Petsmart 2007 Annual Report Download - page 36

margins than merchandise sales. We also opened 35 PetsHotels in 2007 compared to 30 in fiscal 2006. PetsHotels
have higher costs as a percentage of net sales in the first several years.
These decreases in the gross profit percentages were partially offset by improvements in merchandise margins.
Merchandise margins continued to benefit from pricing initiatives, partially offset by a change in product mix.
Hardgood sales, which generally have higher gross margins than consumable merchandise, grew at a slower rate
than consumable sales.
In 2007, we entered into a new master operating agreement with MMIH that has an initial 15-year term and has
resulted in higher license fees. We charge MMIH license fees for the space used by the veterinary hospitals and for
their portion of utilities costs. We treat these amounts as a reduction of the retail stores’ occupancy costs, which are
included as a component of cost of sales in the Consolidated Statements of Operations and Comprehensive Income.
We also charge MMIH for its portion of specific operating expenses and treat the reimbursement as a reduction of
the stores’ operating expense.
Operating, General and Administrative Expenses
Operating, general and administrative expenses decreased as a percentage of net sales to 23.2% for 2007 from
23.3% for 2006.
During 2007, we experienced lower expense for general liability and health insurance compared to 2006 due to
lower average claims during the year. The improvements in claim activity resulted in a smaller increase in the
actuarial assessments of our required reserves than in the prior year. In addition, bonus expense decreased in 2007.
We also recognized $6.0 million of gift card breakage income in 2007. Gift card breakage income is
recognized based upon historical redemption patterns and represents the balance of gift cards for which we believe
the likelihood of redemption by the customer is remote. During 2007, we obtained sufficient historical redemption
data for our gift card program to make a reasonable estimate of the ultimate redemption patterns and breakage rate.
Fiscal 2007 was the first year in which we recognized gift card breakage income.
In addition, expenses decreased in our e-commerce business due to the exit of our equine product line. This
business, which has higher operating expenses as a percentage of net sales, decreased as a percentage of total sales.
These expense decreases were offset by expenses incurred to exit our equine product line and by higher
corporate payroll and other expenses. The expenses to exit the equine product line included accelerated depreciation
of assets, severance and costs to remerchandise the equine sections of our stores. Corporate payroll and other
expenses continued to increase as our revenue growth slowed.
Gain on Sale of Investment and Equity in Income from Investee
During the first quarter of 2007, we sold a portion of our non-voting shares in MMIH resulting in a pre-tax gain
of $95.4 million. In connection with this transaction, we also converted our remaining MMIH non-voting shares to
voting shares. The increase in voting shares caused us to exceed the significant influence threshold as defined by
GAAP, which required us to account for our investment in MMIH using the equity method of accounting instead of
the previously applied cost method in accordance with APB No. 18.
Conversion to the equity method of accounting would typically require a restatement of prior years’
consolidated financial statements for the MMIH earnings. However, since the amounts are not material, we have
not restated prior year financial statements.
Interest Income
Interest income decreased to $6.8 million for 2007 compared to $10.6 million for 2006, primarily due to lower
average investments in auction rate securities during the year, partially due to our use of available cash to fund a
portion of the ASR. As of February 3, 2008, we had no investments in auction rate securities.
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