Petsmart 2007 Annual Report Download - page 37

Interest Expense
Interest expense increased to $51.5 million for 2007 compared to $42.3 million for 2006. The increase is
primarily attributable to continued increases in capital lease obligations and new bank borrowings during 2007 to
fund a portion of the ASR.
Income Tax Expense
In 2007, the $145.2 million income tax expense represents an effective tax rate of 36.1%, compared with 2006
income tax expense of $105.0 million, which represents an effective tax rate of 36.2%.
The effective rate for 2007 includes a benefit from the use of capital loss carryforwards to reduce the tax on the
gain from the sale of MMIH non-voting shares and benefits from the release of uncertain tax positions as a result of
settlements with taxing authorities and from the expiration of the statute of limitations for certain tax positions. The
effective rate for 2006 includes the settlement of an audit with the Internal Revenue Service and tax benefits
primarily due to the expiration of the statute of limitations for certain tax positions and additional federal and state
tax credits.
2006 (52 weeks) compared to 2005 (52 weeks)
Net Sales
Net sales for 2006 increased $473.4 million, or 12.6%, to $4.2 billion, compared to net sales of $3.8 billion in
2005, due to the addition of 82 net new stores and a 5.0% increase in comparable store sales for 2006. Our
comparable store sales growth was 4.2% for 2005. We believe the increase in our comparable store sales growth rate
during 2006 as compared to 2005 was due to general economic conditions. Our 2005 results were also impacted by a
dramatic increase in fuel prices which affected consumer spending. In addition, we lost 437 days of sales from
temporary store closures due to the effect of hurricanes in the third quarter of 2005.
Services sales increased by 25.8%, or $77.2 million, to $376.0 million. This increase was primarily due to
continued strong demand for our grooming and training services as well as the addition of 30 new PetsHotels during
2006.
Gross Profit
Gross profit decreased to 30.9% of net sales for 2006 from 31.2% for 2005.
Services sales increased as a percentage of net sales. Services sales generate lower gross margins than product
sales as we include service-related labor in cost of sales in the Consolidated Statements of Operations and
Comprehensive Income; however, services generate higher operating margins than product sales. In addition, we
opened 30 PetsHotels in fiscal 2006 compared to 16 in 2005. PetsHotels have higher costs as a percentage of
revenue in the first several years.
We also experienced higher redemptions of promotional offers in our PetPerks program, which are recorded as
a reduction in sales, in 2006 compared to 2005.
Also contributing to the gross profit percentage decline was a revision of our early pay discounts recognition
policy. Historically, discounts were recognized as they were taken against payments. Under our revised policy,
discounts are recorded as a reduction of inventory and recognized as a reduction in cost of sales as inventory is sold.
We recorded a $3.9 million charge in the second quarter of 2006 for this change.
We also incurred approximately $3.6 million additional expense in the second and third quarter of 2006 as well
as a shift in mix from higher margin hard-goods towards consumables primarily in the second quarter of 2006 as we
worked through an unplanned re-racking project in our Phoenix distribution center. In addition, we had some higher
costs in our supply chain to increase service levels to our stores during the holiday season.
These negative margin impacts were partially offset by continued positive results from improved buying
practices and pricing initiatives. In addition, 2005 included charges to increase our inventory obsolescence reserve,
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