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PETsMART 10-Q 2011
e10vq
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended July 31, 2011
OR
     
o   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.)
(PETSMART LOGO)
     
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 þ No o
     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 þ No o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
     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, 112,742,383 Shares at August 12, 2011
 
 

 


 

PetSmart, Inc. and Subsidiaries
INDEX
         
    Page
    Number
PART I. FINANCIAL INFORMATION (UNAUDITED)
       
       
    3  
    4  
    5  
    6  
    7  
    12  
    21  
    21  
       
    22  
    22  
    22  
    22  
    24  
 EX-15.1
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
PetSmart, Inc.
Phoenix, Arizona
We have reviewed the accompanying condensed consolidated balance sheets of PetSmart, Inc. and subsidiaries (the “Company”) as of July 31, 2011 and August 1, 2010, 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 January 30, 2011, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated March 24, 2011, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of January 30, 2011, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ DELOITTE & TOUCHE LLP
Phoenix, Arizona
August 25, 2011

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PetSmart, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(In thousands, except par value)
(Unaudited)
                         
    July 31,     January 30,     August 1,  
    2011     2011     2010  
ASSETS
                       
 
                       
Cash and cash equivalents
  $ 259,180     $ 291,949     $ 239,413  
Short-term investments
    11,833       9,708        
Restricted cash
    61,439       61,439       46,515  
Receivables, net
    63,991       53,971       54,042  
Merchandise inventories
    638,294       615,841       622,483  
Deferred income taxes
    44,999       44,999       36,805  
Prepaid expenses and other current assets
    84,177       46,022       92,585  
 
                 
Total current assets
    1,163,913       1,123,929       1,091,843  
Property and equipment, net
    1,072,269       1,132,435       1,158,509  
Equity investment in Banfield
    32,256       42,858       36,043  
Deferred income taxes
    92,198       96,215       87,561  
Goodwill
    45,428       44,111       43,323  
Other noncurrent assets
    37,553       30,672       26,566  
 
                 
Total assets
  $ 2,443,617     $ 2,470,220     $ 2,443,845  
 
                 
 
                       
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
 
                       
Accounts payable and bank overdraft
  $ 189,959     $ 168,776     $ 198,093  
Accrued payroll, bonus and employee benefits
    123,557       139,359       107,203  
Accrued occupancy expenses and deferred rents
    65,704       64,328       62,046  
Current maturities of capital lease obligations
    49,362       45,277       41,147  
Other current liabilities
    142,081       156,065       128,807  
 
                 
Total current liabilities
    570,663       573,805       537,296  
Capital lease obligations
    514,724       521,552       534,928  
Deferred rents
    83,675       86,027       88,279  
Other noncurrent liabilities
    118,620       118,194       105,223  
 
                 
Total liabilities
    1,287,682       1,299,578       1,265,726  
 
                 
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, 163,748, 162,586 and 161,487 shares issued
    16       16       16  
Additional paid-in capital
    1,268,297       1,222,340       1,181,647  
Retained earnings
    1,379,937       1,277,803       1,171,039  
Accumulated other comprehensive income
    7,964       5,380       4,091  
Less: Treasury stock, at cost, 51,003, 47,094 and 42,929 shares
    (1,500,279 )     (1,334,897 )     (1,178,674 )
 
                 
Total stockholders’ equity
    1,155,935       1,170,642       1,178,119  
 
                 
Total liabilities and stockholders’ equity
  $ 2,443,617     $ 2,470,220     $ 2,443,845  
 
                 
The accompanying notes are an integral part of these condensed consolidated financial statements.

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PetSmart, Inc. and Subsidiaries
Condensed Consolidated Statements of Income and Comprehensive Income
(In thousands, except per share data)
(Unaudited)
                                 
    For the Thirteen Weeks Ended     For the Twenty-Six Weeks Ended  
    July 31, 2011     August 1, 2010     July 31, 2011     August 1, 2010  
Merchandise sales
  $ 1,300,473     $ 1,216,682     $ 2,614,822     $ 2,450,277  
Services sales
    177,945       165,305       345,041       318,592  
Other revenue
    9,135       8,553       18,056       16,824  
 
                       
Net sales
    1,487,553       1,390,540       2,977,919       2,785,693  
 
                       
Cost of merchandise sales
    916,736       869,226       1,836,212       1,739,068  
Cost of services sales
    124,698       116,466       245,252       229,214  
Cost of other revenue
    9,135       8,553       18,056       16,824  
 
                       
Total cost of sales
    1,050,569       994,245       2,099,520       1,985,106  
 
                       
Gross profit
    436,984       396,295       878,399       800,587  
Operating, general and administrative expenses
    326,708       304,288       646,440       605,319  
 
                       
Operating income
    110,276       92,007       231,959       195,268  
Interest expense, net
    (14,255 )     (14,590 )     (28,702 )     (29,933 )
 
                       
Income before income tax expense and equity in income from Banfield
    96,021       77,417       203,257       165,335  
Income tax expense
    (37,624 )     (31,150 )     (76,530 )     (64,914 )
Equity in income from Banfield
    2,783       2,119       5,358       3,557  
 
                       
Net income
    61,180       48,386       132,085       103,978  
Other comprehensive (loss) income, net of income tax:
                               
Foreign currency translation adjustments
    (194 )     (695 )     2,572       1,722  
Other
    5             13        
 
                       
Comprehensive income
  $ 60,991     $ 47,691     $ 134,670     $ 105,700  
 
                       
Earnings per common share:
                               
Basic
  $ 0.54     $ 0.41     $ 1.17     $ 0.88  
 
                       
Diluted
  $ 0.54     $ 0.41     $ 1.15     $ 0.87  
 
                       
Weighted average shares outstanding:
                               
Basic
    112,396       117,079       112,972       117,528  
Diluted
    114,341       119,423       115,039       119,917  
The accompanying notes are an integral part of these condensed consolidated financial statements.

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PetSmart, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
                 
    For the Twenty-Six Weeks Ended  
    July 31, 2011     August 1, 2010  
CASH FLOWS FROM OPERATING ACTIVITIES:
               
Net income
  $ 132,085     $ 103,978  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    119,595       118,312  
Loss on disposal of property and equipment
    4,659       5,175  
Stock-based compensation expense
    13,627       12,973  
Deferred income taxes
    2,373       6,343  
Equity in income from Banfield
    (5,358 )     (3,557 )
Dividend received from Banfield
    15,960        
Excess tax benefits from stock-based compensation
    (6,977 )     (5,246 )
Non-cash interest expense
    363       350  
Changes in other operating assets and liabilities:
               
Merchandise inventories
    (21,650 )     (58,276 )
Other assets
    (46,244 )     (38,709 )
Accounts payable
    8,175       (6,145 )
Accrued payroll, bonus and employee benefits
    (15,941 )     1,956  
Other liabilities
    4,579       (8,748 )
 
           
Net cash provided by operating activities
    205,246       128,406  
 
           
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchases of investments
    (15,661 )      
Proceeds from maturities of investments
    3,240        
Proceeds from sales of investments
    838        
Decrease in restricted cash
          1,657  
Cash paid for property and equipment
    (51,186 )     (54,848 )
Proceeds from sales of property and equipment
    212       118  
 
           
Net cash used in investing activities
    (62,557 )     (53,073 )
 
           
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net proceeds from common stock traded under stock incentive plans
    30,009       22,115  
Minimum statutory withholding requirements
    (6,474 )     (5,105 )
Cash paid for treasury stock
    (165,382 )     (107,068 )
Payments of capital lease obligations
    (26,947 )     (28,256 )
Increase (Decrease) in bank overdraft
    12,738       (8,140 )
Excess tax benefits from stock-based compensation
    6,977       5,246  
Cash dividends paid to stockholders
    (28,611 )     (23,905 )
 
           
Net cash used in financing activities
    (177,690 )     (145,113 )
 
           
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
    2,232       833  
 
           
DECREASE IN CASH AND CASH EQUIVALENTS
    (32,769 )     (68,947 )
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    291,949       308,360  
 
           
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 259,180     $ 239,413  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

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PetSmart, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
NOTE 1 — GENERAL
     PetSmart, Inc., including its wholly owned subsidiaries (the “Company,” “PetSmart” or “we”), is the leading specialty provider of products, services and solutions for the lifetime needs of pets in North America. We offer a broad selection of products for all the life stages of pets, as well as various pet services including professional grooming, training, boarding and day camp. We also offer pet products through an e-commerce site. As of July 31, 2011, we operated 1,197 retail stores and had full-service veterinary hospitals in 778 of our stores. MMI Holdings, Inc., through a wholly owned subsidiary, Medical Management International, Inc., collectively referred to as “Banfield,” operated 769 of the veterinary hospitals under the registered trade name of “Banfield, The Pet Hospital.” The remaining 9 hospitals are operated by other third parties in Canada.
     The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or “GAAP,” for interim reporting. Accordingly, they do not include all the information and footnotes required by GAAP for annual financial statements. In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments, which are of a normal, recurring nature, necessary for a fair presentation of the interim periods presented. These condensed consolidated financial statements, which are unaudited, should be read in conjunction with the audited consolidated financial statements and footnotes included in our Annual Report on Form 10-K for the year ended January 30, 2011.
     Due to the seasonal nature of our business, the results of operations for the thirteen and twenty-six weeks ended July 31, 2011, are not necessarily indicative of the results expected for the full year. Our fiscal year consists of 52 or 53 weeks and ends on the Sunday nearest January 31. Fiscal 2011 ends on January 29, 2012, while fiscal 2010 ended on January 30, 2011, both 52 week years. Unless otherwise specified, all references to years in these condensed consolidated financial statements are to fiscal years.
NOTE 2 — DERIVATIVE FINANCIAL INSTRUMENTS
     We use foreign currency exchange forward contracts, or “Foreign Exchange Contracts,” to manage the impact of foreign currency exchange rate fluctuations related to certain balance sheet accounts. We enter into the Foreign Exchange Contracts in Canada primarily to mitigate risk related to non-functional currency exposures. These Foreign Exchange Contracts are not designated as hedges and are recorded at fair value using quoted prices for similar assets or liabilities in active markets. The changes in the fair value are recognized in operating, general and administrative expenses in the Condensed Consolidated Statements of Income and Comprehensive Income.
     At July 31, 2011, we had Foreign Exchange Contracts outstanding with a notional amount of $10.0 million, which represents the amount of foreign currencies to be purchased or sold at maturity and does not represent our exposure on these contracts. The fair value of the liability related to these Foreign Exchange Contracts, included in other current liabilities, was immaterial at July 31, 2011, and August 1, 2010. The fair value of the receivable related to these Foreign Exchange Contracts, included in prepaid expenses and other current assets, was also immaterial at January 30, 2011. We recorded immaterial losses on Foreign Exchange Contracts during the thirteen and twenty-six weeks ended July 31, 2011, and August 1, 2010.
NOTE 3 — INCOME TAXES
     We generally do not materially adjust deferred income taxes as part of our interim income tax provision. During the thirteen weeks ended July 31, 2011, changes in deferred income taxes were primarily due to tax benefits related to stock-based compensation, and changes in accumulated other comprehensive income. During the interim periods, we recognize the provision for income taxes in other current liabilities in the Condensed Consolidated Balance Sheets. The provision is calculated based on our estimated annual effective income tax rate applied to pretax income. A reclassification between other current liabilities and deferred income tax assets and liabilities is likely to occur during the fourth quarter of 2011. During the twenty-six weeks ended July 31, 2011, we recognized a tax benefit of $3.9 million from dividends received from Banfield.
NOTE 4 — INVESTMENTS
     We have an investment in Banfield which is accounted for using the equity method of accounting. Our ownership interest in the stock of Banfield was as follows (in thousands):

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    July 31, 2011     January 30, 2011     August 1, 2010  
    Shares     Amount     Shares     Amount     Shares     Amount  
Voting common stock and preferred stock
    4,693     $ 21,675       4,693     $ 21,675       4,693     $ 21,675  
Equity in income from Banfield
          26,541             21,183             14,368  
Dividend received from Banfield
          (15,960 )                        
 
                                   
Total equity investment in Banfield
    4,693     $ 32,256       4,693     $ 42,858       4,693     $ 36,043  
 
                                   
     Our investment consisted of voting common stock, comprising 21.4% of all voting stock as of July 31, 2011, January 30, 2011, and August 1, 2010. Our ownership percentage as of July 31, 2011, January 30, 2011, and August 1, 2010, considering all classes of stock (voting and non-voting) was 21.0%.
     Banfield’s financial data is summarized as follows (in thousands):
                         
    July 31, 2011   January 30, 2011   August 1, 2010
Current assets
  $ 340,116     $ 351,379     $ 314,625  
Noncurrent assets
    128,942       119,175       122,987  
Current liabilities
    332,841       279,836       278,683  
Noncurrent liabilities
    11,257       12,367       15,932  
                                 
    Thirteen Weeks Ended   Twenty-Six Weeks Ended
    July 31, 2011   August 1, 2010   July 31, 2011   August 1, 2010
Net sales
  $ 176,428     $ 161,346     $ 341,286     $ 310,654  
Income from operations
    23,532       16,929       44,919       28,646  
Net income
    13,250       10,096       25,512       16,940  
     We recognized license fees and reimbursements for specific operating expenses from Banfield of $9.1 million and $8.6 million during the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively, and $18.1 million and $16.8 million during the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively, in other revenue on the Condensed Consolidated Statements of Income and Comprehensive Income. The related costs are included in cost of other revenue in the Condensed Consolidated Statements of Income and Comprehensive Income. Receivables from Banfield totaled $3.1 million, $2.7 million and $3.0 million at July 31, 2011, January 30, 2011, and August 1, 2010, respectively, and were included in receivables, net in the Condensed Consolidated Balance Sheets.
     The master operating agreement also includes a provision for the sharing of profits on the sale of therapeutic pet foods sold in all stores with an operating Banfield hospital. The net sales and gross profit on the sale of therapeutic pet food are not material to our condensed consolidated financial statements.
NOTE 5 — RESERVE FOR CLOSED STORES
     The components of the reserve for closed stores were as follows (in thousands):
                         
    July 31, 2011     January 30, 2011     August 1, 2010  
Total remaining gross occupancy costs
  $ 30,297     $ 34,313     $ 38,059  
Less:
                       
Expected sublease income
    (18,574 )     (22,964 )     (25,198 )
Interest costs
    (1,549 )     (1,585 )     (1,892 )
 
                 
Reserve for closed stores
  $ 10,174     $ 9,764     $ 10,969  
 
                 
 
                       
Current portion, included in other current liabilities
  $ 2,972     $ 3,056     $ 3,153  
Noncurrent portion, included in other noncurrent liabilities
    7,202       6,708       7,816  
 
                 
Reserve for closed stores
  $ 10,174     $ 9,764     $ 10,969  
 
                 

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     The activity related to the reserve for closed stores was as follows (in thousands):
                                 
    Thirteen Weeks Ended     Twenty-Six Weeks Ended  
    July 31, 2011     August 1, 2010     July 31, 2011     August 1, 2010  
Opening balance
  $ 11,315     $ 10,190     $ 9,764     $ 8,216  
 
Provision for new store closures
          749             3,551  
Changes in sublease assumptions
    106       992       2,636       992  
Other
    (29 )     211       169       331  
 
                       
Charges, net
    77       1,952       2,805       4,874  
Payments
    (1,218 )     (1,173 )     (2,395 )     (2,121 )
 
                       
Ending balance
  $ 10,174     $ 10,969     $ 10,174     $ 10,969  
 
                       
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  
    July 31, 2011     August 1, 2010     July 31, 2011     August 1, 2010  
Basic
    112,396       117,079       112,972       117,528  
Effect of dilutive securities:
                               
Stock options, restricted stock and performance share units
    1,945       2,344       2,067       2,389  
 
                       
Diluted
    114,341       119,423       115,039       119,917  
 
                       
     Certain stock-based compensation awards representing 2.7 million and 2.6 million shares of common stock in the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively, and 2.3 million and 2.8 million shares of common stock in the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively, were not included in the calculation of diluted earnings per common share because the inclusion of such awards would have been antidilutive for the periods presented.
NOTE 7 — STOCKHOLDERS’ EQUITY
     Share Purchase Program
     In June 2009, the Board of Directors approved a share purchase program authorizing the purchase of up to $350.0 million of our common stock through January 29, 2012. During the thirteen weeks ended May 2, 2010, we purchased 3.4 million shares of common stock for $107.1 million under this $350.0 million program.
     In June 2010, the Board of Directors approved a share purchase program authorizing the purchase of up to $400.0 million of our common stock through January 29, 2012, replacing the $350.0 million program. During the thirteen weeks ended July 31, 2011, we purchased 1.4 million shares of common stock for $63.0 million under the $400.0 million program. During the twenty-six weeks ended July 31, 2011, we purchased 3.9 million shares of common stock for $165.4 million under the $400.0 million program. Since the inception of the share purchase authorization in June 2010, we purchased 8.1 million shares of common stock for $321.6 million.
     In June 2011, the Board of Directors approved a share purchase program authorizing the purchase of up to $450.0 million of our common stock through January 31, 2013, replacing the $400.0 million program, effective August 1, 2011.
     Dividends
     During the twenty-six weeks ended July 31, 2011, the Board of Directors declared the following dividends:
                         
Date   Dividend Amount     Stockholders of        
Declared   per Share     Record Date     Payment Date  
March 23, 2011
  $ 0.125     April 29, 2011   May 13, 2011
June 15, 2011
  $ 0.14     July 29, 2011   August 12, 2011

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NOTE 8 — STOCK-BASED COMPENSATION
     The stock-based compensation expense, net of forfeitures, and the total income tax benefit recognized in the Condensed Consolidated Statements of Income and Comprehensive Income were as follows (in thousands):
                                 
    Thirteen Weeks Ended     Twenty-Six Weeks Ended  
    July 31, 2011     August 1, 2010     July 31, 2011     August 1, 2010  
Stock options expense
  $ 2,788     $ 2,135     $ 5,717     $ 4,432  
Restricted stock expense
    1,477       1,529       2,594       3,054  
Performance share unit expense
    3,176       1,947       5,316       3,515  
 
                       
Stock-based compensation cost — equity awards
    7,441       5,611       13,627       11,001  
Management equity unit expense
    2,113       790       4,025       1,972  
 
                       
Total stock-based compensation expense
  $ 9,554     $ 6,401     $ 17,652     $ 12,973  
 
                       
Tax benefit
  $ 3,436     $ 2,169     $ 6,109     $ 4,476  
 
                       
     At July 31, 2011, the total unrecognized stock-based compensation expense, net of estimated forfeitures, was $54.4 million and is expected to be recognized over a weighted average period of 1.5 years.
NOTE 9 — FOREIGN CURRENCY
     Foreign currency translation adjustments are included in other comprehensive income and are reported separately in stockholders’ equity in the Condensed Consolidated Balance Sheets. The income tax benefit related to the foreign currency translation adjustments was $0.1 million and $0.4 million for the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively. The income tax expense related to foreign currency translation adjustments was $1.7 million and $1.0 million for the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively. The transaction loss included in net income was $0.4 million and $0.1 million for the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively. The transaction gain included in net income was $0.3 million and $0.6 million for the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively.
     The impact of foreign currency translation adjustments to the carrying value of goodwill was $(0.2) million and $(0.3) million for the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively, and $1.3 million and $1.1 million for the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively.
NOTE 10 — SUPPLEMENTAL SCHEDULE OF CASH FLOWS
     Supplemental cash flow information was as follows (in thousands):
                 
    Twenty-Six Weeks Ended
    July 31, 2011   August 1, 2010
Interest paid
  $ 29,103     $ 29,655  
Income taxes paid, net of refunds
    100,201       109,696  
Assets acquired using capital lease obligations
    21,028       30,691  
Accruals and accounts payable for capital expenditures
    18,368       18,805  
Dividends declared but unpaid
    15,777       14,812  
NOTE 11 — CREDIT FACILITIES
     Effective April 22, 2011, we elected to reduce the aggregate commitment amount under our $350.0 million revolving credit facility, or “Revolving Credit Facility,” to $100.0 million, which allows us to avoid stand-by costs related to the excess commitment amount. This Revolving Credit Facility expires on August 15, 2012. The Revolving Credit Facility also gives us the ability to issue letters of credit, which reduce the amount available under the Revolving Credit Facility.
     We had no borrowings and $31.6 million in stand-by letter of credit issuances outstanding under our Revolving Credit Facility as of July 31, 2011, and January 30, 2011, and as of August 1, 2010, we had no borrowings and $37.2 million in stand-by letter of credit issuances outstanding.
     We also have a $100.0 million stand-alone letter of credit facility, or “Stand-alone Letter of Credit Facility,” that expires on August 15, 2012. As of July 31, 2011, and January 30, 2011, we had $61.4 million in outstanding letters of credit under the Stand-alone Letter

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of Credit Facility and $61.4 million in restricted cash on deposit with the lender. As of August 1, 2010, we had $46.5 million in outstanding letters of credit under the Stand-alone Letter of Credit Facility and $46.5 million in restricted cash on deposit with the lender.
     Our Revolving Credit Facility and Stand-alone Letter of Credit Facility permit the payment of dividends if we are not in default and the payment of dividends would not result in default of the Revolving Credit Facility and Stand-alone Letter of Credit Facility. As of July 31, 2011, we were in compliance with the terms and covenants of our Revolving Credit Facility and Stand-alone Letter of Credit Facility.
NOTE 12 — COMMITMENTS AND CONTINGENCIES
     Advertising Purchase Commitments
     As of July 31, 2011, we had obligations to purchase $27.1 million of advertising through the remainder of 2011 and $21.0 million in 2012.
     Product Purchase Commitments
     As of July 31, 2011, we had various commitments to purchase product from certain vendors that are not material to our total inventory purchases.
     Litigation and Settlements
     In January 2011, we were named as a defendant in Pedroza v. PetSmart, Inc., et al., a lawsuit originally filed in California Superior Court for the County of San Bernardino. The case has been removed to the U.S. District Court for the Central District of California. The complaint alleges, purportedly on behalf of current and former exempt store management in California, that we improperly classified our store management as exempt pursuant to the California Labor Code, and as a result failed to: (i) pay or provide to such managers proper wages, overtime compensation, or rest or meal periods, (ii) maintain and provide accurate wage-related statements and records, and (iii) reimburse certain business expenses, in each case as is required by the California Labor Code.
     The lawsuit seeks compensatory damages, statutory penalties and other relief, including liquidated damages, attorneys’ fees, costs and injunctive relief. At this time, we are not able to predict the outcome of this lawsuit, or any possible monetary exposure associated with the lawsuit. Therefore, we have not accrued any liability. We believe, however, that the lawsuit is without merit and that the case should not be certified as a class or collective action, and we are vigorously defending these claims.
     We are involved in the defense of various other legal proceedings that we do not believe are material to our condensed consolidated financial statements.
NOTE 13 — RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
     In June 2011, the Financial Accounting Standards Board, or “FASB,” issued new guidance on the presentation of comprehensive income. The guidance requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. It eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. Additionally, the guidance requires that reclassification adjustments between other comprehensive income and net income be presented on the face of the financial statements, except in the case of foreign currency translation adjustments that are not the result of complete or substantially complete liquidation of an investment in a foreign entity. The amendments in this update are to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We do not expect our adoption of the new guidance to have a material impact on our consolidated financial statements.
     In May 2011, the FASB issued new guidance to achieve common fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. This new guidance amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. This new guidance is to be applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. We do not expect our adoption of the new guidance to impact our consolidated financial statements.

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
     Except for historical information, the following discussion contains forward-looking statements that involve risks and uncertainties. In the normal course of business, our financial position is routinely subjected to a variety of risks, including market risks associated with store expansion, investments in information systems, international expansion, vendor reliability, competitive forces and government regulatory actions. Our actual results could differ materially from projected results due to some or all of the factors discussed below. You should carefully consider the risks and uncertainties described below:
    A decline in consumer spending or a change in consumer preferences could reduce our sales or profitability and harm our business.
    The pet products and services retail industry is very competitive and continued competitive forces may adversely impact our business and financial results.
    Comparable store sales growth may decrease. If we are unable to increase sales at our existing stores, our results of operations could be harmed.
    We may be unable to continue to open new stores and enter new markets successfully. If we are unable to successfully reformat existing stores and open new stores, our results of operations could be harmed. Also, store development may place increasing demands on management and operating systems and may erode sales at existing stores.
    Our quarterly operating results may fluctuate due to seasonal changes associated with the pet products and services retail industry and the timing of expenses, new store openings and store closures.
    Failure to successfully manage and execute our marketing initiatives could have a negative impact on our business.
    A disruption, malfunction or increased costs in the operation, expansion or replenishment of our distribution centers or our supply chain would impact our ability to deliver to our stores or increase our expenses, which could harm our sales and results of operations.
    Failure to successfully manage our inventory could harm our business.
    If our information systems fail to perform as designed or are interrupted for a significant period of time, our business could be harmed.
    If we fail to protect the integrity and security of customer and associate information, we could be exposed to litigation and our business could be adversely impacted.
    The disruption of the relationship with or the loss of any of our key vendors, including our vendors with whom we have exclusive relationships, a decision by our vendors to make their products available in supermarkets or through warehouse clubs and other mass and retail merchandisers, the inability of our vendors to provide quality products in a timely or cost-effective manner, the availability of generic products, or risks associated with the suppliers from whom products are sourced, all could harm our business.
    Our expanded offering of proprietary branded products may not improve our financial performance and may expose us to product liability claims.
    Food safety, quality and health concerns could affect our business.
    We depend on key executives, store managers and other personnel and may not be able to retain or replace these employees or recruit additional qualified personnel, which could harm our business.
    Our international operations may result in additional market risks, which may harm our business.

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    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.
    Failure to successfully integrate any business we acquire could have an adverse impact on our financial results.
    Failure to protect our intellectual property could have a negative impact on our operating results.
    A determination that we are in violation of any contractual obligations or government regulations could result in a disruption to our operations and could impact our financial results.
    Failure of our internal controls over financial reporting could harm our business and financial results.
    Changes in laws, accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial results.
    An unfavorable determination by tax regulators may cause our provision for income and other taxes to be inadequate and may result in a material impact to our financial results.
    Failure to obtain commercial insurance at acceptable prices or failure to adequately reserve for self-insured exposures might have a negative impact on our business.
    Pending legislation, weather, catastrophic events, disease, or other factors, could disrupt our operations, supply chain and the supply of small pets and products we sell, which could harm our reputation and decrease sales.
    Fluctuations in the stock market, as well as general economic and market conditions, may impact our operations, sales, financial results and market price of our common stock.
    Continued volatility and disruption to the global capital and credit markets may adversely affect our ability to access credit and the financial soundness of our suppliers.
    Our operating and financial performance in any given period may differ from the guidance we have provided to the public.
    We have implemented some anti-takeover provisions that may prevent or delay an acquisition of us that may not be beneficial to our shareholders.
     For more information about these risks, see the discussion under the heading “Risk Factors” in our Form 10-K for the year ended January 30, 2011, filed with the Securities and Exchange Commission on March 24, 2011, which is incorporated herein by reference.

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Overview
     Based on our 2010 net sales of $5.7 billion, we are North America’s leading specialty provider of products, services and solutions for the lifetime needs of pets. As of July 31, 2011, we operated 1,197 stores, and we anticipate opening 30 to 40 net new stores during the remainder of 2011. Our stores carry a broad assortment of high-quality pet supplies at everyday low prices. We offer approximately 10,000 distinct items, including nationally recognized brand names, as well as an extensive selection of proprietary brands across a range of product categories.
     We complement our extensive product assortment with a wide selection of pet services, including grooming, training, boarding and day camp. All our stores offer complete pet training services, and virtually all our stores feature pet styling salons that provide high-quality grooming services. Our PetsHotels provide boarding for dogs and cats, which includes 24-hour supervision, an on-call veterinarian, temperature controlled rooms and suites, daily specialty treats and play time, as well as day camp for dogs. As of July 31, 2011, we operated 185 PetsHotels, and we anticipate opening 5 to 9 additional PetsHotels during the remainder of 2011.
     We make full-service veterinary care available through our strategic relationship with certain third-party operators. As of July 31, 2011, 778 of our stores included full service veterinary hospitals. MMI Holdings, Inc., through a wholly owned subsidiary, Medical Management International, Inc., collectively referred to as “Banfield,” operated 769 of the veterinary hospitals under the registered trade name of “Banfield, The Pet Hospital.” The remaining 9 hospitals are operated by other third parties in Canada.
     The principal challenges we face as a business are the highly competitive market in which we operate and the continuing changes in the macro-economy. However, we believe we have a competitive advantage in our solutions for the Total Lifetime CareSM of pets, including pet services and proprietary brands, which we believe cannot easily be duplicated. Additionally, we consider our cash flow from operations and cash on hand to be adequate to meet our operating, investing and financing needs in the foreseeable future, and we continue to have access to our revolving credit facility. We continuously assess the economic environment and market conditions to guide our decisions regarding our uses of cash, including capital expenditures, investments, dividends and share repurchases.
Executive Summary
    Diluted earnings per common share increased 31.7% to $0.54 on net income of $61.2 million, for the thirteen weeks ended July 31, 2011, compared to diluted earnings per common share of $0.41 on net income of $48.4 million for the thirteen weeks ended August 1, 2010. Diluted earnings per common share were $1.15 and $0.87 for the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively.
 
    Net sales increased 7.0% to $1.5 billion for the thirteen weeks ended July 31, 2011, compared to $1.4 billion for the thirteen weeks ended August 1, 2010. The increase in net sales was partially impacted by $5.8 million in favorable foreign currency fluctuations for the thirteen weeks ended July 31, 2011. Net sales increased 6.9% to $3.0 billion for the twenty-six weeks ended July 31, 2011, compared to $2.8 billion for the twenty-six weeks ended August 1, 2010. The increase in net sales was partially impacted by $10.0 million in favorable foreign currency fluctuations for the twenty-six weeks ended July 31, 2011.
 
    Comparable store sales, or sales in stores open at least one year, increased 5.0% for the thirteen and twenty-six weeks ended July 31, 2011, respectively.
 
    Services sales increased 7.6% to $177.9 million for the thirteen weeks ended July 31, 2011, compared to $165.3 million for the thirteen weeks ended August 1, 2010. Services sales increased 8.3% to $345.0 million for the twenty-six weeks ended July 31, 2011, compared to $318.6 million for the twenty-six weeks ended August 1, 2010.
 
    As of July 31, 2011, we had $320.6 million in cash, cash equivalents and restricted cash. We had no short-term debt, and did not borrow against our revolving credit facility during the twenty-six weeks ended July 31, 2011.
 
    We purchased 1.4 million shares of our common stock for $63.0 million during the thirteen weeks ended July 31, 2011. We purchased 3.9 million shares of our common stock for $165.4 million during the twenty-six weeks ended July 31, 2011.
Critical Accounting Policies and Estimates
     We discuss our critical accounting policies and estimates in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended January 30, 2011. We have made no significant change in our critical accounting policies since January 30, 2011.

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Recently Issued Accounting Pronouncements
     See Note 13, Recently Issued Accounting Pronouncements, in the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for a description of recently issued and adopted accounting pronouncements, including the impact to our consolidated financial statements.
Results of Operations
     The following table presents the percent of net sales of certain items included in our Condensed Consolidated Statements of Income and Comprehensive Income:
                                 
    Thirteen Weeks Ended   Twenty-Six Weeks Ended
    July 31, 2011   August 1, 2010   July 31, 2011   August 1, 2010
Net sales
    100.0 %     100.0 %     100.0 %     100.0 %
Total cost of sales
    70.6       71.5       70.5       71.3  
 
                               
Gross profit
    29.4       28.5       29.5       28.7  
Operating, general and administrative expenses
    22.0       21.9       21.7       21.7  
 
                               
Operating income
    7.4       6.6       7.8       7.0  
Interest expense, net
    (1.0 )     (1.0 )     (1.0 )     (1.1 )
 
                               
Income before income tax expense and equity in income from Banfield
    6.5       5.6       6.8       5.9  
Income tax expense
    (2.5 )     (2.2 )     (2.6 )     (2.3 )
Equity in income from Banfield
    0.2       0.2       0.2       0.1  
 
                               
Net income
    4.1 %     3.5 %     4.4 %     3.7 %
 
                               
Thirteen Weeks Ended July 31, 2011, Compared to the Thirteen Weeks Ended August 1, 2010
     Net Sales
     Net sales increased 7.0% to $1.5 billion for the thirteen weeks ended July 31, 2011, compared to $1.4 billion for the thirteen weeks ended August 1, 2010. The increase in net sales was partially impacted by $5.8 million in favorable foreign currency fluctuations for the thirteen weeks ended July 31, 2011. Approximately 70% of the sales increase is due to a 5.0% increase in comparable store sales for the thirteen weeks ended July 31, 2011 and 30% of the sales increase is due to the addition of 33 net new stores and 17 new PetsHotels since August 1, 2010.
     Comparable store sales growth was driven by an increase in comparable transactions and average sales per comparable transaction due to the impact of merchandising strategies, pricing strategies and new product offerings. The impact of comparable transactions and average sales per comparable transaction is summarized below.
                 
    Thirteen Weeks Ended  
    July 31, 2011     August 1, 2010  
Comparable transactions
    2.0 %     0.8 %
Average sales per comparable transaction
    3.0       3.8  
 
           
Total comparable store sales
    5.0 %     4.6 %
 
           
     Services sales, included in the net sales amount discussed above, increased 7.6% or $12.6 million, to $177.9 million for the thirteen weeks ended July 31, 2011, compared to $165.3 million for the thirteen weeks ended August 1, 2010. The increase in services sales, which include grooming, training, boarding and day camp, is primarily due to continued strong demand for our grooming services, improved occupancy in our PetsHotels and the addition of 33 net new stores and 17 new PetsHotels since August 1, 2010.
     Other revenue included in net sales during the thirteen weeks ended July 31, 2011, represents license fees and reimbursements for utilities and specific operating expenses charged to Banfield under the master operating agreement which comprised 0.6% of net sales, or $9.1 million, compared to 0.6% of net sales, or $8.6 million, for the thirteen weeks ended August 1, 2010. See the Related Party Transactions discussion for further information.
     Gross Profit
     Gross profit increased to 29.4% of net sales for the thirteen weeks ended July 31, 2011, from 28.5% for the thirteen weeks ended August 1, 2010, representing an increase of 90 basis points.

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     Overall merchandise margin increased 70 basis points due to a 95 basis point improvement in rate, which was offset by a 25 basis point decline in mix. The rate improvement is the result of increased sales of higher margin goods within the product categories, improvement in shrink and the anniversary of the rawhide and live goods resets during the thirteen weeks ended July 31, 2011, relative to the thirteen weeks ended August 1, 2010. Mix was negatively impacted as the sales growth in our consumables continued to outpace the sales growth of our higher margin hardgoods category.
     Services margin increased 10 basis points primarily due to increased sales and reduced operating costs of our PetsHotels services, as well as a shift to higher margin offerings in our grooming services.
     Store occupancy and supply chain costs included in margin each provided 5 basis points of leverage associated with the increase in net sales.
     Operating, General and Administrative Expenses
     Operating, general and administrative expenses increased 10 basis points to 22.0% of net sales for the thirteen weeks ended July 31, 2011, compared to 21.9% of net sales for the thirteen weeks ended August 1, 2010.
     Operating, general and administrative expenses increased on a dollar basis by $22.4 million. The primary reasons for the year over year increase include store growth, planned incremental advertising spend focused on our differentiated offerings and higher benefit costs.
     Interest Expense, net
     Interest expense, which is primarily related to capital lease obligations, was $14.5 million during the thirteen weeks ended July 31, 2011, compared to $14.8 million for the thirteen weeks ended August 1, 2010. Included in interest expense, net was interest income of $0.2 million for both the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively.
     Income Tax Expense
     For the thirteen weeks ended July 31, 2011, the $37.6 million income tax expense represents an effective tax rate of 39.2% compared with the thirteen weeks ended August 1, 2010, when we had income tax expense of $31.2 million, which represented an effective tax rate of 40.2%. The decrease in the effective tax rate was primarily due to decreases 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 in income from Banfield, by income before income tax expense and equity in income from Banfield.
     Equity in Income from Banfield
     Our equity in income from our investment in Banfield was $2.8 million and $2.1 million for the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively, based on our ownership percentage in Banfield’s net income.
Twenty-Six Weeks Ended July 31, 2011, Compared to the Twenty-Six Weeks Ended August 1, 2010
     Net Sales
     Net sales increased 6.9% to $3.0 billion for the twenty-six weeks ended July 31, 2011, compared to $2.8 billion for the twenty-six weeks ended August 1, 2010. The increase in net sales was partially impacted by $10.0 million in favorable foreign currency fluctuations for the twenty-six weeks ended July 31, 2011. Approximately 70% of the sales increase is due to a 5.0% increase in comparable store sales for the twenty-six weeks ended July 31, 2011 and 30% of the sales increase is due to the addition of 33 net new stores and 17 new PetsHotels since August 1, 2010.
     Comparable store sales growth was driven by an increase in comparable transactions and average sales per comparable transaction due to the impact of merchandising strategies, pricing strategies and new product offerings. The impact from comparable transactions and average sales per comparable transaction is summarized below.

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    Twenty-six Weeks Ended  
    July 31, 2011     August 1, 2010  
Comparable transactions
    2.4 %     0.2 %
Average sales per comparable transaction
    2.6       3.5  
 
           
Total comparable store sales
    5.0 %     3.7 %
 
           
     Services sales, included in the net sales amount discussed above, increased 8.3%, or $26.4 million, to $345.0 million for the twenty-six weeks ended July 31, 2011, compared to $318.6 million for the twenty-six weeks ended August 1, 2010. The increase in services sales, which include grooming, training, boarding and day camp, is primarily due to continued strong demand for our grooming services, improved occupancy in our PetsHotels and the addition of 33 net new stores and 17 new PetsHotels since August 1, 2010.
     Other revenue included in net sales during the twenty-six weeks ended July 31, 2011, represents license fees and reimbursements for utilities and specific operating expenses charged to Banfield under the master operating agreement which comprised 0.6% of net sales, or $18.1 million, compared to 0.6% of net sales, or $16.8 million, for the twenty-six weeks ended August 1, 2010. See the Related Party Transactions discussion for further information.
     Gross Profit
     Gross profit increased 80 basis points to 29.5% of net sales for the twenty-six weeks ended July 31, 2011, from 28.7% for the twenty-six weeks ended August 1, 2010.
     Overall merchandise margin increased 50 basis points due to a 60 basis point improvement in rate, which was offset by a 10 basis point decline in mix. The rate improvement is the result of increased sales of higher margin goods within the product categories and improvement in shrink during the twenty-six weeks ended July 31, 2011, relative to the twenty-six weeks ended August 1, 2010. Mix was negatively impacted as the sales growth in our consumables continued to outpace the sales growth of our higher margin hardgoods category.
     Services margin increased 10 basis points primarily due to increased sales and reduced operating costs of our PetsHotels services as well as a shift to higher margin offerings in our grooming services.
     Store occupancy costs included in margin provided 20 basis points due to leverage associated with the increase in net sales.
     Supply chain costs included in margin were flat during the twenty-six weeks ended July 31, 2011, compared to the twenty-six weeks ended August 1, 2010.
     Operating, General and Administrative Expenses
     Operating, general and administrative expenses as a percentage of net sales remained flat at 21.7% for the twenty-six weeks ended July 31, 2011, and August 1, 2010.
     Operating, general and administrative expenses increased on a dollar basis by $41.1 million. The primary reasons for the year over year increase include store growth, planned incremental advertising spend focused on our differentiated offerings and higher benefit costs.
     Interest Expense, net
     Interest expense, which is primarily related to capital lease obligations, was $29.3 million during the twenty-six weeks ended July 31, 2011, compared to $30.2 million for the twenty-six weeks ended August 1, 2010. Included in interest expense, net was interest income of $0.6 million and $0.3 million for the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively.
     Income Tax Expense
     For the twenty-six weeks ended July 31, 2011, the $76.5 million income tax expense represents an effective tax rate of 37.7% compared with the twenty-six weeks ended August 1, 2010, when we had income tax expense of $64.9 million, which represented an effective tax rate of 39.3%. The decrease in the effective tax rate was primarily due to a tax deductible dividend received from Banfield.

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The effective tax rate is calculated by dividing our income tax expense, which includes the income tax expense related to our equity in income from Banfield, by income before income tax expense and equity in income from Banfield.
     Equity in Income from Banfield
     Our equity in income from our investment in Banfield was $5.4 million and $3.6 million for the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively, based on our ownership percentage in Banfield’s net income.
Liquidity and Capital Resources
     Cash Flow
     We believe that our operating cash flow and cash on hand will be adequate to meet our operating, investing and financing needs in the foreseeable future. In addition, we also have access to our revolving credit facility, although there can be no assurance of our ability to access these markets on commercially acceptable terms in the future. We expect to continuously assess the economic environment and market conditions to guide our decisions regarding our uses of cash, including capital expenditures, investments, dividends and the purchase of common stock.
     We finance our operations, new store and PetsHotel growth, store remodels and other expenditures to support our growth initiatives primarily through cash generated by operating activities. Receipts from our sales come from cash, checks and third-party debit and credit cards, and therefore provide a significant source of liquidity. Cash is used in operating activities primarily to fund procurement of merchandise inventories and other assets, net of accounts payable and other accrued liabilities. Cash provided by operating activities was $205.2 million for the twenty-six weeks ended July 31, 2011, compared to $128.4 million for the twenty-six weeks ended August 1, 2010. The primary differences between the twenty-six weeks ended July 31, 2011, and August 1, 2010, include increased income, a decrease in purchases of merchandise inventories and the $16.0 million dividend received from Banfield in 2011 as no dividends were received in 2010.
     Cash used in investing activities consisted primarily of expenditures associated with opening new stores, reformatting existing stores, expenditures associated with equipment and computer software in support of our system initiatives, PetsHotel construction costs, and other expenditures to support our growth plans and initiatives. Cash used in investing activities was $62.6 million for the twenty-six weeks ended July 31, 2011, compared to $53.1 million for the twenty-six weeks ended August 1, 2010. The primary difference between the twenty-six weeks ended July 31, 2011, and August 1, 2010, was purchases of investments.
     Net cash used in financing activities was $177.7 million for the twenty-six weeks ended July 31, 2011, and consisted primarily of the cash paid for treasury stock, payments of cash dividends, payments on capital lease obligations, offset by net proceeds from common stock issued under equity incentive plans and an increase in our bank overdraft. Net cash used in financing activities for the twenty-six weeks ended August 1, 2010, was $145.1 million. The primary difference between the twenty-six weeks ended July 31, 2011, and the twenty-six weeks ended August 1, 2010, was an increase in cash paid for treasury stock.
Operating Capital and Capital Expenditure Requirements
     Substantially all our stores are leased facilities. We opened 13 new stores and closed 3 stores in the twenty-six weeks ended July 31, 2011. Generally, each new store requires capital expenditures of approximately $1.1 million for fixtures, equipment and leasehold improvements, approximately $0.3 million for inventory and approximately $0.1 million for preopening costs. We expect total capital spending to be $130 million to $140 million for 2011, based on our plan to open 40 to 50 net new stores and 10 to 15 new PetsHotels, continuing our investment in the development of our information systems, adding to our services capacity with the expansion of certain grooming salons, remodeling or replacing certain store assets and continuing our store refresh program.
     Our ability to fund our operations and make planned capital expenditures depends on our future operating performance and cash flow, which are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond our control.

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     The following table presents our capital expenditures (in thousands):
                 
    Twenty-six Weeks Ended  
    July 31, 2011     August 1, 2010  
Capital Expenditures:
               
New stores .
  $ 13,861     $ 16,809  
Store-related projects(1)
    15,421       19,690  
PetsHotel(2)
    1,579       4,240  
Information technology
    17,513       10,239  
Supply chain
    2,588       3,651  
Other
    224       219  
 
           
Total capital expenditures
  $ 51,186     $ 54,848  
 
           
 
(1)   Includes store remodels, grooming salon expansion, equipment replacement, relocations, and various merchandising projects.
 
(2)   For new and existing stores.
Commitments
     As of July 31, 2011, we had obligations to purchase $27.1 million of advertising through the remainder of 2011 and $21.0 million in 2012.
     As of July 31, 2011, we had various commitments to purchase product from certain vendors that are not material to our total inventory purchases.
     There have been no other material changes in our contractual obligations since January 30, 2011. Information regarding our contractual obligations is provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended January 30, 2011.
Credit Facilities
     Effective April 22, 2011, we decreased the aggregate commitment amount under our $350.0 million revolving credit facility, or “Revolving Credit Facility,” to $100.0 million. We elected to reduce the Revolving Credit Facility as we do not anticipate borrowings, if any, in excess of $100.0 million, which allows us to avoid stand-by costs related to the excess commitment amount. This Revolving Credit Facility expires on August 15, 2012. Borrowings under the Revolving Credit Facility are subject to a borrowing base and bear interest, at our option, at the bank’s prime rate plus 0% to 0.25% or LIBOR plus 0.875% to 1.25%. We are subject to fees payable to lenders each quarter at an annual rate of 0.20% of the unused amount of the Revolving Credit Facility. The Revolving Credit Facility also gives us the ability to issue letters of credit, which reduce the amount available under the Revolving Credit Facility. Letter of credit issuances under the Revolving Credit Facility are subject to interest payable to the lenders and bear interest of 0.875% to 1.25% for stand-by letters of credit or 0.438% to 0.625% for commercial letters of credit.
     We had no borrowings and $31.6 million in stand-by letter of credit issuances outstanding under our Revolving Credit Facility as of July 31, 2011, and January 30, 2011, and as of August 1, 2010, we had no borrowings and $37.2 million in stand-by letter of credit issuances outstanding.
     We also have a $100.0 million stand-alone letter of credit facility, or “Stand-alone Letter of Credit Facility,” that expires August 15, 2012. We are subject to fees payable to the lender each quarter at an annual rate of 0.45% of the average daily face amount of the letters of credit outstanding during the preceding calendar quarter. In addition, we are required to maintain a cash deposit with the lender equal to the amount of outstanding letters of credit or we may use other approved investments as collateral. If we use other approved investments as collateral, we must have an amount on deposit which, when multiplied by the advance rate of 85%, is equal to the amount of the outstanding letters of credit under the Stand-alone Letter of Credit Facility. As of July 31, 2011, and January 30, 2011, we had $61.4 million in outstanding letters of credit under the Stand-alone Letter of Credit Facility and $61.4 million in restricted cash on

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deposit with the lender. As of August 1, 2010, we had $46.5 million in outstanding letters of credit under the Stand-alone Letter of Credit Facility and $46.5 million in restricted cash on deposit with the lender.
     Our Revolving Credit Facility and Stand-alone Letter of Credit Facility permit the payment of dividends if we are not in default and the payment of dividends would not result in default of the Revolving Credit Facility and Stand-alone Letter of Credit Facility. As of July 31, 2011, we were in compliance with the terms and covenants of our Revolving Credit Facility and Stand-alone Letter of Credit Facility. Our Revolving Credit Facility and Stand-alone Letter of Credit Facility are secured by substantially all our personal property assets, our subsidiaries and certain real property.
Dividends
     We believe our ability to generate cash allows us to invest in the growth of our business and, at the same time, distribute a quarterly dividend.
     During the twenty-six weeks ended July 31, 2011, the Board of Directors declared the following dividends:
                         
Date   Dividend Amount     Stockholders of        
Declared   per Share     Record Date     Payment Date  
March 23, 2011
  $ 0.125     April 29, 2011   May 13, 2011
June 15, 2011
  $ 0.14     July 29, 2011   August 12, 2011
Share Purchase Program
     In June 2009, the Board of Directors approved a share purchase program authorizing the purchase of up to $350.0 million of our common stock through January 29, 2012. During the thirteen weeks ended May 2, 2010, we purchased 3.4 million shares of common stock for $107.1 million under this $350.0 million program.
     In June 2010, the Board of Directors approved a share purchase program authorizing the purchase of up to $400.0 million of our common stock through January 29, 2012, replacing the $350.0 million program. During the thirteen weeks ended July 31, 2011, we purchased 1.4 million shares of common stock for $63.0 million under the $400.0 million program. During the twenty-six weeks ended July 31, 2011, we purchased 3.9 million shares of common stock for $165.4 million under the $400.0 million program. Since the inception of the share purchase authorization in June 2010, we purchased 8.1 million shares of common stock for $321.6 million.
     In June 2011, the Board of Directors approved a share purchase program authorizing the purchase of up to $450.0 million of our common stock through January 31, 2013, replacing the $400.0 million program, effective August 1, 2011.
Related Party Transactions
     We have an investment in Banfield, who through a wholly owned subsidiary, Medical Management International, Inc., operates full-service veterinary hospitals in 769 of our stores. Our investment consists of common and preferred stock. As of July 31, 2011, we owned 21.4% of the voting stock and 21.0% of the combined voting and non-voting stock of Banfield.
     Our equity in income from our investment in Banfield, which is recorded one month in arrears under the equity method of accounting, was $2.8 million and $2.1 million for the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively, and $5.4 million and $3.6 million for the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively. During the twenty-six weeks ended July 31, 2011, we received a dividend from Banfield of $16.0 million.
     We recognized license fees and reimbursements for specific operating expenses from Banfield of $9.1 million and $8.6 million during the thirteen weeks ended July 31, 2011, and August 1, 2010, respectively, and $18.1 million and $16.8 million during the twenty-six weeks ended July 31, 2011, and August 1, 2010, respectively, in other revenue on the Condensed Consolidated Statements of Income and Comprehensive Income. The related costs are included in cost of other revenue in the Condensed Consolidated Statements of Income and Comprehensive Income. Receivables from Banfield totaled $3.1 million, $2.7 million and $3.0 million at July 31, 2011, January 30, 2011, and August 1, 2010, respectively, and were included in receivables, net in the Condensed Consolidated Balance Sheets.

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     The master operating agreement also includes a provision for the sharing of profits on the sale of therapeutic pet foods sold in all stores with an operating Banfield hospital. The net sales and gross profit on the sale of therapeutic pet food are not material to our condensed consolidated financial statements.
Seasonality and Inflation
     Our business is subject to seasonal fluctuations. We typically realize a higher portion of our net sales and operating profits during the fourth quarter due to increased holiday traffic. As a result of this seasonality, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of future performance. Controllable expenses could fluctuate from quarter-to-quarter in a year. Since our stores typically draw customers from a large trade area, sales also may be impacted by adverse weather or travel conditions, which are more prevalent during certain seasons of the year. As a result of our expansion plans, the timing of new store and PetsHotel openings and related preopening costs, the amount of revenue contributed by new and existing stores and PetsHotels and the timing and estimated obligations of store closures, our quarterly results of operations may fluctuate. Finally, because new stores tend to experience higher payroll, advertising and other store level expenses as a percentage of sales than mature stores, new store openings will also contribute to lower store operating margins until these stores become established. We expense preopening costs associated with each new location as the costs are incurred.
     While we have experienced inflationary pressure in recent years, we have been able to largely mitigate the effect by increasing retail prices accordingly. Although neither inflation nor deflation has had a material impact on net operating results, we can make no assurance that our business will not be affected by inflation or deflation in the future.
Impact of Federal Health Care Reform Legislation
     In March 2010, the President of the United States signed into law the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, or “the Acts.” The provisions of the Acts are not expected to have a significant impact to our condensed consolidated financial statements in the short term. The longer term potential impacts of the Acts to our business and the condensed consolidated financial statements are currently uncertain. We will continue to assess the impact of the Acts on our health plan.
Item 3. Quantitative and Qualitative Disclosures About Market Risks
     As of July 31, 2011, there have been no material changes in the market risk information disclosed by us in our Annual Report on Form 10-K for the year ended January 30, 2011. More detailed information concerning market risk can be found in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the year ended January 30, 2011.
Item 4. Controls and Procedures
     Management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of July 31, 2011. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
     No changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the thirteen weeks ended July 31, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on the evaluation of our disclosure controls and procedures as of July 31, 2011, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level and designed to meet the objective at the reasonable assurance level.

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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
     In January 2011, we were named as a defendant in Pedroza v. PetSmart, Inc., et al., a lawsuit originally filed in California Superior Court for the County of San Bernardino. The case has been removed to the U.S. District Court for the Central District of California. The complaint alleges, purportedly on behalf of current and former exempt store management in California, that we improperly classified our store management as exempt pursuant to the California Labor Code, and as a result failed to: (i) pay or provide to such managers proper wages, overtime compensation, or rest or meal periods, (ii) maintain and provide accurate wage-related statements and records, and (iii) reimburse certain business expenses, in each case as is required by the California Labor Code.
     The lawsuit seeks compensatory damages, statutory penalties and other relief, including liquidated damages, attorneys’ fees, costs and injunctive relief. At this time, we are not able to predict the outcome of this lawsuit, or any possible monetary exposure associated with the lawsuit. Therefore, we have not accrued any liability. We believe, however, that the lawsuit is without merit and that the case should not be certified as a class or collective action, and we are vigorously defending these claims.
     We are involved in the defense of various other legal proceedings that we do not believe are material to our condensed consolidated financial statements.
Item 1A. Risk Factors
     In addition to the other information in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended January 30, 2011, which could materially affect our business, financial condition or future results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
     The following table shows purchases of our common stock and the available funds to purchase additional common stock for each period in the thirteen weeks ended July 31, 2011:
                                 
                    Total Number of    
    Total           Shares   Value That May
    Number           Purchased as Part of   Yet be Purchased
    of Shares   Average Price   Publicly Announced   Under the Plans or
Period   Purchased   Paid per Share   Plans or Programs   Programs(1)
May 2, 2011 to May 29, 2011
    275,395     $ 45.09       275,395     $ 128,935,000  
May 30, 2011 to July 3, 2011
    1,145,662     $ 44.11       1,145,662     $ 78,395,000  
July 4, 2011 to July 31, 2011
                    $ 78,395,000  
 
                               
Thirteen Weeks Ended July 31, 2011
    1,421,057     $ 44.30       1,421,057     $ 78,395,000  
 
(1)   In June 2011, the Board of Directors approved a share purchase program authorizing the purchase of up to $450.0 million of our common stock through January 31, 2013, replacing the previously authorized $400.0 million program, effective August 1, 2011.
Item 6. Exhibits
(a) Exhibits
     
Exhibit 10.1
  PetSmart 2011 Equity Incentive Plan(1)
 
   
Exhibit 10.2
  Form of Nonstatutory Stock Option Agreement for 2011 Equity Incentive Plan(2)
 
   
Exhibit 10.3
  Form of Restricted Stock Agreement for 2011 Equity Incentive Plan(3)
 
   
Exhibit 10.4
  Form of Performance Share Unit Grant Notice and Performance Share Unit Agreement for 2011 Equity Incentive Plan(4)
 
   
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.

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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.
 
**   In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
 
(1)   Incorporated by reference to Appendix A to PetSmart’s definitive proxy statement on Schedule 14A filed with the Securities and Exchange Commission on May 2, 2011.
 
(2)   Incorporated by reference to Exhibit 10.2 to PetSmart’s Current Report on Form 8-K (File No. 0-21888), filed with the Securities and Exchange Commission on June 17, 2011.
 
(3)   Incorporated by reference to Exhibit 10.3 to PetSmart’s Current Report on Form 8-K (File No. 0-21888), filed with the Securities and Exchange Commission on June 17, 2011.
 
(4)   Incorporated by reference to Exhibit 10.4 to PetSmart’s Current Report on Form 8-K (File No. 0-21888), filed with the Securities and Exchange Commission on June 17, 2011.

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SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  PetSmart, Inc.
(Registrant)
 
 
  /s/ Lawrence P. Molloy    
Date: August 25, 2011  Lawrence P. Molloy
Senior Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer) 
 

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