PETM - 2013.08.04

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

Please wait

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 August 4, 2013



¨	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, 103,907,741 Shares at August 16, 2013

Table of Contents

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 August 4, 2013, February 3, 2013, and July 29, 2012	4
Condensed Consolidated Statements of Income and Comprehensive Income for the thirteen and twenty-six weeks ended August 4, 2013, and July 29, 2012	5
Condensed Consolidated Statements of Cash Flows for the twenty-six weeks ended August 4, 2013, and July 29, 2012	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	23
Item 4. Controls and Procedures	23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	24
Item 1A. Risk Factors	24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 6. Exhibits	25
Signatures	26

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 August 4, 2013 and July 29, 2012, and the related condensed consolidated statements of income and comprehensive income for the thirteen week and twenty-six week periods then ended, and of cash flows for the twenty-six 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 3, 2013, 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 28, 2013, 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 3, 2013, 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

August 29, 2013

Table of Contents

PetSmart, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands, except par value)

(Unaudited)



	August 4, 2013			February 3, 2013			July 29, 2012
ASSETS
Cash and cash equivalents	$	281,554		$	335,155		$	282,011
Short-term investments	3,087			9,150			16,730
Restricted cash	71,226			71,916			71,916
Receivables, net	69,118			72,198			56,358
Merchandise inventories	770,268			679,090			691,820
Deferred income taxes	62,859			62,859			51,381
Prepaid expenses and other current assets	115,319			86,768			131,521
Total current assets	1,373,431			1,317,136			1,301,737
Property and equipment, net	951,499			985,707			1,016,359
Equity investment in Banfield	29,678			39,934			30,940
Deferred income taxes	98,162			102,992			84,288
Goodwill	43,031			44,242			44,043
Other noncurrent assets	54,105			46,970			44,115
Total assets	$	2,549,906		$	2,536,981		$	2,521,482
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and bank overdraft	$	248,467		$	202,122		$	248,072
Accrued payroll, bonus and employee benefits	163,494			176,082			140,607
Accrued occupancy expenses and deferred rents	72,829			70,671			71,543
Current maturities of capital lease obligations	64,449			61,581			58,152
Other current liabilities	221,150			244,436			188,978
Total current liabilities	770,389			754,892			707,352
Capital lease obligations	454,673			464,578			482,099
Deferred rents	68,856			73,855			77,992
Other noncurrent liabilities	108,649			120,064			117,272
Total liabilities	1,402,567			1,413,389			1,384,715
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, 168,891, 167,209 and 166,607 shares issued	17			17			17
Additional paid-in capital	1,487,860			1,418,411			1,377,678
Retained earnings	1,989,401			1,827,996			1,647,088
Accumulated other comprehensive income	2,475			5,506			5,322
Less: Treasury stock, at cost, 64,951, 61,879 and 58,464 shares	(2,332,414		)	(2,128,338		)	(1,893,338		)
Total stockholders’ equity	1,147,339			1,123,592			1,136,767
Total liabilities and stockholders’ equity	$	2,549,906		$	2,536,981		$	2,521,482

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

Table of Contents

PetSmart, Inc. and Subsidiaries

Condensed Consolidated Statements of Income and Comprehensive Income

(In thousands, except per share data)

(Unaudited)



	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	August 4, 2013			July 29, 2012			August 4, 2013			July 29, 2012
Merchandise sales	$	1,492,457		$	1,419,383		$	3,001,829		$	2,858,942
Services sales	204,707			190,867			396,284			371,881
Other revenue	8,833			9,417			18,480			18,737
Net sales	1,705,997			1,619,667			3,416,593			3,249,560
Cost of merchandise sales	1,040,814			986,885			2,077,928			1,981,393
Cost of services sales	141,130			134,550			275,219			263,241
Cost of other revenue	8,833			9,417			18,480			18,737
Total cost of sales	1,190,777			1,130,852			2,371,627			2,263,371
Gross profit	515,220			488,815			1,044,966			986,189
Operating, general and administrative expenses	358,670			352,755			720,898			695,778
Operating income	156,550			136,060			324,068			290,411
Interest expense, net	(12,828		)	(13,550		)	(25,996		)	(27,679		)
Income before income tax expense and equity income from Banfield	143,722			122,510			298,072			262,732
Income tax expense	(54,493		)	(48,333		)	(110,040		)	(96,505		)
Equity income from Banfield	4,139			4,343			7,751			6,976
Net income	93,368			78,520			195,783			173,203
Other comprehensive income, net of income tax:
Foreign currency translation adjustments	(2,030		)	(1,384		)	(3,017		)	(165		)
Other	(5		)	—			(14		)	(3		)
Comprehensive income	$	91,333		$	77,136		$	192,752		$	173,035
Earnings per common share:
Basic	$	0.90		$	0.73		$	1.89		$	1.59
Diluted	$	0.89		$	0.71		$	1.87		$	1.57
Weighted average shares outstanding:
Basic	103,474			108,260			103,390			108,595
Diluted	104,512			109,934			104,547			110,507

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

Table of Contents

PetSmart, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)



	Twenty-Six Weeks Ended
	August 4, 2013			July 29, 2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	195,783		$	173,203
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	117,939			119,777
Loss on disposal of property and equipment	1,281			3,342
Stock-based compensation expense	12,889			14,628
Deferred income taxes	6,758			9,302
Equity income from Banfield	(7,751		)	(6,976		)
Dividend received from Banfield	18,007			13,860
Excess tax benefits from stock-based compensation	(21,576		)	(35,276		)
Non-cash interest expense	311			478
Changes in assets and liabilities:
Merchandise inventories	(92,363		)	(46,967		)
Other assets	(24,092		)	(64,768		)
Accounts payable	56,007			44,926
Accrued payroll, bonus and employee benefits	(12,357		)	(17,458		)
Other liabilities	(16,801		)	23,916
Net cash provided by operating activities	234,035			231,987
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments	(6,846		)	(4,027		)
Proceeds from maturities of investments	7,165			11,915
Proceeds from sales of investments	580			1,059
Decrease (Increase) in restricted cash	690			(1,727		)
Cash paid for property and equipment	(61,306		)	(71,011		)
Proceeds from sales of property and equipment	8,915			1,334
Net cash used in investing activities	(50,802		)	(62,457		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from common stock issued under stock incentive plans	38,330			37,288
Minimum statutory withholding requirements	(5,767		)	(22,466		)
Cash paid for treasury stock	(225,404		)	(221,611		)
Payments of capital lease obligations	(36,343		)	(32,103		)
(Decrease) Increase in bank overdraft	(9,507		)	3,978
Excess tax benefits from stock-based compensation	21,576			35,276
Cash dividends paid to stockholders	(17,043		)	(30,590		)
Net cash used in financing activities	(234,158		)	(230,228		)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS	(2,676		)	(183		)
DECREASE IN CASH AND CASH EQUIVALENTS	(53,601		)	(60,881		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD	335,155			342,892
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	281,554		$	282,011

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid	$	26,224		$	27,790
Income taxes paid, net of refunds	$	155,771		$	123,508
Assets acquired using capital lease obligations	$	28,672		$	12,468
Accruals and accounts payable for capital expenditures	$	32,711		$	31,589
Dividends declared but unpaid	$	17,677		$	17,994

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

Table of Contents

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 3, 2013.

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 pet services including training and day camp for dogs, professional grooming, and boarding. We also offer pet products through our website, PetSmart.com. As of August 4, 2013, we operated 1,301 retail stores and had full-service veterinary hospitals in 830 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 823 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 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.

Due to the seasonal nature of our business, the results of operations for the thirteen and twenty-six weeks ended August 4, 2013, 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 2013, a 52-week year, ends on February 2, 2014, while fiscal 2012, a 53-week year, ended on February 3, 2013. Unless otherwise specified, all references to years in these condensed consolidated financial statements are to fiscal years.

Note 2 — Correction to the Condensed Consolidated Statement of Cash Flows

The Condensed Consolidated Statement of Cash Flows for the twenty-six weeks ended July 29, 2012, has been adjusted from amounts previously reported to reflect a correction to the excess tax benefits from stock-based compensation included in cash flows from operating activities and cash flows from financing activities. This was due to the exclusion of the amount of excess tax benefits relating to restricted stock awards and performance share units that should have been included. The correction resulted in a decrease to net cash provided by operating activities and a corresponding decrease to net cash used in financing activities. The correction is not material to our previously issued condensed consolidated financial statements.

The following table reflects the effects on the financial statement line items of the Condensed Consolidated Statement of Cash Flows (in thousands):



	Twenty-Six Weeks Ended July 29, 2012
	As Reported			Correction			Adjusted
Excess tax benefits from stock-based compensation included in operating activities	$	(13,892	)	$	(21,384	)	$	(35,276	)
Net cash provided by operating activities	253,371			(21,384		)	231,987
Excess tax benefits from stock-based compensation included in financing activities	13,892			21,384			35,276
Net cash used in financing activities	(251,612		)	21,384			(230,228		)
Decrease in cash and cash equivalents	(60,881		)	—			(60,881		)

Note 3 — 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.

Table of Contents

PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

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



	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	August 4, 2013			July 29, 2012			August 4, 2013			July 29, 2012
Deferred tax benefit on translation adjustments	$	1,297		$	886		$	1,928		$	106
Transaction loss	(429		)	(99		)	(632		)	(42		)

The change in the carrying value of goodwill was due to the impact of foreign currency translation adjustments during the thirteen and twenty-six weeks ended August 4, 2013, and July 29, 2012.

Note 4 — Investments

Short-term Investments

At August 4, 2013, February 3, 2013, and July 29, 2012, our short-term investments consisted of municipal bonds with various maturities, representing funds available for current operations. These short-term investments are classified as available-for-sale and are carried at fair value using quoted prices in active markets for identical assets or liabilities (Level 1). Accrued interest was immaterial at August 4, 2013, February 3, 2013, and July 29, 2012. The amortized cost basis at August 4, 2013, February 3, 2013, and July 29, 2012, was $3.1 million, $9.1 million, and $16.6 million, respectively. Unrealized gains and losses are included in other comprehensive income in the Condensed Consolidated Statements of Income and Comprehensive Income.

Investments in Negotiable Certificates of Deposit

At August 4, 2013, February 3, 2013, and July 29, 2012, 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.

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



	August 4, 2013		February 3, 2013		July 29, 2012
Prepaid expenses and other current assets	$	5,409	$	2,571	$	8,487
Noncurrent assets	2,400		240		975

The aggregate fair value of our investments in NCDs was $7.8 million, $2.8 million, and $9.5 million at August 4, 2013, February 3, 2013, and July 29, 2012, 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. Unrecognized gains and losses for the thirteen and twenty-six weeks ended August 4, 2013, and July 29, 2012, were immaterial.

Equity Investment in Banfield

We have an investment in Banfield which is accounted for using the equity method of accounting. As of August 4, 2013, February 3, 2013, and July 29, 2012, our investment represented 21.4% of the voting common stock and 21.0% of the combined voting and non-voting stock. 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):



	August 4, 2013		February 3, 2013		July 29, 2012
Current assets	$	422,450	$	429,787	$	381,683
Noncurrent assets	157,506		141,209		143,086
Current liabilities	466,992		388,729		324,189
Noncurrent liabilities	26,451		16,508		5,888

Table of Contents

PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)



	Thirteen Weeks Ended				Twenty-Six Weeks Ended
	August 4, 2013		July 29, 2012		August 4, 2013		July 29, 2012
Net sales	$	235,361	$	211,775	$	457,490	$	406,053
Income from operations	34,608		36,545		64,224		57,866
Net income	19,709		20,683		36,908		33,226

We recognized license fees and reimbursements for specific operating expenses from Banfield of $8.8 million and $9.4 million during the thirteen weeks ended August 4, 2013, and July 29, 2012, respectively, and $18.5 million and $18.7 million during the twenty-six weeks ended August 4, 2013, and July 29, 2012, 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 $3.4 million, $3.2 million, and $3.4 million at August 4, 2013, February 3, 2013, and July 29, 2012, respectively, and were included in receivables, net in the Condensed Consolidated Balance Sheets.

Note 5 — Reserve for Closed Stores

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



	August 4, 2013			February 3, 2013			July 29, 2012
Total remaining gross occupancy costs	$	19,516		$	22,699		$	23,381
Less:
Expected sublease income	(12,709		)	(13,117		)	(14,719		)
Interest costs	(459		)	(856		)	(876		)
Reserve for closed stores	$	6,348		$	8,726		$	7,786

Current portion, included in other current liabilities	2,973			3,466			3,003
Noncurrent portion, included in other noncurrent liabilities	3,375			5,260			4,783
Reserve for closed stores	$	6,348		$	8,726		$	7,786

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



	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	August 4, 2013			July 29, 2012			August 4, 2013			July 29, 2012
Opening balance	$	8,121		$	9,892		$	8,726		$	10,007
Provision for new store closures	—			642			669			2,165
Lease terminations	—			(584		)	—			(584		)
Changes in sublease assumptions	(474		)	146			(495		)	(169		)
Other charges	103			90			170			170
Payments	(1,402		)	(2,400		)	(2,722		)	(3,803		)
Ending balance	$	6,348		$	7,786		$	6,348		$	7,786

Note 6 — 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		Twenty-Six Weeks Ended
	August 4, 2013	July 29, 2012	August 4, 2013	July 29, 2012
Basic	103,474	108,260	103,390	108,595
Dilutive stock-based compensation awards	1,038	1,674	1,157	1,912
Diluted	104,512	109,934	104,547	110,507

Table of Contents

PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

Certain stock-based compensation awards representing 0.5 million and 0.6 million shares of common stock in the thirteen weeks ended August 4, 2013, and July 29, 2012, respectively, and 0.4 million and 0.5 million shares of common stock in the twenty-six weeks ended August 4, 2013, and July 29, 2012, 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 7 — Stockholders’ Equity

Share Purchase Program

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



			Thirteen Weeks Ended
Share Purchase Program			August 4, 2013			July 29, 2012
Authorized Amount	Date Approved by Board	Program Termination Date	Shares Purchased	Purchase Value		Shares Purchased	Purchase Value
$450,000	June 2011	January 31, 2013	—	$	—	730	$	46,703
$525,000	June 2012	January 31, 2014	336	24,076		—	—
			336	$	24,076	730	$	46,703



			Twenty-Six Weeks Ended
Share Purchase Program			August 4, 2013			July 29, 2012
Authorized Amount	Date Approved by Board	Program Termination Date	Shares Purchased	Purchase Value		Shares Purchased	Purchase Value
$450,000	June 2011	January 31, 2013	—	$	—	3,779	$	221,611
$525,000	June 2012	January 31, 2014	3,072	204,076		—	—
			3,072	$	204,076	3,779	$	221,611

As of August 4, 2013, $142.9 million remained available under the $525.0 million program.

Dividends

During the twenty-six weeks ended August 4, 2013, the Board of Directors declared the following dividends:



Date Declared	Dividend Amount per Share	Stockholders of Record Date	Payment Date
March 26, 2013	$0.165	May 3, 2013	May 17, 2013
June 14, 2013	$0.165	August 2, 2013	August 16, 2013

Note 8 — 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				Twenty-Six Weeks Ended
	August 4, 2013		July 29, 2012		August 4, 2013		July 29, 2012
Stock options expense	$	1,295	$	2,527	$	4,992	$	5,343
Restricted stock expense	2,102		1,230		3,456		2,425
Performance share unit expense	396		3,556		4,441		6,860
Stock-based compensation expense – equity awards	3,793		7,313		12,889		14,628
Management equity unit expense	1,685		3,338		3,320		7,331
Total stock-based compensation expense	$	5,478	$	10,651	$	16,209	$	21,959
Tax benefit	$	2,100	$	3,987	$	6,249	$	8,231

Table of Contents

PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

At August 4, 2013, the total unrecognized stock-based compensation expense for equity awards, net of estimated forfeitures, was $48.8 million and is expected to be recognized over a weighted average period of 2.3 years. At August 4, 2013, the total unrecognized stock-based compensation expense for liability awards, net of estimated forfeitures, was $2.5 million and is expected to be recognized over a weighted average period of 0.7 years.

The 2010 management equity unit grant vested on March 29, 2013, and $10.8 million was paid in cash in April 2013. The 2009 management equity unit grant vested on March 9, 2012, and $11.9 million was paid in cash in March 2012.

Note 9 — 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.

In July 2013, the Financial Accounting Standards Board, or “FASB,” issued an accounting standards update on the presentation of unrecognized tax benefits. The update clarifies that unrecognized tax benefits related to a net operating loss carryforward, or similar tax loss, or tax credit carryforward, should generally be presented in the financial statements as a reduction to a deferred tax asset. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The update allows for early adoption. We have accordingly presented applicable uncertain tax positions as reductions to deferred income tax assets in the Condensed Consolidated Balance Sheet as of August 4, 2013. These amounts are presented in other current liabilities and other noncurrent liabilities in the Condensed Consolidated Balance Sheets as of February 3, 2013, and July 29, 2012. The adoption of the new guidance does not have a material impact on our condensed consolidated financial statements.

Note 10 — Credit Facilities

As of August 4, 2013, February 3, 2013, and July 29, 2012, we had no borrowings and $17.9 million, $17.9 million, and $24.4 million in stand-by letter of credit issuances under our $100.0 million revolving credit facility, respectively.

We had $69.2 million, $69.8 million, and $69.8 million in outstanding letters of credit, issued for guarantees provided for insurance programs, under our $100.0 million stand-alone letter of credit facility as of August 4, 2013, February 3, 2013, and July 29, 2012, respectively. We had $71.2 million, $71.9 million, and $71.9 million in restricted cash on deposit with the stand-alone letter of credit facility lender as of August 4, 2013, February 3, 2013, and July 29, 2012, respectively.

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 the agreement are satisfied. As of August 4, 2013, 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 11 — Commitments and Contingencies

Advertising Purchase Commitments

As of August 4, 2013, we had obligations to purchase $8.9 million of advertising through the remainder of 2013.

Product Purchase Commitments

As of August 4, 2013, we had various commitments to purchase $29.1 million of merchandise from certain vendors through the remainder of 2013, and $31.1 million from 2014 through 2016.

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

Table of Contents

PetSmart, Inc. and Subsidiaries

Notes to the Condensed Consolidated Financial Statements — (Continued)

(Unaudited)

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 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 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 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, 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 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 and similarly situated employees. 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.

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, 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 so that it could be consolidated with the Moore, et al. v. PetSmart, Inc., et. al. case discussed above. That motion is currently pending.

On December 14, 2012, a group of four former managers filed a lawsuit against us captioned Miller, et al. v. PetSmart, Inc. in the United States District Court for the Eastern District of California. The plaintiffs seek to assert claims on behalf of hourly and exempt store management personnel from December 14, 2008, to the present for alleged unreimbursed mileage expenses. The lawsuit seeks compensatory damages, statutory penalties, and other relief, including attorneys’ fees, costs, and injunctive relief.

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. The case was subsequently 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.

On February 20, 2013, a former employee 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 complaint seeks to certify a class of all former PetSmart employees in California since February 20, 2010, who were not paid all wages owed upon their separations. The complaint also challenges PetSmart's use of pay cards for separation payments and seeks waiting time penalties, attorneys' fees, and other relief. The plaintiff is currently seeking to amend her complaint to assert additional claims under California's Private Attorney General Act as well as individual claims for wrongful termination and disability discrimination.

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

Table of Contents

PetSmart, Inc. and Subsidiaries

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, 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.


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


•	Volatility and disruption to the global capital and credit markets could adversely affect our ability to access credit and the financial soundness of our suppliers.


•	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.

Table of Contents

PetSmart, Inc. and Subsidiaries


•	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.


•	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 February 3, 2013, filed with the Securities and Exchange Commission on March 28, 2013, which is incorporated herein by reference.

Table of Contents

PetSmart, Inc. and Subsidiaries

Overview

Based on our 2012 net sales of $6.8 billion, we are North America's leading specialty provider of products, services, and solutions for the lifetime needs of pets. As of August 4, 2013, we operated 1,301 stores, and we plan to continue our store growth during the remainder of 2013. 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 10,000 additional items on our 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 pet services, including training and day camp for dogs, professional grooming, and boarding. 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 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 August 4, 2013, we operated 196 PetsHotels.

We make full-service veterinary care available through our strategic relationship with certain third-party operators. As of August 4, 2013, full-service veterinary hospitals were in 830 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 823 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 the Total Lifetime Care^SMof pets, including pet services and proprietary brands, which we think cannot be easily 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 the purchase of treasury stock.

Executive Summary

•

Diluted earnings per common share increased 25.4% to $0.89 on net income of $93.4 million, for the thirteen weeks ended August 4, 2013, compared to diluted earnings per common share of $0.71 on net income of $78.5 million for the thirteen weeks ended July 29, 2012. Diluted earnings per common share were $1.87 and $1.57 for the twenty-six weeks ended August 4, 2013, and July 29, 2012, respectively.

•

Net sales increased 5.3% to $1.7 billion for the thirteen weeks ended August 4, 2013, compared to $1.6 billion for the thirteen weeks ended July 29, 2012. The increase in net sales for the thirteen weeks ended August 4, 2013, included an unfavorable impact from foreign currency fluctuations of $1.4 million. Net sales increased 5.1% to $3.4 billion for the twenty-six weeks ended August 4, 2013, compared to $3.2 billion for the twenty-six weeks ended July 29, 2012. The increase in net sales for the twenty-six weeks ended August 4, 2013, included an unfavorable impact from foreign currency fluctuations of $3.3 million.


•	Comparable store sales, or sales in stores open at least one year, increased 3.4% and 3.5% for the thirteen and twenty-six weeks ended August 4, 2013. Internet sales are included in comparable store sales.


•	Services sales increased 7.3% to $204.7 million for the thirteen weeks ended August 4, 2013, compared to $190.9 million for the thirteen weeks ended July 29, 2012. Services sales increased 6.6% to $396.3 million for the twenty-six weeks ended August 4, 2013, compared to $371.9 million for the twenty-six weeks ended July 29, 2012.


•	As of August 4, 2013, we had $281.6 million in cash and cash equivalents and $71.2 million in restricted cash. We had no short-term debt, and did not borrow against our revolving credit facility during the twenty-six weeks ended August 4, 2013.


•	We purchased 0.3 million shares of our common stock for $24.1 million during the thirteen weeks ended August 4, 2013, and 3.1 million shares of our common stock for $204.1 million during the twenty-six weeks ended August 4, 2013.

Table of Contents

PetSmart, Inc. and Subsidiaries

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 February 3, 2013. We have made no significant change in our critical accounting policies since February 3, 2013.

Recently Issued Accounting Pronouncements

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				Twenty-Six Weeks Ended
	August 4, 2013		July 29, 2012		August 4, 2013		July 29, 2012
Net sales	100.0	%	100.0	%	100.0	%	100.0	%
Total cost of sales	69.8		69.8		69.4		69.7
Gross profit	30.2		30.2		30.6		30.3
Operating, general and administrative expenses	21.0		21.8		21.1		21.4
Operating income	9.2		8.4		9.5		8.9
Interest expense, net	(0.8	)	(0.8	)	(0.8	)	(0.9	)
Income before income tax expense and equity income from Banfield	8.4		7.6		8.7		8.1
Income tax expense	(3.2	)	(3.0	)	(3.2	)	(3.0	)
Equity income from Banfield	0.2		0.3		0.2		0.2
Net income	5.5	%	4.8	%	5.7	%	5.3	%

Thirteen Weeks Ended August 4, 2013, Compared to the Thirteen Weeks Ended July 29, 2012

Net Sales

Net sales increased 5.3% to $1.7 billion for the thirteen weeks ended August 4, 2013, compared to $1.6 billion for the thirteen weeks ended July 29, 2012. The increase in net sales for the thirteen weeks ended August 4, 2013, included an unfavorable impact from foreign currency fluctuations of $1.4 million. Approximately 65% of the sales increase is due to a 3.4% increase in comparable store sales, which includes internet sales, for the thirteen weeks ended August 4, 2013, and 35% of the sales increase is due to the addition of 52 net new stores and 2 net new PetsHotels since July 29, 2012. Internet sales were not material to net sales or comparable store sales for the thirteen weeks ended August 4, 2013, or July 29, 2012.

Comparable store sales growth was driven by higher average sales per comparable transaction and an increase in comparable transactions. Comparable transactions grew 1.0% for the thirteen weeks ended August 4, 2013, and 2.9% for the thirteen weeks ended July 29, 2012.

During the thirteen weeks ended August 4, 2013, we continued to see strength in our super-premium natural foods, which was driven by the expansion of that space during the thirteen weeks ended May 5, 2013. Within our exclusive and proprietary

Table of Contents

PetSmart, Inc. and Subsidiaries

brands, our focus on innovation and newness cultivated increased penetration and brand recognition. We have also seen stabilization in our premium science category with recent brand re-launches. Additionally, during the thirteen weeks ended August 4, 2013, we reset the space dedicated to reptiles, our fastest growing species in specialty. We focused on solutions in this space by improving adjacencies and layouts and adding educational signage to provide an easier shopping experience. We also continued to simplify the shopping experience by making strides in our omni-channel efforts, including e-commerce, e-influence, and building new capabilities.

Services sales, which include training and day camp for dogs, professional grooming, and boarding, increased 7.3% to $204.7 million for the thirteen weeks ended August 4, 2013, compared to $190.9 million for the thirteen weeks ended July 29, 2012. Services sales represented 12.0% and 11.8% of net sales for the thirteen weeks ended August 4, 2013, and July 29, 2012, respectively. The increase in services sales is primarily due to continued strong demand for our grooming services, improved occupancy in our PetsHotels, and the addition of new stores and PetsHotels since July 29, 2012. Our quality of care, along with a strong pipeline of innovative services and exclusive offerings, supported the continued strength in grooming. PetsHotels also performed well, driven by an authentic customer connection, along with a focus on driving improved operational efficiencies.

Other revenue included in net sales during the thirteen weeks ended August 4, 2013, represents license fees and reimbursements for utilities and specific operating expenses charged to Banfield under the master operating agreement which comprised 0.5% of net sales, or $8.8 million, compared to 0.6% of net sales, or $9.4 million, for the thirteen weeks ended July 29, 2012.

Gross Profit

Gross profit remained flat at 30.2% of net sales for the thirteen weeks ended August 4, 2013, as compared to the thirteen weeks ended July 29, 2012. Merchandise margin decreased by 55 basis points, due to rate and mix. Rate was driven by an increase in promotional activity in cat consumables. Sales mix was impacted by our services business growing faster than merchandise sales, and lower sales of aquatics consumables and hardgoods. Services margin contributed 25 basis points to the overall rate, driven by strong sales growth in our PetsHotels and grooming salons, as well as rate improvements from payroll costs. Store occupancy costs and supply chain costs included in margin each provided 15 basis points of leverage.

Operating, General and Administrative Expenses

Operating, general and administrative expenses as a percentage of net sales decreased to 21.0% for the thirteen weeks ended August 4, 2013, compared to 21.8% for the thirteen weeks ended July 29, 2012. Approximately one-third of the improvement is attributed to a one-time benefit from forfeitures on stock-based compensation expense. In addition, other payroll-related benefit costs decreased as compared to the thirteen weeks ended July 29, 2012.

Interest Expense, net

Interest expense, which is primarily related to capital lease obligations, was $13.0 million during the thirteen weeks ended August 4, 2013, compared to $13.9 million for the thirteen weeks ended July 29, 2012. The decrease in interest expense was due to a decrease in capital lease obligations. Included in interest expense, net was interest income of $0.2 million and $0.3 million for the thirteen weeks ended August 4, 2013, and July 29, 2012, respectively.

Income Tax Expense

For the thirteen weeks ended August 4, 2013, the $54.5 million income tax expense represents an effective tax rate of 37.9% compared with the thirteen weeks ended July 29, 2012, when we had income tax expense of $48.3 million, which represented an effective tax rate of 39.5%. The decrease in the effective tax rate was primarily due to a tax deductible dividend received from Banfield during the thirteen weeks ended August 4, 2013, and tax exempt gains 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 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 $4.1 million and $4.3 million for the thirteen weeks ended August 4, 2013, and July 29, 2012, respectively, based on our 21.0% ownership in Banfield.

Table of Contents

PetSmart, Inc. and Subsidiaries

Twenty-Six Weeks Ended August 4, 2013, Compared to the Twenty-Six Weeks Ended July 29, 2012

Net Sales

Net sales increased 5.1% to $3.4 billion for the twenty-six weeks ended August 4, 2013, compared to $3.2 billion for the twenty-six weeks ended July 29, 2012. The increase in net sales for the twenty-six weeks ended August 4, 2013, included an unfavorable impact from foreign currency fluctuations of $3.3 million. Approximately 65% of the sales increase is due to a 3.5% increase in comparable store sales, which includes internet sales, for the twenty-six weeks ended August 4, 2013, and 35% of the sales increase is due to the addition of 52 net new stores and 2 net new PetsHotels since July 29, 2012. Internet sales were not material to net sales or comparable store sales for the twenty-six weeks ended August 4, 2013, or July 29, 2012.

Comparable store sales growth was driven by higher average sales per comparable transaction and an increase in comparable transactions. Comparable transactions grew 0.9% for the twenty-six weeks ended August 4, 2013, and 3.1% for the twenty-six weeks ended July 29, 2012.

We implemented initiatives to increase traffic and continue to improve average sales per transaction. We expanded the space dedicated to certain brands of super-premium foods, including our proprietary brand Simply Nourish. We also introduced new formulations in both dog and cat foods across our top channel-exclusive brands, which further expanded the grain-free and high protein offerings. During the latter half of the twenty-six weeks ended August 4, 2013, we continued to see strength in our super-premium natural foods, as well as increased penetration and brand recognition in our exclusive and proprietary brands as a result of these initiatives. Additionally, we have seen stabilization in our premium science category with recent brand re-launches.

We expanded hardgoods with new brands of pet apparel and toys available exclusively at PetSmart, and refreshed the assortments of existing brands during the twenty-six weeks ended August 4, 2013. We also reset the space dedicated to reptiles, our fastest growing species in specialty. We focused on solutions in this space by improving adjacencies and layouts and adding educational signage to provide an easier shopping experience for our customers.

Additionally, we continued to enhance our website with richer content and better navigation, including new tools like our online Food Selector, which helps pet parents narrow our wide assortment down to choices that offer the best nutrition for their pets' unique health needs and preferences. During the twenty-six weeks ended August 4, 2013, we continued to make strides in our omni-channel efforts, including e-commerce, e-influence, and building new capabilities, with the goal of simplifying the shopping experience for our customers.

Services sales, which include training and day camp for dogs, professional grooming, and boarding, increased 6.6% to $396.3 million for the twenty-six weeks ended August 4, 2013, compared to $371.9 million for the twenty-six weeks ended July 29, 2012. Services sales represented 11.6% and 11.4% of net sales for the twenty-six weeks ended August 4, 2013, and July 29, 2012, respectively. During the twenty-six weeks ended August 4, 2013, we rolled out several new services offerings in the grooming salon such as new puppy bath packages and application of flea and tick solution. We also continued to develop our pipeline of innovative services and exclusive offerings that are integrated with our merchandise brands and supported by marketing. The increase in services sales is primarily due to continued strong demand for our grooming services, improved occupancy in our PetsHotels, and the addition of new stores and PetsHotels since July 29, 2012.

Other revenue included in net sales during the twenty-six weeks ended August 4, 2013, represents license fees and reimbursements for utilities and specific operating expenses charged to Banfield under the master operating agreement which comprised 0.5% of net sales, or $18.5 million, compared to 0.6% of net sales, or $18.7 million, for the twenty-six weeks ended July 29, 2012.

Gross Profit

Gross profit increased 25 basis points to 30.6% of net sales for the twenty-six weeks ended August 4, 2013, from 30.3% for the twenty-six weeks ended July 29, 2012. Merchandise margin decreased by 30 basis points, while services margin contributed 20 basis points to the overall rate. Store occupancy costs and supply chain costs included in margin provided 20 basis points, and 15 basis points of leverage, respectively.

Table of Contents

PetSmart, Inc. and Subsidiaries

Operating, General and Administrative Expenses

Operating, general and administrative expenses as a percentage of net sales decreased to 21.1% for the twenty-six weeks ended August 4, 2013, compared to 21.4% for the twenty-six weeks ended July 29, 2012. A one-time benefit from forfeitures on stock-based compensation expense, and other payroll-related cost savings, comprised a majority of the leverage.

Interest Expense, net

Interest expense, which is primarily related to capital lease obligations, was $26.4 million during the twenty-six weeks ended August 4, 2013, compared to $28.4 million for the twenty-six weeks ended July 29, 2012. The decrease in interest expense was due to a decrease in capital lease obligations. Included in interest expense, net was interest income of $0.4 million and $0.7 million for the twenty-six weeks ended August 4, 2013, and July 29, 2012, respectively.

Income Tax Expense

For the twenty-six weeks ended August 4, 2013, the $110.0 million income tax expense represents an effective tax rate of 36.9% compared with the twenty-six weeks ended July 29, 2012, when we had income tax expense of $96.5 million, which represented an effective tax rate of 36.7%. The increase in the effective tax rate was primarily due to an increase in certain state tax liabilities. 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 $7.8 million and $7.0 million for the twenty-six weeks ended August 4, 2013, and July 29, 2012, 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 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 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 $234.0 million for the twenty-six weeks ended August 4, 2013, compared to $232.0 million for the twenty-six weeks ended July 29, 2012. The primary differences between the twenty-six weeks ended August 4, 2013, and July 29, 2012, include increased net income of $22.6 million, a decrease in excess tax benefits from stock-based compensation of $13.7 million, and an $11.1 million increase in accounts payable, offset by an increase in merchandise inventories of $45.4 million.

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 $50.8 million for the twenty-six weeks ended August 4, 2013, compared to $62.5 million for the twenty-six weeks ended July 29, 2012. The primary differences between the twenty-six weeks ended August 4, 2013, and July 29, 2012, were a decrease in purchases of property and equipment of $9.7 million and an increase in proceeds from sales of property and equipment of $7.6 million, offset by a decrease in proceeds from maturities of investments of $4.8 million.

Net cash used in financing activities was $234.2 million for the twenty-six weeks ended August 4, 2013, and consisted primarily of the cash paid for treasury stock, payments on capital lease obligations, offset by net proceeds from common stock issued under equity incentive plans. Net cash used in financing activities for the twenty-six weeks ended July 29, 2012, was $230.2 million. The primary differences between the twenty-six weeks ended August 4, 2013, and the twenty-six weeks ended July 29, 2012, were a decrease in excess tax benefits from stock-based compensation of $13.7 million, a decrease in bank overdraft of $13.5 million, offset by a decrease in minimum statutory withholding requirements of $16.7 million and a decrease in cash dividends paid to

Table of Contents

PetSmart, Inc. and Subsidiaries

stockholders of $13.5 million. Dividends declared in December are typically paid to stockholders in February of the following year, which was the case for the dividend declared on December 7, 2011. The Board of Directors approved the payment date for the dividend declared on December 7, 2012, to be accelerated to December 31, 2012.

Operating Capital and Capital Expenditure Requirements

All our stores are leased facilities. We opened 25 new stores and closed 2 stores in the twenty-six weeks ended August 4, 2013. Generally, each new store requires capital expenditures of approximately $0.7 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 $140 million to $150 million for 2013, 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.

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



	Twenty-Six Weeks Ended
	August 4, 2013		July 29, 2012
Capital Expenditures:
New stores	$	10,929	$	15,633
Store-related projects (1)	32,250		34,476
Information technology	7,807		16,245
Supply chain	10,120		4,420
Other	200		237
Total capital expenditures	$	61,306	$	71,011

____________


(1)	Includes store and grooming salon remodels, equipment replacement, relocations, and various merchandising projects, as well as building PetsHotels in new and existing locations.

Commitments

As of August 4, 2013, we had obligations to purchase $8.9 million of advertising through the remainder of 2013.

As of August 4, 2013, we had various commitments to purchase $29.1 million of merchandise from certain vendors through the remainder of 2013, and $31.1 million from 2014 through 2016.

There have been no other material changes in our contractual obligations since February 3, 2013. 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 February 3, 2013.

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.

Table of Contents

PetSmart, Inc. and Subsidiaries

As of August 4, 2013, February 3, 2013, and July 29, 2012, we had no borrowings and $17.9 million, $17.9 million, and $24.4 million in stand-by letter of credit issuances under our Revolving Credit Facility, respectively.

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, $69.8 million, and $69.8 million in outstanding letters of credit, issued for guarantees provided for insurance programs, under our Stand-alone Letter of Credit Facility as of August 4, 2013, February 3, 2013, and July 29, 2012, respectively. We had $71.2 million, $71.9 million, and $71.9 million in restricted cash on deposit with the Stand-alone Letter of Credit Facility lender as of August 4, 2013, February 3, 2013, and July 29, 2012, respectively.

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 the agreement are satisfied. As of August 4, 2013, 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.

Share Purchase Program

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



			Thirteen Weeks Ended
Share Purchase Program			August 4, 2013			July 29, 2012
Authorized Amount	Date Approved by Board	Program Termination Date	Shares Purchased	Purchase Value		Shares Purchased	Purchase Value
$450,000	June 2011	January 31, 2013	—	$	—	730	$	46,703
$525,000	June 2012	January 31, 2014	336	24,076		—	—
			336	$	24,076	730	$	46,703



			Twenty-Six Weeks Ended
Share Purchase Program			August 4, 2013			July 29, 2012
Authorized Amount	Date Approved by Board	Program Termination Date	Shares Purchased	Purchase Value		Shares Purchased	Purchase Value
$450,000	June 2011	January 31, 2013	—	$	—	3,779	$	221,611
$525,000	June 2012	January 31, 2014	3,072	204,076		—	—
			3,072	$	204,076	3,779	$	221,611

As of August 4, 2013, $142.9 million remained available under the $525.0 million program.

Dividends

During the twenty-six weeks ended August 4, 2013, the Board of Directors declared the following dividends:



Date Declared	Dividend Amount per Share	Stockholders of Record Date	Payment Date
March 26, 2013	$0.165	May 3, 2013	May 17, 2013
June 14, 2013	$0.165	August 2, 2013	August 16, 2013

Related Party Transactions

Table of Contents

PetSmart, Inc. and Subsidiaries

Our equity income from our investment in Banfield, which is recorded one month in arrears under the equity method of accounting, was $4.1 million and $4.3 million for the thirteen weeks ended August 4, 2013, and July 29, 2012, respectively, and $7.8 million and $7.0 million for the twenty-six weeks ended August 4, 2013, and July 29, 2012, respectively. During the twenty-six weeks ended August 4, 2013, and July 29, 2012, we received dividends from Banfield of $18.0 million and $13.9 million, respectively.

We recognized license fees and reimbursements for specific operating expenses from Banfield of $8.8 million and $9.4 million during the thirteen weeks ended August 4, 2013, and July 29, 2012, respectively, and $18.5 million and $18.7 million during the twenty-six weeks ended August 4, 2013, and July 29, 2012, 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 $3.4 million, $3.2 million, and $3.4 million at August 4, 2013, February 3, 2013, and July 29, 2012, respectively, and were included in receivables, net in the Condensed Consolidated Balance Sheets.

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 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. Because 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. 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 sales than mature stores, new store openings will 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 expect to be 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.

Table of Contents

PetSmart, Inc. and Subsidiaries

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of August 4, 2013, 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 3, 2013. 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 3, 2013.

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 August 4, 2013. 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 August 4, 2013, 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 August 4, 2013, 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.

Table of Contents

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Reference is made to the lawsuit against us captioned Negrete, et al. v. PetSmart, Inc., originally filed in September 2012, in California Superior Court for the County of Shasta, and previously disclosed in our Annual Report on Form 10-K for the fiscal year ended February 3, 2013 (the "2012 Form 10-K") and our Quarterly Report on Form 10-Q for the period ended May 5, 2013 (the "Q1 2013 Form 10-Q"). As previously disclosed, the plaintiff in that proceeding, a former groomer, 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, 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 Negrete 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 so that it could be consolidated with the lawsuit captioned Moore, et al. v. PetSmart, Inc., et. al. (which was also previously disclosed in our 2012 Form 10-K and Q1 2013 Form 10-Q). That motion is currently pending.

As previously disclosed, the Moore proceeding was filed in May 2012, in the California Superior Court for the County of Alameda, and PetSmart removed it to the United States District Court for the Northern District of California. The Moore 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, 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.

Except as noted above, there have not been any material developments in any legal proceedings previously reported in our 2012 Form 10-K or 2013 Form 10-Q filings. See Item 1 of Part I, "Financial Statements - Note 11 - Commitments and Contingencies - Litigation and Settlements" of this Quarterly Report on Form 10-Q for information concerning previously reported proceedings. 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 February 3, 2013, 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 August 4, 2013:



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⁾
May 6, 2013 to June 2, 2013	—	$	—	—	$166,941,000
June 3, 2013 to July 7, 2013	—	$	—	—	$166,941,000
July 8, 2013 to August 4, 2013	336,210	$	71.61	336,210	$142,865,000
Thirteen Weeks Ended August 4, 2013	336,210	$	71.61	336,210	$142,865,000

__________


(1)	In June 2012, the Board of Directors approved a share purchase program authorizing the purchase of up to $525.0 million of our common stock through January 31, 2014.

Table of Contents

PetSmart, Inc. and Subsidiaries

Item 6. Exhibits

(a) Exhibits



Exhibit 10.1+		PetSmart Amended and Restated Executive Short-Term Incentive Plan (previously filed as Appendix A to the Company's Definitive Proxy Statement filed with the SEC on May 3, 2013, and incorporated herein by reference).

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

____________



+	Compensation plans or arrangements in which directors or executive officers are eligible to participate.
*	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.

Table of Contents

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:	August 29, 2013	Carrie W. Teffner
		Senior Vice President and Chief Financial Officer
		(Principal Financial Officer and Principal Accounting Officer)