PETSMART INC - FORM 10-Q

PETSMART INC - FORM 10-Q - May 29, 2014

Attached files

Attached files

PETSMART INC Reports

file	filename
EXCEL - IDEA: XBRL DOCUMENT - PETSMART INC	Financial_Report.xls
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER AS REQUIRED BY RULE 13A-14(A) - PETSMART INC	petm-20140504xex312.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER AS REQUIRED BY RULE 13A-14(B) - PETSMART INC	petm-20140504xex322.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER AS REQUIRED BY RULE 13A-14(B) - PETSMART INC	petm-20140504xex321.htm
EX-15.1 - AWARENESS LETTER FROM DELOITTE & TOUCHE LLP - PETSMART INC	petm-20140504xex151.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER AS REQUIRED BY RULE 13A-14(A) - PETSMART INC	petm-20140504xex311.htm

Table of Contents

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 May 4, 2014



¨	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.

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, 99,208,627 Shares at May 16, 2014

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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 May 4, 2014, February 2, 2014, and May 5, 2013	4
Condensed Consolidated Statements of Income and Comprehensive Income for the thirteen weeks ended May 4, 2014, and May 5, 2013	5
Condensed Consolidated Statements of Cash Flows for the thirteen weeks ended May 4, 2014, and May 5, 2013	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	21
Item 4. Controls and Procedures	21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	22
Item 1A. Risk Factors	22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 6. Exhibits	23
Signatures	24

Table of Contents

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 May 4, 2014 and May 5, 2013, and the related condensed consolidated statements of income and comprehensive income and of cash flows for the thirteen 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 February 2, 2014, 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 27, 2014, 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 February 2, 2014, 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

May 29, 2014

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PetSmart, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands, except par value)

(Unaudited)



	May 4, 2014			February 2, 2014			May 5, 2013
ASSETS
Cash and cash equivalents	$	230,102		$	285,622		$	252,988
Short-term investments	—			—			7,455
Restricted cash	71,226			71,226			71,226
Receivables, net	65,944			72,685			66,272
Merchandise inventories	792,140			740,302			738,568
Deferred income taxes	71,940			71,945			62,859
Prepaid expenses and other current assets	81,314			76,463			81,041
Total current assets	1,312,666			1,318,243			1,280,409
Property and equipment, net	949,167			952,955			972,679
Equity investment in Banfield	29,272			33,577			28,426
Deferred income taxes	102,316			110,408			100,601
Goodwill	41,510			41,140			43,914
Other noncurrent assets	62,124			65,645			48,155
Total assets	$	2,497,055		$	2,521,968		$	2,474,184
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and bank overdraft	$	244,114		$	255,251		$	257,628
Accrued payroll, bonus, and employee benefits	136,310			160,008			132,705
Accrued occupancy expenses and deferred rents	70,298			81,867			69,626
Current maturities of capital lease obligations	68,858			66,887			63,180
Other current liabilities	280,633			230,332			246,431
Total current liabilities	800,213			794,345			769,570
Capital lease obligations	450,538			451,597			462,436
Deferred rents	63,563			65,932			71,565
Other noncurrent liabilities	111,400			116,312			119,352
Total liabilities	1,425,714			1,428,186			1,422,923
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, 169,748, 169,178, and 167,909 shares issued	17			17			17
Additional paid-in capital	1,537,707			1,515,333			1,441,863
Retained earnings	2,257,308			2,173,005			1,913,209
Accumulated other comprehensive (loss) income	(1,277		)	(2,159		)	4,510
Less: Treasury stock, at cost, 70,546, 68,520, and 64,615 shares	(2,722,414		)	(2,592,414		)	(2,308,338		)
Total stockholders’ equity	1,071,341			1,093,782			1,051,261
Total liabilities and stockholders’ equity	$	2,497,055		$	2,521,968		$	2,474,184

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)



	Thirteen Weeks Ended
	May 4, 2014			May 5, 2013
Merchandise sales	$	1,519,006		$	1,509,372
Services sales	200,155			191,577
Other revenue	9,971			9,647
Net sales	1,729,132			1,710,596
Cost of merchandise sales	1,051,644			1,037,114
Cost of services sales	136,679			134,089
Cost of other revenue	9,971			9,647
Total cost of sales	1,198,294			1,180,850
Gross profit	530,838			529,746
Operating, general, and administrative expenses	359,080			362,228
Operating income	171,758			167,518
Interest expense, net	(13,183		)	(13,168		)
Income before income tax expense and equity income from Banfield	158,575			154,350
Income tax expense	(58,592		)	(55,547		)
Equity income from Banfield	3,783			3,612
Net income	103,766			102,415
Other comprehensive income (loss), net of income tax:
Foreign currency translation adjustments	882			(987		)
Other	—			(9		)
Comprehensive income	$	104,648		$	101,419
Earnings per common share:
Basic	$	1.05		$	0.99
Diluted	$	1.04		$	0.98
Weighted average shares outstanding:
Basic	99,205			103,305
Diluted	99,844			104,583

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)



	Thirteen Weeks Ended
	May 4, 2014			May 5, 2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	103,766		$	102,415
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	57,854			58,916
Loss on disposal of property and equipment	363			755
Stock-based compensation expense	6,597			9,096
Deferred income taxes	7,533			3,022
Equity income from Banfield	(3,783		)	(3,612		)
Dividend received from Banfield	8,088			15,120
Excess tax benefits from stock-based compensation	(4,890		)	(8,874		)
Non-cash interest expense	93			162
Changes in assets and liabilities:
Merchandise inventories	(51,423		)	(59,829		)
Other assets	4,921			8,950
Accounts payable	(2,398		)	51,897
Accrued payroll, bonus, and employee benefits	(23,743		)	(43,340		)
Other liabilities	33,528			12,568
Net cash provided by operating activities	136,506			147,246
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments	(2,127		)	—
Proceeds from maturities of investments	1,845			2,695
Proceeds from sales of investments	240			125
Decrease in restricted cash	—			690
Cash paid for property and equipment	(32,151		)	(34,818		)
Proceeds from sales of property and equipment	—			2,792
Net cash used in investing activities	(32,193		)	(28,516		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from common stock issued under stock incentive plans	16,372			11,253
Minimum statutory withholding requirements	(4,765		)	(5,685		)
Cash paid for treasury stock	(130,000		)	(201,328		)
Payments of capital lease obligations	(18,568		)	(16,655		)
Change in bank overdraft and other financing activities	(8,811		)	3,599
Excess tax benefits from stock-based compensation	4,890			8,874
Cash dividends paid to stockholders	(19,620		)	—
Net cash used in financing activities	(160,502		)	(199,942		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	669			(955		)
DECREASE IN CASH AND CASH EQUIVALENTS	(55,520		)	(82,167		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	285,622			335,155
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	230,102		$	252,988

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid	$	13,408		$	13,305
Income taxes paid, net of refunds	$	10,026		$	31,260
Assets acquired using capital lease obligations	$	18,806		$	16,346
Accruals and accounts payable for capital expenditures	$	21,041		$	25,788
Dividends declared, but unpaid	$	20,322		$	17,544

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

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended February 2, 2014.

PetSmart, Inc., including its wholly owned subsidiaries (the “Company,” “PetSmart,” “we,” or “us”), 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 services including professional grooming, boarding, and training and day camp for dogs. We also offer pet products through our e-commerce website, PetSmart.com. As of May 4, 2014, we operated 1,340 stores and had full-service veterinary hospitals in 853 of our stores. We have a 21.0% investment in MMI Holdings, Inc., which is accounted for under the equity method of accounting. MMI Holdings, Inc., through a wholly owned subsidiary, Medical Management International, Inc., collectively referred to as “Banfield,” operated 846 of the veterinary hospitals under the registered trade name of “Banfield, The Pet Hospital.” The remaining 7 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 our opinion, 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.

Due to the seasonal nature of our business, the results of operations for the thirteen weeks ended May 4, 2014, 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 2014 ends on February 1, 2015, while fiscal 2013 ended on February 2, 2014, both 52-week years. Unless otherwise specified, all references to years in these condensed consolidated financial statements are to fiscal years.

Note 2 — Foreign Currency

Foreign currency translation adjustments are included in other comprehensive income and are reported in stockholders' equity in the Condensed Consolidated Balance Sheets. Transaction gains and losses are included in net income in the Condensed Consolidated Statements of Income and Comprehensive Income.

Activities related to foreign currency adjustments were as follows (in thousands):



	Thirteen Weeks Ended
	May 4, 2014			May 5, 2013
Deferred tax (expense) benefit on translation adjustments	$	(564	)	$	631
Transaction loss	(51		)	(203		)

The carrying value of goodwill changed solely from the impact of foreign currency translation adjustments during the thirteen weeks ended May 4, 2014, and May 5, 2013.

Note 3 — Investments

Short-term Investments

As of May 5, 2013, our short-term investments consisted of municipal bonds with various maturities, representing funds available for current operations. These short-term investments were classified as available-for-sale and were carried at fair value using quoted prices in active markets for identical assets or liabilities (Level 1). At May 5, 2013, the amortized cost basis was $7.3 million, and accrued interest was immaterial. Unrealized gains and losses were included in other comprehensive income in the Condensed Consolidated Statements of Income and Comprehensive Income. We did not have short-term investments as of May 4, 2014, or February 2, 2014.

Investments in Negotiable Certificates of Deposit

At May 4, 2014, February 2, 2014, and May 5, 2013, we had investments in negotiable certificates of deposit, or “NCDs,” with various maturities. These investments are classified as held-to-maturity and are carried at their amortized cost basis.

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PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

The amortized cost basis of our investments in NCDs was classified in the Condensed Consolidated Balance Sheets as follows (in thousands):



	May 4, 2014		February 2, 2014		May 5, 2013
Prepaid expenses and other current assets	$	6,873	$	7,045	$	1,646
Other noncurrent assets	5,974		5,760		—

The aggregate fair value of our investments in NCDs was $12.8 million, $12.8 million, and $1.6 million at May 4, 2014, February 2, 2014, and May 5, 2013, respectively. The fair value is determined using pricing models, which use inputs based on observable market data (Level 2). The inputs of the pricing models are issuer spreads and reported trades. We had no unrecognized gains or losses for the thirteen weeks ended May 4, 2014, and May 5, 2013.

Equity Investment in Banfield

Our investment in Banfield is accounted for using the equity method of accounting. As of May 4, 2014, February 2, 2014, and May 5, 2013, our investment represented 21.4% of the voting common stock and 21.0% of the combined voting and non-voting stock of Banfield. Our investment includes goodwill of $15.9 million. The goodwill is calculated as the excess of the purchase price for each step of the acquisition of our ownership interest in Banfield relative to that step’s portion of Banfield’s net assets at the respective acquisition date.

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



	May 4, 2014		February 2, 2014		May 5, 2013
Current assets	$	439,114	$	450,657	$	467,478
Noncurrent assets	165,739		160,268		153,478
Current liabilities	517,263		448,665		527,151
Noncurrent liabilities	25,683		26,776		27,001



	Thirteen Weeks Ended
	May 4, 2014		May 5, 2013
Net sales	$	250,857	$	222,129
Income from operations	31,974		29,616
Net income	18,015		17,199

We recognized license fees and reimbursements for specific operating expenses from Banfield of $10.0 million and $9.6 million during the thirteen weeks ended May 4, 2014, and May 5, 2013, respectively, in other revenue in 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 $3.3 million, $3.3 million, and $3.2 million at May 4, 2014, February 2, 2014, and May 5, 2013, respectively, and were included in receivables, net in the Condensed Consolidated Balance Sheets.

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PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

Note 4 — Reserve for Closed Stores

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



	May 4, 2014			February 2, 2014			May 5, 2013
Total remaining gross occupancy costs	$	11,912		$	13,180		$	21,443
Less:
Expected sublease income	(8,453		)	(8,922		)	(12,588		)
Interest costs	(259		)	(312		)	(734		)
Reserve for closed stores	$	3,200		$	3,946		$	8,121

Current portion, included in other current liabilities	1,312			1,690			3,615
Noncurrent portion, included in other noncurrent liabilities	1,888			2,256			4,506
Reserve for closed stores	$	3,200		$	3,946		$	8,121

Activities related to the reserve for closed stores were as follows (in thousands):



	Thirteen Weeks Ended
	May 4, 2014			May 5, 2013
Opening balance	$	3,946		$	8,726
Provision for new store closures	—			669
Lease terminations	(53		)	—
Changes in sublease assumptions	(51		)	(21		)
Other charges	50			68
Payments	(692		)	(1,321		)
Ending balance	$	3,200		$	8,121

Note 5 — 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
	May 4, 2014	May 5, 2013
Basic	99,205	103,305
Dilutive stock-based compensation awards	639	1,278
Diluted	99,844	104,583

Certain stock-based compensation awards representing 0.5 million and 0.8 million shares of common stock in the thirteen weeks ended May 4, 2014, and May 5, 2013, 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.

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PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

Note 6 — Stockholders’ Equity

Share Purchase Programs

The following table presents our purchases of our common stock under the respective share purchase programs (in thousands):



			Thirteen Weeks Ended
Share Purchase Programs			May 4, 2014			May 5, 2013
Authorized Amount	Date Approved by Board	Program Termination Date	Shares Purchased	Purchase Value		Shares Purchased	Purchase Value
$525,000	June 2012	January 31, 2014	—	$	—	2,736	$	180,000
$535,000	September 2013	January 31, 2015	2,026	130,000		—	—
			2,026	$	130,000	2,736	$	180,000

As of May 4, 2014, $287.9 million remained available under the $535.0 million program.

Dividends

During the thirteen weeks ended May 4, 2014, the Board of Directors declared the following dividend:

Note 7 — Stock-based Compensation

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
	May 4, 2014		May 5, 2013
Stock options expense	$	2,210	$	3,697
Restricted stock expense	2,262		1,354
Performance share unit expense	2,125		4,045
Stock-based compensation expense – equity awards	6,597		9,096
Management equity unit expense	1,377		1,635
Total stock-based compensation expense	$	7,974	$	10,731
Tax benefit	$	3,110	$	4,149

At May 4, 2014, the total unrecognized stock-based compensation expense for equity awards, net of estimated forfeitures, was $48.0 million and is expected to be recognized over a weighted average period of 2.4 years.

The 2011 annual management equity unit grant vested on March 28, 2014, and $10.4 million was paid in cash in April 2014. The remaining unvested management equity units will vest during fiscal 2014 and are not material to the Condensed Consolidated Statements of Income and Comprehensive Income. The 2010 annual management equity unit grant vested on March 29, 2013, and $10.8 million was paid in cash in April 2013.

Note 8 — Income Taxes

At the end of each interim period, we estimate the annual effective tax rate and apply that rate to our quarterly earnings. The tax expense or benefit related to significant, unusual, or extraordinary items is recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws, rates, or tax status is recognized in the interim period in which the change occurs. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained, or the tax environment changes.

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PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

Note 9 — Credit Facilities

As of May 4, 2014, February 2, 2014, and May 5, 2013, we had no borrowings and $14.3 million, $14.3 million, and $17.9 million, respectively, in stand-by letter of credit issuances under our $100.0 million revolving credit facility agreement, or “Revolving Credit Facility.”

We had $69.2 million in outstanding letters of credit, issued for guarantees provided for insurance programs, under our $100.0 million stand-alone letter of credit facility agreement, or “Stand-alone Letter of Credit Facility,” as of May 4, 2014, February 2, 2014, and May 5, 2013. We had $71.2 million in restricted cash on deposit as of May 4, 2014, February 2, 2014, and May 5, 2013.

Our Revolving Credit Facility and Stand-alone Letter of Credit Facility permit the payment of dividends if we are not in default and payment conditions, as defined in each respective agreement, are satisfied. As of May 4, 2014, we were in compliance with the terms and covenants of our Revolving Credit Facility and Stand-alone Letter of Credit Facility. The Revolving Credit Facility and Stand-alone Letter of Credit Facility are secured by substantially all our financial assets.

Note 10 — Commitments and Contingencies

Advertising Purchase Commitments

As of May 4, 2014, we had obligations to purchase $34.5 million of advertising through the remainder of 2014.

Product Purchase Commitments

As of May 4, 2014, we had various commitments to purchase $21.5 million of merchandise from certain vendors through the remainder of 2014, and $103.5 million from 2015 through 2017.

Litigation and Settlements

We are involved in the legal proceedings described below and are subject to other claims and litigation arising in the normal course of our business. We have made accruals with respect to certain of these matters, where appropriate, that are reflected in our condensed consolidated financial statements but are not, individually or in the aggregate, considered material. For other matters, we have not made accruals because we have not yet determined that a loss is probable or because the amount of loss cannot be reasonably estimated. While the ultimate outcome of the matters described below cannot be determined, we currently do not expect that these proceedings and claims, individually or in the aggregate, will have a material effect on our consolidated financial position, results of operations, or cash flows. The outcome of any litigation is inherently uncertain, however, and if decided adversely to us, or if we determine that settlement of particular litigation is appropriate, we may be subject to liability that could have a material adverse effect on our consolidated financial position, results of operations, or cash flows. Accordingly, we disclose matters below for which a material loss is reasonably possible. In each case, however, we have either determined that the range of loss is not reasonably estimable or that any reasonably estimable range of loss is not material to our condensed consolidated financial statements.

In May 2012, we were named as a defendant in Moore, et al. v. PetSmart, Inc., et al., a lawsuit originally filed in the California Superior Court for the County of Alameda. PetSmart removed the case to the United States District Court for the Northern District of California. The complaint brings both individual and class action claims, first alleging that PetSmart failed to engage in the interactive process and failed to accommodate the disabilities of four current and former named associates. The complaint also alleges on behalf of current and former hourly store associates that PetSmart failed to provide pay for all hours worked, failed to properly reimburse associates for business expenses, failed to properly calculate and pay vacation, failed to provide suitable seating, and failed to provide timely and uninterrupted meal and rest periods. The lawsuit seeks compensatory damages, statutory penalties, and other relief, including attorneys' fees, costs, and injunctive relief. In January 2014, the parties entered a proposed settlement agreement to resolve this matter in line with reserves that were established for this case in the first and second quarters of 2013. The motion for preliminary approval of the settlement was filed on January 31, 2014. In March 2014, the court heard oral arguments on the motion for preliminary approval of the proposed settlement. In May 2014, the court approved the motion.

In September 2012, a former associate named us as a defendant in McKee, et al. v. PetSmart, Inc., which is currently pending before the United States District Court for the District of Delaware. The case seeks to assert a Fair Labor Standards Act collective action on behalf of PetSmart's operations managers nationwide. The complaint alleges that PetSmart has misclassified operations managers as exempt and as a result failed to pay them overtime for hours worked in excess of forty hours per week. The plaintiffs seek compensatory damages, liquidated damages, and other relief, including attorneys' fees, costs, and injunctive relief. The

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PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

plaintiffs filed a motion for conditional certification in September 2013, which was granted. The court conditionally certified a collective action consisting of all current and former operations managers employed by PetSmart at any time in the preceding three-year period. Notices were sent to potential class members in February 2014, and the 60-day period within which recipients may consent to join the lawsuit closed in April 2014. Discovery is ongoing.

Also in September 2012, a former groomer filed a lawsuit against us captioned Negrete, et al. v. PetSmart, Inc. in the California Superior Court for the County of Shasta. The plaintiff seeks to assert claims on behalf of current and former California pet stylists that PetSmart failed to provide pay for all hours worked, failed to properly reimburse associates for business expenses, failed to provide proper wage statements, failed to properly calculate and pay vacation, and failed to provide timely and uninterrupted meal and rest periods. The lawsuit seeks compensatory damages, statutory penalties, and other relief, including attorneys' fees, costs, and injunctive relief. On June 14, 2013, we removed the case to the United States District Court for the Eastern District of California and subsequently filed a motion to transfer the case to the United States District Court for the Northern District of California. On November 1, 2013, the court deemed the Negrete and the Moore actions related and the Negrete action was reassigned to the same judge overseeing the Moore action. All deadlines have been stayed until the case management conference, which is currently scheduled for June 2014.

On December 22, 2012, a customer filed a lawsuit against us captioned Matin, et al. v. Nestle Purina PetCare Company, et al. in the United States District Court for the Northern District of California. The plaintiff claims he purchased jerky treats containing duck or chicken imported from China that caused injury to his pet, and he seeks to assert claims on behalf of a nationwide class of consumers. We tendered the claim to Nestle Purina, and Nestle Purina is currently defending the case on our behalf. In May 2013, the case was transferred to the Northern District of Illinois and consolidated with another case involving the same products, Adkins, et al. v. Nestle Purina PetCare Company, et al. Mediation discussions are ongoing.

On February 20, 2013, a former groomer in California filed a complaint in the Superior Court of California for the County of Orange captioned Pace v. PetSmart, Inc. PetSmart removed the case to the United States District Court for the Central District of California. The plaintiff seeks to certify a class of all former PetSmart employees in California since February 20, 2010, who were not paid all wages owed within 72 hours of their separations. The plaintiff challenges PetSmart's use of pay cards for separation payments and seeks waiting time penalties, attorneys' fees, and other relief. The plaintiff also asserts claims under California's Private Attorney General Act as well as individual claims for wrongful termination and disability discrimination. The plaintiff filed a motion for class certification on January 31, 2014, and a hearing was held in March 2014.

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

The following discussion contains 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. Any statements made in this Quarterly Report on Form 10-Q, or “Quarterly Report,” that are not statements of historical fact, including statements concerning our expectations for future events, future financial performance, or events or developments that management expects or anticipates will or may occur in the future, are forward-looking statements.

Readers should not place undue reliance on these forward-looking statements, which are based on currently available information and management's current expectations and beliefs about future events or future financial performance. We have attempted to identify forward-looking statements by words such as “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “should,” or other comparable terminology. However, such terminology is not the exclusive means of identifying forward-looking statements and its absence does not mean that the statement is not forward-looking. Although we believe the expectations and beliefs reflected in the forward-looking statements are reasonable, such statements speak only as of the date this Quarterly Report is filed, and we disclaim any intent or obligation to update any of the forward-looking statements after such date unless required by law.

Forward-looking statements are not guarantees of future performance or results, and involve inherent risks and uncertainties such as those described below that could cause actual results to materially differ from those predicted in such forward-looking statements:


•	A decline in consumer spending, change in consumer preferences, or failure to successfully manage and execute our marketing initiatives 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.

•

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, and comparable store sales at our existing stores may decrease due to age or the impact of opening new stores in the same area, which could adversely impact our results of operations. 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.


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


•	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, 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, 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.


•	Our inability to attract, train, and retain qualified leaders and associates 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.


•	Changes in existing or new laws and regulations or regulatory enforcement priorities could adversely affect our business.


•	We may be subject to various types of litigation and our insurance may not be sufficient to cover damages related to those claims.


•	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.


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

For more information on our risk factors that could cause our actual results to differ from the results predicted in these forward-looking statements, please see “Item 1A. Risk Factors,” contained in Part I of our Annual Report on Form 10-K for the year ended February 2, 2014, filed with the Securities and Exchange Commission on March 27, 2014, which is incorporated herein by reference. Readers are also urged to carefully review and consider our various other disclosures in this Quarterly Report and in the other reports we file with the Securities and Exchange Commission, including our periodic reports on Form 10-Q and current reports on Form 8-K, and those described from time to time in our press releases and other communications, which attempt to advise interested parties of the risks that may affect our business, prospects, and results of operations.

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Overview

Based on our 2013 net sales of $6.9 billion, we are North America's leading specialty provider of products, services, and solutions for the lifetime needs of pets. As of May 4, 2014, we operated 1,340 stores, and we plan to continue our store growth during the remainder of 2014. Our stores carry a broad assortment of high-quality pet supplies at everyday low prices. We offer approximately 11,000 distinct items in our stores and 7,000 additional items on our e-commerce website, PetSmart.com, 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 services, including professional grooming and boarding, as well as training and day camp for dogs. All our stores feature pet styling salons that provide high-quality grooming services and most of our stores offer comprehensive dog training services. Our PetsHotels provide boarding for dogs and cats, which includes 24-hour supervision by caregivers who are PetSmart trained to provide personalized pet care, temperature-controlled rooms and suites, daily specialty treats and play time, as well as day camp for dogs. As of May 4, 2014, we operated 200 PetsHotels.

We make full-service veterinary care available through our strategic relationships with certain third-party operators. As of May 4, 2014, we had full-service veterinary hospitals in 853 of our stores. We have a 21.0% investment in MMI Holdings, Inc., which is accounted for under the equity method of accounting. MMI Holdings, Inc., through a wholly owned subsidiary, Medical Management International, Inc., collectively referred to as “Banfield,” operated 846 of the veterinary hospitals under the registered trade name of “Banfield, The Pet Hospital.” The remaining 7 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 volatility in the macro-economy. However, we believe we have a competitive advantage in our solutions for pet parents, which cannot be easily duplicated, including differentiated products and merchandising capabilities, as well as expansion of our proprietary and exclusive brands and services. Additionally, 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, 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 the purchase of treasury stock.

Executive Summary


•	Diluted earnings per common share increased 6.1% to $1.04 on net income of $103.8 million for the thirteen weeks ended May 4, 2014, compared to diluted earnings per common share of $0.98 on net income of $102.4 million for the thirteen weeks ended May 5, 2013.


•	Net sales were $1.7 billion for the thirteen weeks ended May 4, 2014, an increase of 1.1% over the thirteen weeks ended May 5, 2013. The increase in net sales for the thirteen weeks ended May 4, 2014, included an unfavorable impact from foreign currency fluctuations of $7.8 million.


•	Comparable store sales, or sales in stores open at least one year, including online sales, decreased 0.6% for the thirteen weeks ended May 4, 2014, compared to an increase of 3.5% for the thirteen weeks ended May 5, 2013.


•	Services sales increased 4.5% to $200.2 million for the thirteen weeks ended May 4, 2014, compared to $191.6 million for the thirteen weeks ended May 5, 2013.


•	As of May 4, 2014, we had $230.1 million in cash and cash equivalents and $71.2 million in restricted cash. We did not borrow against our revolving credit facility during the thirteen weeks ended May 4, 2014.


•	We purchased 2.0 million shares of our common stock for $130.0 million during the thirteen weeks ended May 4, 2014, and 2.7 million shares of our common stock for $180.0 million during the thirteen weeks ended May 5, 2013.

Critical Accounting Policies and Estimates

We discuss our critical accounting policies and estimates in Part II, 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 February 2, 2014. We have made no significant changes in our critical accounting policies since February 2, 2014.

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Results of Operations

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



	Thirteen Weeks Ended
	May 4, 2014		May 5, 2013
Net sales	100.0	%	100.0	%
Total cost of sales	69.3		69.0
Gross profit	30.7		31.0
Operating, general, and administrative expenses	20.8		21.2
Operating income	9.9		9.8
Interest expense, net	(0.8	)	(0.8	)
Income before income tax expense and equity income from Banfield	9.2		9.0
Income tax expense	(3.4	)	(3.2	)
Equity income from Banfield	0.2		0.2
Net income	6.0	%	6.0	%

Thirteen Weeks Ended May 4, 2014, Compared to the Thirteen Weeks Ended May 5, 2013

Net Sales

Net sales were $1.7 billion for the thirteen weeks ended May 4, 2014, an increase of 1.1% over the thirteen weeks ended May 5, 2013. The increase in net sales for the thirteen weeks ended May 4, 2014, included an unfavorable impact from foreign currency fluctuations of $7.8 million. The primary driver for the increase in net sales was the addition of 51 net new stores and 4 net new PetsHotels since May 5, 2013. Foreign currency fluctuations and weather negatively impacted comparable store sales, which declined by 0.6% during the thirteen weeks ended May 4, 2014, by approximately 40 basis points each. Comparable store sales grew by 3.5% during the thirteen weeks ended May 5, 2013. Online sales, which are included in comparable store sales, were not material to net sales or comparable store sales for the thirteen weeks ended May 4, 2014, or May 5, 2013.

Comparable store sales are comprised of average sales per comparable transaction and comparable transactions. Average sales per comparable transaction grew by 1.6% and 2.7% for the thirteen weeks ended May 4, 2014, and May 5, 2013, respectively. Comparable transactions declined 2.2% and grew 0.8% for the thirteen weeks ended May 4, 2014, and May 5, 2013, respectively.

Sales of our exclusive and proprietary products and services during the thirteen weeks ended May 4, 2014, accounted for roughly 36% of our total net sales. During the thirteen weeks ended May 4, 2014, we drove increased penetration of proprietary and exclusive products to 27.5% of merchandise sales, an improvement of 250 basis points as compared to the thirteen weeks ended May 5, 2013. During the thirteen weeks ended May 4, 2014, we introduced hundreds of new items as part of the consumables reset, which we believe has positioned us for future growth with the increased offerings and solutions we introduced in the natural and channel-exclusive category.

Services sales, which include professional grooming and boarding, as well as training and day camp for dogs, increased 4.5% to $200.2 million for the thirteen weeks ended May 4, 2014, compared to $191.6 million for the thirteen weeks ended May 5, 2013. Services sales represented 11.6% and 11.2% of net sales for the thirteen weeks ended May 4, 2014, and May 5, 2013, respectively. The increase in services sales was primarily due to continued strong demand for our grooming and boarding services, and the addition of new stores and PetsHotels since May 5, 2013.

Other revenue included in net sales during the thirteen weeks ended May 4, 2014, which represents license fees and reimbursements for specific operating expenses charged to Banfield under the master operating agreement, comprised 0.6% of net sales, or $10.0 million, compared to 0.6% of net sales, or $9.6 million, for the thirteen weeks ended May 5, 2013.

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Gross Profit

Gross profit decreased 30 basis points to 30.7% of net sales for the thirteen weeks ended May 4, 2014, from 31.0% for the thirteen weeks ended May 5, 2013. The decrease in gross profit was driven by warehouse and distribution costs primarily associated with opening our new distribution center in Bethel, Pennsylvania. Merchandise margin decreased slightly, which was more than offset by an increase in services margin.

Operating, General, and Administrative Expenses

Operating, general, and administrative expenses as a percentage of net sales decreased to 20.8% for the thirteen weeks ended May 4, 2014, compared to 21.2% for the thirteen weeks ended May 5, 2013. The 40 basis point improvement was primarily driven by lower professional fees and travel expenses, partially offset by increases in advertising expense.

Interest Expense, net

Interest expense, which is primarily related to capital lease obligations, was $13.3 million during the thirteen weeks ended May 4, 2014, compared to $13.4 million for the thirteen weeks ended May 5, 2013. The decrease in interest expense was due to more store capital leases entering the latter part of the lease term. Interest expense, net included interest income of $0.1 million and $0.2 million for the thirteen weeks ended May 4, 2014, and May 5, 2013, respectively.

Income Tax Expense

Income tax expense was $58.6 million for the thirteen weeks ended May 4, 2014, representing an effective tax rate of 36.9% compared with the thirteen weeks ended May 5, 2013, when we had income tax expense of $55.5 million, representing an effective tax rate of 36.0%. The increase in the effective tax rate was primarily due to lower tax deductible dividends received from Banfield in the thirteen weeks ended May 4, 2014. The effective tax rate is calculated by dividing our income tax expense, which includes the income tax expense related to our equity income from Banfield, by income before income tax expense and equity income from Banfield.

Equity Income from Banfield

Our equity income from our investment in Banfield was $3.8 million and $3.6 million for the thirteen weeks ended May 4, 2014, and May 5, 2013, respectively, based on our 21.0% ownership in Banfield.

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 have access to our $100.0 million revolving credit facility, which expires on March 23, 2017. However, there can be no assurance of our ability to access credit markets on commercially acceptable terms in the future. We 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 treasury 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. Net cash provided by operating activities was $136.5 million for the thirteen weeks ended May 4, 2014, compared to $147.2 million for the thirteen weeks ended May 5, 2013. Cash provided by operating activities for the thirteen weeks ended May 4, 2014, as compared to the thirteen weeks ended May 5, 2013, decreased due to a change in the accounts payable balance of $54.3 million, as a result of timing of inventory purchases during the comparative quarters. This was partially offset by a $28.8 million change in other current liabilities, primarily due to timing of our income tax payments, as well as a $19.6 million change in the accrued payroll, bonus, and employee benefits balance, which decreased less during the thirteen weeks ended May 4, 2014, than during the thirteen weeks ended May 5, 2013.

Net 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, and other expenditures to support our growth plans and initiatives. Net cash used in investing activities was $32.2 million for the thirteen weeks ended May 4, 2014, compared to $28.5 million for the thirteen weeks ended May 5, 2013. The primary differences between the thirteen weeks ended May 4, 2014, and May 5, 2013, were due to a $2.1 million increase in cash used to purchase investments

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in securities, primarily negotiable certificates of deposit, and a $2.8 million decrease in proceeds from sale of property and equipment, which was offset by a $2.7 million decrease in cash paid for property and equipment.

Net cash used in financing activities was $160.5 million for the thirteen weeks ended May 4, 2014, and consisted primarily of cash paid for treasury stock, cash dividends paid to stockholders, and payments on capital lease obligations. Net cash used in financing activities for the thirteen weeks ended May 5, 2013, was $199.9 million. Cash used in financing activities decreased in the thirteen weeks ended May 4, 2014, as compared to the thirteen weeks ended May 5, 2013, primarily due to a $71.3 million decrease in cash paid for treasury stock. This was partially offset by a $19.6 million increase in cash dividends paid to stockholders. The dividend declared on December 4, 2013, was paid on February 14, 2014. There was no dividend payment in the thirteen weeks ended May 5, 2013, as the payment date of the dividend declared on December 7, 2012, was accelerated to December 31, 2012.

Operating Capital and Capital Expenditure Requirements

All our stores are leased facilities. We opened 7 new stores and did not close any stores in the thirteen weeks ended May 4, 2014. Generally, each new store requires capital expenditures of approximately $0.6 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 expenditures to be $150 million to $160 million for 2014, based on our plan to continue our store growth, remodel or replace certain store assets, enhance our supply chain, including costs to fixture and equip a new distribution center in Bethel, Pennsylvania, continue our investment in the development of our information systems, and improve our infrastructure.

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.

Commitments

As of May 4, 2014, we had obligations to purchase $34.5 million of advertising through the remainder of 2014.

As of May 4, 2014, we had various commitments to purchase $21.5 million of merchandise from certain vendors through the remainder of 2014, and $103.5 million from 2015 through 2017.

There have been no other material changes in our contractual obligations since February 2, 2014. Information regarding our contractual obligations is provided in Part II, 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 February 2, 2014.

Credit Facilities

We have a $100.0 million revolving credit facility agreement, or “Revolving Credit Facility,” which expires on March 23, 2017. Borrowings under this Revolving Credit Facility are subject to a borrowing base and bear interest, at our option, at LIBOR plus 1.25%, or Base Rate plus 0.25%. The Base Rate is defined as the highest of the following rates: the Federal Funds Rate plus 0.5%, the Adjusted LIBOR plus 1.0%, or the Prime Rate.

We are subject to fees payable each month 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 and bear interest of 0.625% for standby letters of credit and commercial letters of credit.

We also have a $100.0 million stand-alone letter of credit facility agreement, or “Stand-alone Letter of Credit Facility,” which expires on March 23, 2017. We are subject to fees payable each month at an annual rate of 0.175% of the average daily face amount of the letters of credit outstanding during the preceding month. In addition, we are required to maintain a cash deposit with the lender equal to 103% of the amount of outstanding letters of credit.

We had $69.2 million in outstanding letters of credit, issued for guarantees provided for insurance programs, under our Stand-alone Letter of Credit Facility as of May 4, 2014, February 2, 2014, and May 5, 2013. We had $71.2 million in restricted cash on deposit as of May 4, 2014, February 2, 2014, and May 5, 2013.

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Share Purchase Programs

The following table presents our purchases of our common stock under the respective share purchase programs (in thousands):



			Thirteen Weeks Ended
Share Purchase Programs			May 4, 2014			May 5, 2013
Authorized Amount	Date Approved by Board	Program Termination Date	Shares Purchased	Purchase Value		Shares Purchased	Purchase Value
$525,000	June 2012	January 31, 2014	—	$	—	2,736	$	180,000
$535,000	September 2013	January 31, 2015	2,026	130,000		—	—
			2,026	$	130,000	2,736	$	180,000

As of May 4, 2014, $287.9 million remained available under the $535.0 million program.

Dividends

During the thirteen weeks ended May 4, 2014, the Board of Directors declared the following dividend:

Related Party Transactions

We have an investment in MMI Holdings, Inc., which is accounted for under the equity method of accounting. MMI Holdings Inc. through a wholly owned subsidiary, Medical Management International, Inc., collectively referred to as “Banfield,” operated 846 full-service veterinary hospitals in our stores under the registered trade name of “Banfield, The Pet Hospital.” As of May 4, 2014, February 2, 2014, and May 5, 2013, our investment represented 21.4% of the voting common stock and 21.0% of the combined voting and non-voting stock of Banfield.

Our equity income from our investment in Banfield, which is recorded one month in arrears, was $3.8 million and $3.6 million for the thirteen weeks ended May 4, 2014, and May 5, 2013, respectively. During the thirteen weeks ended May 4, 2014, and May 5, 2013, we received dividends from Banfield of $8.1 million and $15.1 million, respectively. In 2013, we began receiving dividends from Banfield on a quarterly basis, as compared to 2012, when we received annual dividends from Banfield. The dividend received during the thirteen weeks ended May 5, 2013, represented the 2012 annual dividend payment from Banfield.

Our 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.

Seasonality and Inflation

Our business is subject to seasonal fluctuation. We typically realize a higher portion of net sales and operating profits during our fourth quarter, as compared to our other quarters, 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. Because our stores typically draw customers from a large trade area, sales may also 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. Controllable expenses could fluctuate from quarter-to-quarter in a year. Finally, because new stores tend to experience higher payroll, advertising, and other store level expenses as a percentage of net sales than mature stores, new store openings also contribute to lower store operating margins until these stores become established.

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 Act.” We are in compliance with the law in 2014 and intend to be in compliance with the employer mandate portion of the Act, which is effective in 2015. We do not expect the impact on our condensed consolidated financial statements to be material.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of May 4, 2014, 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 February 2, 2014. 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 February 2, 2014.

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 May 4, 2014. 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 May 4, 2014, 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 May 4, 2014, 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.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In January 2014, the parties entered a proposed settlement agreement to resolve this matter in line with reserves that were established for this case in the first and second quarters of 2013. The motion for preliminary approval of the settlement was filed on January 31, 2014. In March 2014, the court heard oral arguments on the motion for preliminary approval of the proposed settlement. In May 2014, the court approved the motion.

In September 2012, a former groomer filed a lawsuit against us captioned Negrete, et al. v. PetSmart, Inc. in the California Superior Court for the County of Shasta. The plaintiff seeks to assert claims on behalf of current and former California groomers that PetSmart failed to provide pay for all hours worked, failed to properly reimburse associates for business expenses, failed to provide proper wage statements, failed to properly calculate and pay vacation, and failed to provide timely and uninterrupted meal and rest periods. The lawsuit seeks compensatory damages, statutory penalties, and other relief, including attorneys' fees, costs, and injunctive relief.

On June 14, 2013, we removed the case to the United States District Court for the Eastern District of California and subsequently filed a motion to transfer the case to the United States District Court for the Northern District of California. On November 1, 2013, the Court deemed the Negrete and the Moore actions related and the Negrete action was reassigned to the same judge overseeing the Moore action. All deadlines have been stayed until the case management conference, which is currently scheduled for June 2014.

Other than as set forth above, there have been no material developments in the legal proceedings included in Part I, Item 3 of, and Note 12 to, the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended February 2, 2014.

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 February 2, 2014, 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 our purchases of our common stock and the available funds to purchase additional common stock for each period in the thirteen weeks ended May 4, 2014:



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⁾
February 3, 2014 to March 2, 2014	2,026,188	$	64.16	2,026,188	$	287,866,000
March 3, 2014 to April 6, 2014	—	$	—	—	$	287,866,000
April 7, 2014 to May 4, 2014	—	$	—	—	$	287,866,000
Thirteen Weeks Ended May 4, 2014	2,026,188	$	64.16	2,026,188	$	287,866,000

____________

(1) In September 2013, the Board of Directors approved a share purchase program authorizing the purchase of up to $535.0 million of our common stock through January 31, 2015.

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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.

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.

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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/ Carrie W. Teffner
Date:	May 29, 2014	Carrie W. Teffner
		Executive Vice President and Chief Financial Officer
		(Principal Financial Officer and Principal Accounting Officer)

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