alone Letter of Credit Facility and $46.5 million in restricted cash on deposit with the lender.

Our Revolving Credit Facility and Stand-alone Letter of Credit Facility permit the payment of dividends if we are not in default and the payment of dividends would not result in default of the Revolving Credit Facility and Stand-alone Letter of Credit Facility. As of October 30, 2011, we were in compliance with the terms and covenants of our Revolving Credit Facility and Stand-alone Letter of Credit Facility.

NOTE 13 — COMMITMENTS AND CONTINGENCIES

Advertising Purchase Commitments

As of October 30, 2011, we had obligations to purchase $10.0 million of advertising through the remainder of 2011 and $22.6 million in 2012.

Product Purchase Commitments

As of October 30, 2011, we had various commitments to purchase product from certain vendors that are not material to our total inventory purchases.

Litigation and Settlements

In January 2011, we were named as a defendant in Pedroza v. PetSmart, Inc., et al., a lawsuit originally filed in California Superior Court for the County of San Bernardino. The case has been removed to the U.S. District Court for the Central District of California. The complaint alleges, purportedly on behalf of current and former exempt store management in California, that we improperly classified our store management as exempt pursuant to the California Labor Code, and as a result failed to: (i) pay or provide to such managers proper wages, overtime compensation, or rest or meal periods, (ii) maintain and provide accurate wage-related statements and records, and (iii) reimburse certain business expenses, in each case as is required by the California Labor Code.

 

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The lawsuit seeks compensatory damages, statutory penalties and other relief, including liquidated damages, attorneys’ fees, costs and injunctive relief. At this time, we are not able to predict the outcome of this lawsuit, or any possible monetary exposure associated with the lawsuit. Therefore, we have not accrued any liability. We believe, however, that the lawsuit is without merit and that the case should not be certified as a class or collective action, and we are vigorously defending these claims.

Additionally, in October 2011, we were named as a defendant in Acosta v. PetSmart, Inc., et. al., a lawsuit originally filed in California Superior Court for the County of Los Angeles. The Acosta complaint raises substantially similar allegations to those raised in the Pedroza case, but the allegations in Acosta are limited to store Operations Managers only.

Like Pedroza, the Acosta lawsuit seeks compensatory damages, statutory penalties, and other relief, including liquidated damages, attorneys’ fees, and costs. At this time, we are not able to predict the outcome of this lawsuit, or any possible monetary exposure associated with the lawsuit. Therefore, we have not accrued any liability. As with Pedroza, however, we do not believe the allegations in Acosta have merit, we do not believe that the case should be certified as a class or collective action, and we are vigorously defending these claims.

We are involved in the defense of various other legal proceedings that we do not believe are material to our condensed consolidated financial statements.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Except for historical information, the following discussion contains forward-looking statements that involve risks and uncertainties. In the normal course of business, our financial position is routinely subjected to a variety of risks, including market risks associated with store expansion, investments in information systems, international expansion, vendor reliability, competitive forces and government regulatory actions. Our actual results could differ materially from projected results due to some or all of the factors discussed below. You should carefully consider the risks and uncertainties described below:

 

•

A decline in consumer spending or a change in consumer preferences could reduce our sales or profitability and harm our business.

 

•

The pet products and services retail industry is very competitive and continued competitive forces may adversely impact our business and financial results.

 

•

Comparable store sales growth may decrease. If we are unable to increase sales at our existing stores, our results of operations could be harmed.

 

•

We may be unable to continue to open new stores and enter new markets successfully. If we are unable to successfully reformat existing stores and open new stores, our results of operations could be harmed. Also, store development may place increasing demands on management and operating systems and may erode sales at existing stores.

 

•

Our quarterly operating results may fluctuate due to seasonal changes associated with the pet products and services retail industry and the timing of expenses, new store openings and store closures.

 

•

Failure to successfully manage and execute our marketing initiatives could have a negative impact on our business.

 

•

A disruption, malfunction or increased costs in the operation, expansion or replenishment of our distribution centers or our supply chain would impact our ability to deliver to our stores or increase our expenses, which could harm our sales and results of operations.

 

•

Failure to successfully manage our inventory could harm our business.

 

•

If our information systems fail to perform as designed or are interrupted for a significant period of time, our business could be harmed.

 

•

If we fail to protect the integrity and security of customer and associate information, we could be exposed to litigation and our business could be adversely impacted.

 

•

The disruption of the relationship with or the loss of any of our key vendors, including our vendors with whom we have exclusive relationships, a decision by our vendors to make their products available in supermarkets or through warehouse clubs and other mass and retail merchandisers, the inability of our vendors to provide quality products in a timely or cost-effective manner, the availability of generic products, or risks associated with the suppliers from whom products are sourced, all could harm our business.

 

•

Our expanded offering of proprietary branded products may not improve our financial performance and may expose us to product liability claims.

 

•

Food safety, quality and health concerns could affect our business.

 

•

We depend on key executives, store managers and other personnel and may not be able to retain or replace these employees or recruit additional qualified personnel, which could harm our business.

 

•

Our international operations may result in additional market risks, which may harm our business.

 

•

Our business may be harmed if the operation of veterinary hospitals at our stores is limited or fails to continue.

 

•

We face various risks as an e-commerce retailer.

 

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•

Our business could be harmed if we were unable to effectively manage our cash flow and raise any needed additional capital on acceptable terms.

 

•

Failure to successfully integrate any business we acquire could have an adverse impact on our financial results.

 

•

Failure to protect our intellectual property could have a negative impact on our operating results.

 

•

A determination that we are in violation of any contractual obligations or government regulations could result in a disruption to our operations and could impact our financial results.

 

•

Failure of our internal controls over financial reporting could harm our business and financial results.

 

•

Changes in laws, accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial results.

 

•

An unfavorable determination by tax regulators may cause our provision for income and other taxes to be inadequate and may result in a material impact to our financial results.

 

•

Failure to obtain commercial insurance at acceptable prices or failure to adequately reserve for self-insured exposures might have a negative impact on our business.

 

•

Pending legislation, weather, catastrophic events, disease, or other factors, could disrupt our operations, supply chain and the supply of small pets and products we sell, which could harm our reputation and decrease sales.

 

•

Fluctuations in the stock market, as well as general economic and market conditions, may impact our operations, sales, financial results and market price of our common stock.

 

•

Continued volatility and disruption to the global capital and credit markets may adversely affect our ability to access credit and the financial soundness of our suppliers.

 

•

Our operating and financial performance in any given period may differ from the guidance we have provided to the public.

 

•

We have implemented some anti-takeover provisions that may prevent or delay an acquisition of us that may not be beneficial to our shareholders.

For more information about these risks, see the discussion under the heading “Risk Factors” in our Form 10-K for the year ended January 30, 2011, filed with the Securities and Exchange Commission on March 24, 2011, which is incorporated herein by reference.

 

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Overview

Based on our 2010 net sales of $5.7 billion, we are North America’s leading specialty provider of products, services and solutions for the lifetime needs of pets. As of October 30, 2011, we operated 1,210 stores, and we anticipate opening 20 to 25 net new stores during the remainder of 2011. Our stores carry a broad assortment of high-quality pet supplies at everyday low prices. We offer approximately 10,000 distinct items, including nationally recognized brand names, as well as an extensive selection of proprietary brands across a range of product categories.

We complement our extensive product assortment with a wide selection of pet services, including grooming, training, boarding and day camp. All our stores feature pet styling salons that provide high-quality grooming services and offer comprehensive pet training services. Our PetsHotels provide boarding for dogs and cats, which includes 24-hour supervision, an on-call veterinarian, temperature controlled rooms and suites, daily specialty treats and play time, as well as day camp for dogs. As of October 30, 2011, we operated 189 PetsHotels, and we anticipate opening 3 additional PetsHotels during the remainder of 2011.

We make full-service veterinary care available through our strategic relationship with certain third-party operators. As of October 30, 2011, full service veterinary hospitals operated in 792 of our stores. MMI Holdings, Inc., through a wholly owned subsidiary, Medical Management International, Inc., collectively referred to as “Banfield,” operated 784 of the veterinary hospitals under the registered trade name of “Banfield, The Pet Hospital.” The remaining 8 hospitals are operated by other third parties in Canada.

The principal challenges we face as a business are the highly competitive market in which we operate and the continuing changes in the macro-economy. However, we believe we have a competitive advantage in our solutions for the Total Lifetime Care^SM of pets, including pet services and proprietary brands, which we feel cannot easily be duplicated. Additionally, we consider our cash flow from operations and cash on hand to be adequate to meet our operating, investing and financing needs in the foreseeable future, and we continue to have access to our revolving credit facility. We continuously assess the economic environment and market conditions to guide our decisions regarding our uses of cash, including capital expenditures, investments, dividends and share repurchases.

Executive Summary

 

•

Diluted earnings per common share increased 31.6% to $0.50 on net income of $56.2 million, for the thirteen weeks ended October 30, 2011, compared to diluted earnings per common share of $0.38 on net income of $45.6 million for the thirteen weeks ended October 31, 2010. Diluted earnings per common share were $1.65 and $1.25 for the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively.

 

•

Net sales increased 7.9% to $1.5 billion for the thirteen weeks ended October 30, 2011, compared to $1.4 billion for the thirteen weeks ended October 31, 2010. The increase in net sales was partially impacted by $2.6 million in favorable foreign currency fluctuations for the thirteen weeks ended October 30, 2011. Net sales increased 7.2% to $4.5 billion for the thirty-nine weeks ended October 30, 2011, compared to $4.2 billion for the thirty-nine weeks ended October 31, 2010. The increase in net sales was partially impacted by $12.5 million in favorable foreign currency fluctuations for the thirty-nine weeks ended October 30, 2011.

 

•

Comparable store sales, or sales in stores open at least one year, increased 6.1% and 5.4% for the thirteen and thirty-nine weeks ended October 30, 2011, respectively.

 

•

Services sales increased 8.8% to $161.3 million for the thirteen weeks ended October 30, 2011, compared to $148.3 million for the thirteen weeks ended October 31, 2010. Services sales increased 8.5% to $506.4 million for the thirty-nine weeks ended October 30, 2011, compared to $466.9 million for the thirty-nine weeks ended October 31, 2010.

 

•

As of October 30, 2011, we had $332.7 million in cash, cash equivalents and restricted cash. We had no short-term debt, and did not borrow against our revolving credit facility during the thirty-nine weeks ended October 30, 2011.

 

•

We purchased 1.7 million shares of our common stock for $70.0 million during the thirteen weeks ended October 30, 2011. We purchased 5.6 million shares of our common stock for $235.3 million during the thirty-nine weeks ended October 30, 2011.

 

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Critical Accounting Policies and Estimates

We discuss our critical accounting policies and estimates in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended January 30, 2011. We have made no significant change in our critical accounting policies since January 30, 2011.

Recently Issued Accounting Pronouncements

See Note 2, Recently Issued Accounting Pronouncements, in the Notes to the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for a description of recently issued and adopted accounting pronouncements, including the impact to our consolidated financial statements.

Results of Operations

The following table presents the percent of net sales of certain items included in our Condensed Consolidated Statements of Income and Comprehensive Income:

 

		Thirteen Weeks Ended								Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010				October 30, 2011				October 31, 2010
Net sales			100.0	%			100.0	%			100.0	%			100.0	%
Total cost of sales			71.4				72.0				70.8				71.5
Gross profit			28.6				28.0				29.2				28.5
Operating, general and administrative expenses			21.8				22.0				21.7				21.8
Operating income			6.8				6.0				7.4				6.7
Interest expense, net			(0.9	)			(1.0	)			(1.0	)			(1.1	)
Income before income tax expense and equity in income from Banfield			5.8				5.0				6.5				5.6
Income tax expense			(2.3	)			(1.9	)			(2.5	)			(2.2	)
Equity in income from Banfield			0.2				0.2				0.2				0.1
Net income			3.7	%			3.3	%			4.2	%			3.6	%

Thirteen Weeks Ended October 30, 2011, Compared to the Thirteen Weeks Ended October 31, 2010

Net Sales

Net sales increased 7.9% to $1.5 billion for the thirteen weeks ended October 30, 2011, compared to $1.4 billion for the thirteen weeks ended October 31, 2010. The increase in net sales was partially impacted by $2.6 million in favorable foreign currency fluctuations for the thirteen weeks ended October 30, 2011. Approximately 80% of the sales increase is due to a 6.1% increase in comparable store sales for the thirteen weeks ended October 30, 2011, and 20% of the sales increase is due to the addition of 38 net new stores and 17 new PetsHotels since October 31, 2010.

Comparable store sales growth was driven by an increase in comparable transactions and average sales per comparable transaction due to the impact of merchandising strategies, pricing strategies and new product offerings. The impact of comparable transactions and average sales per comparable transaction is summarized below.

 

		Thirteen Weeks Ended
		October 30, 2011				October 31, 2010
Comparable transactions			2.2	%			3.6	%
Average sales per comparable transaction			3.8				2.0

Services sales, included in the net sales amount discussed above, increased 8.8% or $13.0 million, to $161.3 million for the thirteen weeks ended October 30, 2011, compared to $148.3 million for the thirteen weeks ended October 31, 2010. The increase in services sales, which include grooming, training, boarding and day camp, is primarily due to continued strong demand for our grooming services, improved occupancy in our PetsHotels and the addition of 38 net new stores and 17 new PetsHotels since October 31, 2010.

 

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Other revenue included in net sales during the thirteen weeks ended October 30, 2011, represents license fees and reimbursements for utilities and specific operating expenses charged to Banfield under the master operating agreement which comprised 0.6% of net sales, or $9.4 million, compared to 0.6% of net sales, or $8.9 million, for the thirteen weeks ended October 31, 2010. See the Related Party Transactions discussion for further information.

Gross Profit

Gross profit increased to 28.6% of net sales for the thirteen weeks ended October 30, 2011, from 28.0% for the thirteen weeks ended October 31, 2010, representing an increase of 60 basis points.

Overall merchandise margin decreased 10 basis points due to a decline in mix while rate remained flat. Mix was negatively impacted as the sales growth in our consumables continued to outpace the sales growth of our higher margin hardgoods category.

Services margin increased 5 basis points primarily due to increased sales as well as a shift to higher margin offerings in our grooming services.

Store occupancy and supply chain costs included in margin provided 45 and 20 basis points of leverage, respectively, associated with the increase in net sales.

Operating, General and Administrative Expenses

Operating, general and administrative expenses decreased 20 basis points to 21.8% of net sales for the thirteen weeks ended October 30, 2011, compared to 22.0% of net sales for the thirteen weeks ended October 31, 2010.

Operating, general and administrative expenses increased on a dollar basis by $21.6 million. The primary reasons for the year over year increase include store growth, planned incremental advertising spend focused on our differentiated offerings and higher incentive compensation.

Interest Expense, net

Interest expense, which is primarily related to capital lease obligations, was $14.3 million during the thirteen weeks ended October 30, 2011, compared to $14.5 million for the thirteen weeks ended October 31, 2010. Included in interest expense, net was interest income of $0.3 million and $0.2 million for the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively.

Income Tax Expense

For the thirteen weeks ended October 30, 2011, the $33.8 million income tax expense represents an effective tax rate of 38.8% compared with the thirteen weeks ended October 31, 2010, when we had income tax expense of $26.4 million, which represented an effective tax rate of 38.0%. The increase in the effective tax rate was primarily due to tax exempt losses from invested assets to fund our deferred compensation plan. The effective tax rate is calculated by dividing our income tax expense, which includes the income tax expense related to our equity in income from Banfield, by income before income tax expense and equity in income from Banfield.

Equity in Income from Banfield

Our equity in income from our investment in Banfield was $2.8 million and $2.6 million for the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively, based on our ownership percentage in Banfield’s net income.

Thirty-Nine Weeks Ended October 30, 2011, Compared to the Thirty-Nine Weeks Ended October 31, 2010

Net Sales

Net sales increased 7.2% to $4.5 billion for the thirty-nine weeks ended October 30, 2011, compared to $4.2 billion for the thirty-nine weeks ended October 31, 2010. The increase in net sales was partially impacted by $12.5 million in favorable foreign currency fluctuations for the thirty-nine weeks ended October 30, 2011. Approximately 75% of the sales increase is due to a 5.4% increase in comparable store sales for the thirty-nine weeks ended October 30, 2011 and 25% of the sales increase is due to the addition of 38 net new stores and 17 new PetsHotels since October 31, 2010.

 

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Comparable store sales growth was driven by an increase in comparable transactions and average sales per comparable transaction due to the impact of merchandising strategies, pricing strategies and new product offerings. The impact from comparable transactions and average sales per comparable transaction is summarized below.

 

		Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010
Comparable transactions			2.4	%			1.3	%
Average sales per comparable transaction			3.0				3.0

Services sales, included in the net sales amount discussed above, increased 8.5% or $39.5 million, to $506.4 million for the thirty-nine weeks ended October 30, 2011, compared to $466.9 million for the thirty-nine weeks ended October 31, 2010. The increase in services sales, which include grooming, training, boarding and day camp, is primarily due to continued strong demand for our grooming services, improved occupancy in our PetsHotels and the addition of 38 net new stores and 17 new PetsHotels since October 31, 2010.

Other revenue included in net sales during the thirty-nine weeks ended October 30, 2011, represents license fees and reimbursements for utilities and specific operating expenses charged to Banfield under the master operating agreement which comprised 0.6% of net sales, or $27.5 million, compared to 0.6% of net sales, or $25.7 million, for the thirty-nine weeks ended October 31, 2010. See the Related Party Transactions discussion for further information.

Gross Profit

Gross profit increased 70 basis points to 29.2% of net sales for the thirty-nine weeks ended October 30, 2011, from 28.5% for the thirty-nine weeks ended October 31, 2010.

Overall merchandise margin increased 30 basis points due to a 35 basis point improvement in rate, which was offset by a 5 basis point decline in mix. The rate improvement is the result of increased sales of higher margin goods within the product categories and improvement in shrink during the thirty-nine weeks ended October 30, 2011, relative to the thirty-nine weeks ended October 31, 2010. Mix was negatively impacted as the sales growth in our consumables continued to outpace the sales growth of our higher margin hardgoods category.

Services margin increased 5 basis points primarily due to increased sales as well as a shift to higher margin offerings in our grooming services.

Store occupancy costs included in margin provided 30 basis points due to leverage associated with the increase in net sales.

Supply chain costs included in margin provided 5 basis points of leverage during the thirty-nine weeks ended October 30, 2011, compared to the thirty-nine weeks ended October 31, 2010.

Operating, General and Administrative Expenses

Operating, general and administrative expenses decreased 10 basis points to 21.7% of net sales for the thirty-nine weeks ended October 30, 2011, compared to 21.8% of net sales for the thirty-nine weeks ended October 31, 2010.

Operating, general and administrative expenses increased on a dollar basis by $62.7 million. The primary reasons for the year over year increase include store growth, planned incremental advertising spend focused on our differentiated offerings and higher incentive compensation costs.

Interest Expense, net

Interest expense, which is primarily related to capital lease obligations, was $43.6 million during the thirty-nine weeks ended October 30, 2011, compared to $44.7 million for the thirty-nine weeks ended October 31, 2010. Included in interest expense, net was interest income of $0.9 million and $0.5 million for the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively.

 

 

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Income Tax Expense

For the thirty-nine weeks ended October 30, 2011, the $110.4 million income tax expense represents an effective tax rate of 38.0% compared with the thirty-nine weeks ended October 31, 2010, when we had income tax expense of $91.3 million, which represented an effective tax rate of 38.9%. The decrease in the effective tax rate was primarily due to a tax deductible dividend received from Banfield, which was partially offset by an increase in the effective tax rate due to tax exempt losses from invested assets to fund our deferred compensation plan. The effective tax rate is calculated by dividing our income tax expense, which includes the income tax expense related to our equity in income from Banfield, by income before income tax expense and equity in income from Banfield.

Equity in Income from Banfield

Our equity in income from our investment in Banfield was $8.2 million and $6.2 million for the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively, based on our ownership percentage in Banfield’s net income.

Liquidity and Capital Resources

Cash Flow

We believe that our operating cash flow and cash on hand will be adequate to meet our operating, investing and financing needs in the foreseeable future. In addition, we also have access to our revolving credit facility, although there can be no assurance of our ability to access these markets on commercially acceptable terms in the future. We expect to continuously assess the economic environment and market conditions to guide our decisions regarding our uses of cash, including capital expenditures, investments, dividends and the purchase of common stock.

We finance our operations, new store and PetsHotel growth, store remodels and other expenditures to support our growth initiatives primarily through cash generated by operating activities. Receipts from our sales come from cash, checks and third-party debit and credit cards, and therefore provide a significant source of liquidity. Cash is used in operating activities primarily to fund procurement of merchandise inventories and other assets, net of accounts payable and other accrued liabilities. Cash provided by operating activities was $329.6 million for the thirty-nine weeks ended October 30, 2011, compared to $213.1 million for the thirty-nine weeks ended October 31, 2010. The primary differences between the thirty-nine weeks ended October 30, 2011, and October 31, 2010, include increased net income, a decrease in purchases of merchandise inventories and the $16.0 million dividend received from Banfield in 2011, as no dividends were received in 2010.

Cash used in investing activities consisted primarily of expenditures associated with opening new stores, reformatting existing stores, expenditures associated with equipment and computer software in support of our system initiatives, PetsHotel construction costs, and other expenditures to support our growth plans and initiatives. Cash used in investing activities was $100.8 million for the thirty-nine weeks ended October 30, 2011, compared to $87.0 million for the thirty-nine weeks ended October 31, 2010. The primary difference between the thirty-nine weeks ended October 30, 2011, and October 31, 2010, was purchases of investments.

Net cash used in financing activities was $249.9 million for the thirty-nine weeks ended October 30, 2011, and consisted primarily of the cash paid for treasury stock, payments of cash dividends, payments on capital lease obligations, offset by net proceeds from common stock issued under equity incentive plans and an increase in our bank overdraft. Net cash used in financing activities for the thirty-nine weeks ended October 31, 2010, was $200.2 million. The primary differences between the thirty-nine weeks ended October 30, 2011, and the thirty-nine weeks ended October 31, 2010, were an increase in cash paid for treasury stock and an increase in our bank overdraft.

Operating Capital and Capital Expenditure Requirements

Substantially all our stores are leased facilities. We opened 28 new stores and closed 5 stores in the thirty-nine weeks ended October 30, 2011. Generally, each new store requires capital expenditures of approximately $0.9 million for fixtures, equipment and leasehold improvements, approximately $0.3 million for inventory and approximately $0.1 million for preopening costs. We expect total capital spending to be $130 million to $140 million for 2011, based on our plan to open approximately 45 net new stores and 10 to 12 new PetsHotels, continuing our investment in the development of our information systems, adding to our services capacity with the expansion of certain grooming salons, remodeling or replacing certain store assets and continuing our store refresh program.

Our ability to fund our operations and make planned capital expenditures depends on our future operating performance and cash flow, which are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond our control.

 

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The following table presents our capital expenditures (in thousands):

 

		Thirty-Nine Weeks Ended
		October 30, 2011				October 31, 2010
Capital Expenditures:
New stores		$	26,283			$	27,112
Store-related projects(1)			20,324				38,369
PetsHotel(2)			2,232				6,876
Information technology			27,765				12,808
Supply chain			2,719				3,423
Other			227				223
Total capital expenditures		$	79,550			$	88,811

 

(1)	Includes store remodels, grooming salon expansion, equipment replacement, relocations, and various merchandising projects.

(2)	For new and existing stores.

Commitments

As of October 30, 2011, we had obligations to purchase $10.0 million of advertising through the remainder of 2011 and $22.6 million in 2012.

As of October 30, 2011, we had various commitments to purchase product from certain vendors that are not material to our total inventory purchases.

There have been no other material changes in our contractual obligations since January 30, 2011. Information regarding our contractual obligations is provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended January 30, 2011.

Credit Facilities

Effective April 22, 2011, we elected to reduce the aggregate commitment amount under our $350.0 million revolving credit facility, or “Revolving Credit Facility,” to $100.0 million, which allows us to avoid stand-by costs related to the excess commitment amount. This Revolving Credit Facility expires on August 15, 2012. Borrowings under the Revolving Credit Facility are subject to a borrowing base and bear interest, at our option, at the bank’s prime rate plus 0% to 0.25% or LIBOR plus 0.875% to 1.25%. We are subject to fees payable to lenders each quarter at an annual rate of 0.20% of the unused amount of the Revolving Credit Facility. The Revolving Credit Facility also gives us the ability to issue letters of credit, which reduce the amount available under the Revolving Credit Facility. Letter of credit issuances under the Revolving Credit Facility are subject to interest payable to the lenders and bear interest of 0.875% to 1.25% for stand-by letters of credit or 0.438% to 0.625% for commercial letters of credit.

We had no borrowings and $31.6 million in stand-by letter of credit issuances outstanding under our Revolving Credit Facility as of October 30, 2011, January 30, 2011, and October 31, 2010.

We also have a $100.0 million stand-alone letter of credit facility, or “Stand-alone Letter of Credit Facility,” that expires August 15, 2012. We are subject to fees payable to the lender each quarter at an annual rate of 0.45% of the average daily face amount of the letters of credit outstanding during the preceding calendar quarter. In addition, we are required to maintain a cash deposit with the lender equal to the amount of outstanding letters of credit or we may use other approved investments as collateral. If we use other approved investments as collateral, we must have an amount on deposit which, when multiplied by the advance rate of 85%, is equal to the amount of the outstanding letters of credit under the Stand-alone Letter of Credit Facility. As of October 30, 2011, and January 30, 2011, we had $61.4 million in outstanding letters of credit under the Stand-alone Letter of Credit Facility and $61.4 million in restricted cash on deposit with the lender. As of October 31, 2010, we had $46.5 million in outstanding letters of credit under the Stand-alone Letter of Credit Facility and $46.5 million in restricted cash on deposit with the lender.

Our Revolving Credit Facility and Stand-alone Letter of Credit Facility permit the payment of dividends if we are not in default and the payment of dividends would not result in default of the Revolving Credit Facility and Stand-alone Letter of Credit Facility. As of October 30, 2011, we were in compliance with the terms and covenants of our Revolving Credit Facility and Stand-alone Letter of Credit Facility. Our Revolving Credit Facility and Stand-alone Letter of Credit Facility are secured by substantially all our personal property assets, our subsidiaries and certain real property.

 

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Share Purchase Program

In June 2009, the Board of Directors approved a share purchase program authorizing the purchase of up to $350.0 million of our common stock through January 29, 2012. During the thirteen weeks ended May 2, 2010, we purchased 3.4 million shares of common stock for $107.1 million under this $350.0 million program.

In June 2010, the Board of Directors approved a share purchase program authorizing the purchase of up to $400.0 million of our common stock through January 29, 2012, replacing the $350.0 million program. During the thirteen weeks ended October 31, 2010, we purchased 1.6 million shares of common stock for $56.3 million under the $400.0 million program. We did not purchase any shares of common stock under the $400.0 million program during the thirteen weeks ended August 1, 2010. During the twenty-six weeks ended July 31, 2011, we purchased 3.9 million shares of common stock for $165.4 million under the $400.0 million program.

In June 2011, the Board of Directors approved a share purchase program authorizing the purchase of up to $450.0 million of our common stock through January 31, 2013, replacing the $400.0 million program, effective August 1, 2011. During the thirteen weeks ended October 30, 2011, we purchased 1.7 million shares of common stock for $70.0 million under the $450.0 million program. As of October 30, 2011, $380.1 million remained available under the $450.0 million program.

Dividends

During the thirty-nine weeks ended October 30, 2011, the Board of Directors declared the following dividends:

 

Date Declared		Dividend Amount per Share				Stockholders of Record Date		Payment Date
March 23, 2011		$	0.125			April 29, 2011		May 13, 2011
June 15, 2011		$	0.14			July 29, 2011		August 12, 2011
September 21, 2011		$	0.14			October 28, 2011		November 11, 2011

Related Party Transactions

We have an investment in Banfield, who through a wholly owned subsidiary, Medical Management International, Inc., operates full-service veterinary hospitals in 784 of our stores. Our investment consists of common and preferred stock. As of October 30, 2011, we owned 21.4% of the voting stock and 21.0% of the combined voting and non-voting stock of Banfield.

Our equity in income from our investment in Banfield, which is recorded one month in arrears under the equity method of accounting, was $2.8 million and $2.6 million for the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively, and $8.2 million and $6.2 million for the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively. During the thirty-nine weeks ended October 30, 2011, we received a dividend from Banfield of $16.0 million.

We recognized license fees and reimbursements for specific operating expenses from Banfield of $9.4 million and $8.9 million during the thirteen weeks ended October 30, 2011, and October 31, 2010, respectively, and $27.5 million and $25.7 million during the thirty-nine weeks ended October 30, 2011, and October 31, 2010, respectively, in other revenue on the Condensed Consolidated Statements of Income and Comprehensive Income. The related costs are included in cost of other revenue in the Condensed Consolidated Statements of Income and Comprehensive Income. Receivables from Banfield totaled $3.0 million, $2.7 million and $2.9 million at October 30, 2011, January 30, 2011, and October 31, 2010, respectively, and were included in receivables, net in the Condensed Consolidated Balance Sheets.

The master operating agreement also includes a provision for the sharing of profits on the sale of therapeutic pet foods sold in all stores with an operating Banfield hospital. The net sales and gross profit on the sale of therapeutic pet food are not material to our condensed consolidated financial statements.

 

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Seasonality and Inflation

Our business is subject to seasonal fluctuations. We typically realize a higher portion of our net sales and operating profits during the fourth quarter due to increased holiday traffic. As a result of this seasonality, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance. Controllable expenses could fluctuate from quarter-to-quarter in a year. Since our stores typically draw customers from a large trade area, sales also may be impacted by adverse weather or travel conditions, which are more prevalent during certain seasons of the year. As a result of our expansion plans, the timing of new store and PetsHotel openings and related preopening costs, the amount of revenue contributed by new and existing stores and PetsHotels and the timing and estimated obligations of store closures, our quarterly results of operations may fluctuate. Finally, because new stores tend to experience higher payroll, advertising and other store level expenses as a percentage of sales than mature stores, new store openings will also contribute to lower store operating margins until these stores become established. We expense preopening costs associated with each new location as the costs are incurred.

While we have experienced inflationary pressure in recent years, we have been able to largely mitigate the effect by increasing retail prices accordingly. Although neither inflation nor deflation has had a material impact on net operating results, we can make no assurance that our business will not be affected by inflation or deflation in the future.

Impact of Federal Health Care Reform Legislation

In March 2010, the President of the United States signed into law the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, or “the Acts.” The provisions of the Acts are not expected to have a significant impact to our condensed consolidated financial statements in the short term. The longer term potential impacts of the Acts to our business and the condensed consolidated financial statements are currently uncertain. We will continue to assess the impact of the Acts on our health plan.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

As of October 30, 2011, there have been no material changes in the market risk information disclosed by us in our Annual Report on Form 10-K for the year ended January 30, 2011. More detailed information concerning market risk can be found in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the year ended January 30, 2011.

Item 4. Controls and Procedures

Management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of October 30, 2011. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

No changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the thirteen weeks ended October 30, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on the evaluation of our disclosure controls and procedures as of October 30, 2011, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level and designed to meet the objective at the reasonable assurance level.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In January 2011, we were named as a defendant in Pedroza v. PetSmart, Inc., et al., a lawsuit originally filed in California Superior Court for the County of San Bernardino. The case has been removed to the U.S. District Court for the Central District of California. The complaint alleges, purportedly on behalf of current and former exempt store management in California, that we improperly classified our store management as exempt pursuant to the California Labor Code, and as a result failed to: (i) pay or provide to such managers proper wages, overtime compensation, or rest or meal periods, (ii) maintain and provide accurate wage-related statements and records, and (iii) reimburse certain business expenses, in each case as is required by the California Labor Code.

 

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The lawsuit seeks compensatory damages, statutory penalties and other relief, including liquidated damages, attorneys’ fees, costs and injunctive relief. At this time, we are not able to predict the outcome of this lawsuit, or any possible monetary exposure associated with the lawsuit. Therefore, we have not accrued any liability. We believe, however, that the lawsuit is without merit and that the case should not be certified as a class or collective action, and we are vigorously defending these claims.

Additionally, in October 2011, we were named as a defendant in Acosta v. PetSmart, Inc., et. al., a lawsuit originally filed in California Superior Court for the County of Los Angeles. The Acosta complaint raises substantially similar allegations to those raised in the Pedroza case, but the allegations in Acosta are limited to store Operations Managers only.

Like Pedroza, the Acosta lawsuit seeks compensatory damages, statutory penalties, and other relief, including liquidated damages, attorneys’ fees, and costs. At this time, we are not able to predict the outcome of this lawsuit, or any possible monetary exposure associated with the lawsuit. Therefore, we have not accrued any liability. As with Pedroza, however, we do not believe the allegations in Acosta have merit, we do not believe that the case should be certified as a class or collective action, and we are vigorously defending these claims.

We are involved in the defense of various other legal proceedings that we do not believe are material to our condensed consolidated financial statements.

Item 1A. Risk Factors

In addition to the other information in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended January 30, 2011, which could materially affect our business, financial condition or future results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table shows purchases of our common stock and the available funds to purchase additional common stock for each period in the thirteen weeks ended October 30, 2011:

 

Period		Total Number of Shares Purchased				Average Price Paid per  Share				Total Number  of Shares Purchased as Part  of Publicly Announced Plans or Programs				Value That May Yet  be Purchased Under the Plans or Programs(1)
August 1, 2011 to August 28, 2011			310,000			$	40.40				310,000			$	437,475,000
August 29, 2011 to October 2, 2011			1,345,788			$	42.67				1,345,788			$	380,050,000
October 3, 2011 to October 30, 2011			—				—				—			$	380,050,000
Thirteen Weeks Ended October 30, 2011			1,655,788			$	42.25				1,655,788			$	380,050,000

 

(1)	In June 2011, the Board of Directors approved a share purchase program authorizing the purchase of up to $450.0 million of our common stock through January 31, 2013, replacing the previously authorized $400.0 million program, effective August 1, 2011.

Item 6. Exhibits

(a) Exhibits

 

Exhibit 15.1		Awareness Letter from Deloitte & Touche LLP regarding unaudited interim financial statements.
Exhibit 31.1		Certification of Chief Executive Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
Exhibit 31.2		Certification of Chief Financial Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
Exhibit 32.1*		Certification of Chief Executive Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.
Exhibit 32.2*		Certification of Chief Financial Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended.

 

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Exhibit 101.INS **		XBRL Instance
Exhibit 101.SCH **		XBRL Taxonomy Extension Schema
Exhibit 101.CAL **		XBRL Taxonomy Extension Calculation
Exhibit 101.LAB **		XBRL Taxonomy Extension Labels
Exhibit 101.PRE **		XBRL Taxonomy Extension Presentation
Exhibit 101.DEF **		XBRL Taxonomy Extension Definition

 

*

The certifications attached as Exhibit 32.1 and Exhibit 32.2 accompanying this Quarterly Report on Form 10-Q are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of PetSmart, Inc., under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

**

In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

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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.

 

						PetSmart, Inc.
						(Registrant)
						/s/ Lawrence P. Molloy
Date: November 23, 2011						Lawrence P. Molloy
						Senior Vice President and Chief Financial Officer
						(Principal Financial Officer and Principal Accounting Officer)

 

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