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Building a Powerful Brand
PETsMART, Inc. 2003 Annual Report

Table of contents

  • Page 1
    Building a Powerful Brand PETsMART, Inc. 2003 Annual Report

  • Page 2
    ... and Canada, as well as a large pet supply catalog business and the Internet's leading online provider of pet products and information (www.petsmart.com). PETsMART provides a broad range of competitively priced pet food and supplies, and offers complete pet training, grooming and adoption services.

  • Page 3
    FINANCIAL HIGHLIGHTS (In thousands, except margins and per-share amounts) 2003 2002 2001 TO TA L R E S U LT S N ET S ALES G ROSS M ARGIN N ET I NCOME E ARNINGS P ER S HARE O PERATING C ASH F LOW TOTAL D EBT $ $ $ $ $ 2,996,051 $ 2,695,184 $ 2,501,012 30.4% 139,549 0.95 246,433 170,702 $ $ $ $ ...

  • Page 4
    ...60 markets. In 2004, we will open 90 net new stores, adding up to annual square footage growth of about 12 percent. We completed reformats of virtually every store in the chain, changing the shopping experience in ways that matter to our customer, driving returns and further differentiating PETsMART...

  • Page 5
    ... Operating Officer Philip L. Francis Chairman and Chief Executive Officer At PETsMART, taking care of pets is who we are. From our educated and caring associates, to our customer-friendly stores, to our powerful blend of pet services-PETsMART is the place for the Total Lifetime Careâ„¢ of pets...

  • Page 6
    ... business and reinforce PETsMART's position as the destination for the Total Lifetime Care for pets. "When it comes to customer relationships, our associates are our most powerful asset." In addition to all we've accomplished and all that's ahead, I'd like to point out the lives saved through...

  • Page 7

  • Page 8
    ...Who we are in the eyes, minds and hearts of our customers Our customers tell us they choose PETsMART because they trust us. They trust us to offer the best products, services and solutions for the lifetime needs of pets. And, they trust us to do what's right by all pets-whether pampered or homeless.

  • Page 9

  • Page 10
    ... a new level of boarding, â„¢ The day care and Doggy Day Camp. PETsHOTEL gives us another powerful dimension to the brand by expanding our ability to provide Total Lifetime Care for pets. And, it gives us another opportunity to drive traffic to other services, such as grooming. keeps our customers...

  • Page 11

  • Page 12
    ... adoption programs have saved the lives of more than 1.7 million homeless pets. the heart of our brand. And, it's one reason our customers pass up the competition to come to our stores. More than 1.7 million pets have found homes through PETsMART Charities Adoption Centers. We're using advertising...

  • Page 13

  • Page 14
    ...committee member roles and responsibilities. Philip L. Francis Chairman and Chief Executive Officer • PETsMART has a clear code of business ethics and policies. • PETsMART has complaint procedures in place for both associates and others. • The internal audit department of PETsMART reviews key...

  • Page 15
    ...AT I O N Corporate Offices 19601 North 27th Avenue Phoenix, AZ 85027 (623) 580-6100 Transfer Agent and Registrar Wells Fargo Bank, N.A. Wells Fargo Shareowner Services P.O. Box 64854 St. Paul, MN 55164-0854 www.wellsfargo.com/com/shareowner_services Independent Accountants Deloitte & Touche LLP 2901...

  • Page 16
    19 6 0 1 N O R T H 27TH AV E N U E PHOENIX, AZ 85027 6 2 3-5 8 0-6 1 0 0 W W W . P E T S M A R T. C O M

  • Page 17
    ...deÃ'ned in Exchange Act Rule 12b-2). Yes Â¥ No n The aggregate market value of the common stock held by non-aÇliates of the registrant, based on the closing sale price of the Registrant's Common Stock on August 3, 2003, the last business day of the Registrant's most recently completed second Ã'scal...

  • Page 18
    ...Registrant Executive Compensation Security Ownership of Certain BeneÃ'cial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions Principal Accountant Fees and Services PART IV Exhibits, Financial Statement Schedules, and Reports on Form 8-K 1 13...

  • Page 19
    ... new management information systems, focused on developing our pet services business, and worked to develop a culture of customer service. In addition, we completed the reformatting of our stores in 2003. Our new store design creates a specialty store environment by organizing store layout by pet...

  • Page 20
    ...changes designed to attract new customers and promote lifetime loyalty. Expand our pet services business. Based on sales, we are the leading provider of professional grooming and pet training services. Pet services are an integral part of our strategy, and we are focused on driving proÃ'table growth...

  • Page 21
    ... systems, drive reduced store inventory and transportation costs, more eÇcient use of store labor, improved in-stock positions, and better distribution center productivity. We operate the following distribution centers: Location Square Footage Date Opened Distribution Type Brockport, New...

  • Page 22
    ..., shampoos, medication, toys, pet carriers, doghouses, cat furniture, and equestrian supplies. We also oÃ...er a complete line of supplies for Ã'sh, birds, and small pets. These products include aquariums, Ã'lters, birdcages, and small pet supplies. In certain stores, we have an equine department that...

  • Page 23
    ... sale of live pets, self-insured health plans, and worker compensation insurance. Property insurance covers approximately $948.7 million in buildings and contents, including furniture and Ã'xtures, leasehold improvements, and inventory. Under our casualty and workers compensation insurance policies...

  • Page 24
    ... and Exchange Commission. Business Risks In the normal course of business, our Ã'nancial 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...

  • Page 25
    ...distribution, merchandise planning and replenishment functions, and to maintain our in-stock positions. Our information systems are centrally located at our headquarters in Phoenix, Arizona, and we possess oÃ...site redundancy capabilities. The failure of our information systems to perform as designed...

  • Page 26
    ..., could harm our business. We have no long-term supply commitments from our vendors. We buy from several hundred vendors worldwide and, together, our two largest vendors accounted for approximately 16.2% of our total sales for Ã'scal 2003. Sales of premium pet food for dogs and cats comprise a signi...

  • Page 27
    ... exchange rates; ‚ Changes in international staÇng and employment issues; ‚ TariÃ... and other trade barriers; ‚ The burden of complying with foreign laws, including tax laws; and ‚ Political and economic instability and developments. Our business may be harmed if the operation of veterinary...

  • Page 28
    ...diseases from pets in our stores to associates and customers. In addition, from time to time, we have been subject to product liability claims for some of the products we sell. Any negative publicity or claims relating to any of the foregoing could harm our reputation and business, as well as expose...

  • Page 29
    ...President, Store Operations Senior Vice President, Chief Marketing OÇcer Senior Vice President, Chief Information OÇcer Senior Vice President, Chief Financial OÇcer Senior Vice President, Services, Strategic Planning and Business Development Vice President, Controller, and Chief Accounting OÇcer...

  • Page 30
    ... served as Director of Systems and Logistics at Salinas y Rocha, in Mexico City. Prior to that, Mr. King held positions at Datamerica Corporation, Tymshare, Inc., and Boeing Computer Services, Inc. He was also the President and owner of two software and information system consulting Ã'rms, KingTec...

  • Page 31
    ... Stores Alabama Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New...

  • Page 32
    ... Rhode Island South Carolina Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Total U.S. stores Canada Total North America stores 22 23 8 7 22 1 7 10 58 8 1 22 16 1 3 622 21 643 We lease substantially all of our stores, retail distribution centers, corporate...

  • Page 33
    ...SFAS No. 13, ""Accounting for Leases.'' As a result, we recognized capital lease assets and related obligations of approximately $10.7 million upon execution of the lease agreements. One of the buildings and the related land for all seven stores are classiÃ'ed as operating leases. These transactions...

  • Page 34
    ..., and veterinary care. We continue to invest in training for our approximately 26,500 associates as part of our on-going cultural shift with an emphasis on customer service and providing pet solutions. In 2004, we expect to open approximately 90 new stores, net of store closures. Critical Accounting...

  • Page 35
    ... sale of live pets, self-insured health plans, and worker compensation insurance. Property insurance covers approximately $948.7 million in buildings and contents, including furniture and Ã'xtures, leasehold improvements, and inventory. Under our casualty and workers compensation insurance policies...

  • Page 36
    ... store sales. Included in store sale, services sales increased by 25.4%, or $39.2 million. The increase in services revenue, which includes grooming, training, and PETsHOTEL operations, was due primarily to higher volume. The increases were partially oÃ...set by a decrease in direct marketing channel...

  • Page 37
    ... we opened 25 new stores, relocated two stores and closed four stores. The increase in services revenue, which includes grooming, training and our PETsHOTEL operations, was due primarily to increased traÇc. The decrease in revenue from direct marketing channels was from lower pet catalog sales, due...

  • Page 38
    ... related to litigation costs, and $0.7 million for other asset write downs. We also recorded cash proceeds of $17.0 million associated with a vendor resolution, totaling net charges of $12.8 million. These charges represented 0.5% of sales. In 2002, the reductions in our direct marketing channels...

  • Page 39
    ... was primarily due to new store growth, completion of the store reformatting initiatives, purchase of a corporate aircraft, and equipment and computer software in support of our systems initiatives. In January 2002, we acquired all the remaining shares held by PETsMART.com minority stockholders for...

  • Page 40
    ...2004), as well as the planned opening of additional stores in existing markets, which may diminish sales of existing stores, we anticipate that comparable store sales increases may be lower in future periods. As a result of our expansion plans, we anticipate the timing of new store openings, related...

  • Page 41
    ... an investment in MMI Holdings, Inc., or MMIH, a provider of veterinary and other pet-related services. MMIH, through a wholly owned subsidiary, Medical Management International, Inc., or MMI, operates full-service veterinary hospitals and wellness hospitals inside over half our stores, under the...

  • Page 42
    ... from transactions in the normal course of our business. Such risk is principally associated with interest rate and foreign exchange Ã-uctuations, as well as changes in our credit standing. In addition, a market risk exists associated with the current fuel price. We are assessing the impact the fuel...

  • Page 43
    ...2004. The required information concerning our executive oÇcers is contained in Item 1, Part 1 of this Annual Report on Form 10-K. All PETsMART associates must act ethically at all times and in accordance with the policies comprising the PETsMART Code of Business Ethics and Policies. We require full...

  • Page 44
    ...this Annual Report or which are incorporated herein by reference are set forth in the Exhibit Index on page E-1. (b) Reports on Form 8-K. PETsMART furnished a current Report on Form 8-K, dated November 20, 2003, on November 20, 2003, reporting under ""Item 12. Disclosure of Results of Operations and...

  • Page 45
    ..., in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and to Ã'le the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents and each of them...

  • Page 46
    Signature Title Date /s/ NANCY J. PEDOT Nancy J. Pedot WALTER J. SALMON Walter J. Salmon Director April 12, 2004 /s/ Director April 12, 2004 /s/ THOMAS G. STEMBERG Thomas G. Stemberg Director April 12, 2004 28

  • Page 47
    ... 10.9(13) Form of Promissory Note with executive oÇcers. 10.10*‰ Non-QualiÃ'ed Deferred Compensation Plan, as amended. 10.11‰(14) Executive Short Term Incentive Plan, as amended. 10.12(15) Employment Agreement, between PETsMART and Philip L. Francis, Chairman of the Board of Directors and Chief...

  • Page 48
    ...by reference into any Ã'ling 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 Annual Report on Form 10-K, irrespective of any general incorporation language contained in such Ã'ling. 30

  • Page 49
    PETsMART, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE Page Report of Independent Auditors Consolidated Balance Sheets as of February 1, 2004, and February 2, 2003 Consolidated Statements of Operations for the Ã'scal years ended February 1, ...

  • Page 50
    INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders PETsMART, Inc. Phoenix, Arizona We have audited the accompanying consolidated balance sheets of PETsMART, Inc. and subsidiaries (the ""Company'') as of February 1, 2004 and February 2, 2003, and the related consolidated statements of ...

  • Page 51
    ... and other current assets Total current assets Property and equipment, net Investments Deferred income taxes Goodwill, net Intangible assets, net Other assets Total assets LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable and bank overdraft Accrued payroll, bonus, and employee beneÃ'ts...

  • Page 52
    PETsMART, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Fiscal Year Ended February 1, February 2, February 3, 2004 2003 2002 (In thousands, except per share data) Net sales Cost of sales Gross proÃ't Operating expenses General and administrative expenses Operating income ...

  • Page 53
    ... incentive plans 4,037 Issuance of common stock under an oÃ...ering 3,492 Conversion of 63/4% Subordinated Convertible Notes to common stock 19,797 Amortization of deferred compensation, net of award reacquisitions and adjustments 21) Compensation expense related to options held by non-employees...

  • Page 54
    ... of debt Compensation expense related to non-employee options Tax beneÃ't from exercise of stock options Deferred income taxes Changes in assets and liabilities: Receivables, net Merchandise inventories Prepaid expenses and other current assets Other noncurrent assets Accounts payable...

  • Page 55
    ...cant Accounting Policies Business PETsMART, Inc., and subsidiaries (the ""Company'' or ""PETsMART''), is North America's leading provider of food, supplies, accessories, live pets and professional services for the lifetime needs of pets. As of February 1, 2004, the Company operated 643 retail stores...

  • Page 56
    ... related to the services line of business; warehousing costs, including procurement and distribution costs; store occupancy and utilities costs; and inventory shrinkage costs. Also included in cost of goods sold are reductions for vendor rebates and discounts. Inventory Shrinkage Reserves PETsMART...

  • Page 57
    ..., represents the excess of the cost of acquired businesses over the fair market value of their net assets. In Ã'scal 2002, the Company recorded $1,200,000 of additional goodwill related to the payment of contingent consideration associated with the acquisition of PETsMART PETsHOTELSM in 2000. In the...

  • Page 58
    ... the sale of live pets, self-insured health plans, and workers compensation insurance. Property insurance covers approximately $949,000,000 in buildings and contents, including furniture and Ã'xtures, leasehold improvements, and inventory. Under casualty and workers compensation insurance policies...

  • Page 59
    ... sales when the products are shipped for catalog and electronic commerce sales. The Company records an allowance for estimated returns in the period of sale. Revenue for grooming, pet training, and PETsHOTEL is recognized when services are performed. Advertising The Company charges advertising costs...

  • Page 60
    ... option plans as well an Employee Stock Purchase Plan (see Note 14). The Company accounts for those plans under APB No. 25, and related Interpretations. Accordingly, no compensation cost is reÃ-ected in net income, as all options granted under those plans had an exercise price equal to the market...

  • Page 61
    ... No. 123 to record compensation expense for stock options and employee stock purchases (in thousands, except per share data). 2003 Fiscal Year 2002 2001 Net income, as reported Less: Compensation expense for option awards determined by the fair value based method, net of related tax eÃ...ects Pro...

  • Page 62
    ... reclassiÃ'cation, and require companies to account for all amounts received from vendors as a reduction of the cost of the products purchased unless certain criteria are met that allow companies to account for vendor funding as a reduction of related selling, general and administrative expenses...

  • Page 63
    ... in MMI Holdings, Inc. (""MMIH''), a provider of veterinary and other pet-related services. MMIH, through a wholly-owned subsidiary, Medical Management International, Inc., (""MMI''), operates full-service veterinary hospitals and wellness hospitals inside approximately 350 PETsMART stores, under...

  • Page 64
    ...oÇce located in Phoenix, Arizona. PETsMART Direct has, among other functions, the merchandising, human resource, and Ã'nance operations provided by the personnel in Arizona under a shared services arrangement. As a result of the reorganization of these functions, the Company eliminated 44 positions...

  • Page 65
    ... TO CONSOLIDATED FINANCIAL STATEMENTS ÃŒ (Continued) store State Line Tack departments, and manages customer service for all direct marketing operations. Also, as part of the plan, the Company closed Ã've small neighborhood PetWise retail stores located in upstate New York, and recorded a reserve in...

  • Page 66
    ... analysis of the current business model, the Company recorded a $6,927,000 impairment loss associated with PETsMART Direct's building, Ã'xtures, equipment, software, and goodwill, which was recorded in general and administrative expenses. The fair value of such assets was determined based on market...

  • Page 67
    PETsMART...February 3, 2003 2002 Current provision: Federal State Deferred...of the federal statutory income tax rate to the Company's eÃ...ective tax rate before minority interest is as ... taxes Costs associated with the settlement of litigation Enacted change in foreign income tax rate Change in ...

  • Page 68
    ... balance sheets are as follows (in thousands): February 1, 2004 February 2, 2003 Deferred income tax assets: Reserve for closed stores Miscellaneous reserves and accruals Employee beneÃ't expense Capital lease Net operating loss carryforwards Capital loss carryforwards Other Total...

  • Page 69
    ... and 2001, options to purchase approximately 362,609, 609,300, and 2,616,000 shares of common stock, respectively, were outstanding but not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of common shares. F-21

  • Page 70
    ... of those contributions, as approved by the Board of Directors. Certain employees can elect to defer receipt of certain salary and cash bonus payments pursuant to the Company's Non-QualiÃ'ed Deferred Compensation Plan. The Company matches employee contributions up to certain amounts as deÃ'ned in...

  • Page 71
    ...12,000, respectively. The Company has entered into sale and leaseback transactions for several of its store locations, which included buildings and underlying land. Such assets were sold at cost and were leased back at terms similar to those of other leased stores. The Company has no future material...

  • Page 72
    ... in the Company's retail stores occupied by veterinary services, that are recorded as a reduction to cost of sales in the accompanying consolidated statements of operations. Licensing fees are determined by Ã'xed costs per square foot, adjusted for the number of days the hospitals are open and sales...

  • Page 73
    ... of approximately $10,701,000 upon execution of the lease agreements. One of the buildings and the related land for all seven stores resulted in operating leases. These transactions have eliminated any arrangements between special purpose entities and the Company. Note 13 Ì Commitments and...

  • Page 74
    ... Plan. Under the terms of the plans, employees may be awarded shares of common stock of the Company, subject to approval by the Board of Directors. The employee may be required to pay par value for the shares depending on their length of service. The shares of common stock awarded under the plans...

  • Page 75
    ... Plan and the PETsMART, Inc. 2003 Equity Incentive Plan either incentive stock options, nonstatutory options and other stock awards to purchase up to 24,155,700 shares of common stock. These grants are made to employees, including oÇcers, consultants and directors of the Company, at the fair market...

  • Page 76
    ... to common stock Assets acquired using capital lease obligations Note 16 Ì Financial Information by Business Segment $20,382 $52,983 $ Ì $10,701 $ 19,260 $ 74,009 $174,732 $ 11,263 $ 24,405 $ 9,427 $ Ì $107,930 As of February 3, 2002, the Company had three operating segments; PETsMART North...

  • Page 77
    ... to reÃ-ect the current single reportable segment. Note 17 ÃŒ Selected Quarterly Financial Data (Unaudited) Fiscal Year Ended February 1, 2004 First Quarter Second Third Fourth Quarter Quarter Quarter (In thousands, except per share data) Net sales Gross proÃ't Operating income Income before...

  • Page 78
    PETsMART, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Note 18 Ì Subsequent Event On March 23, 2004, the Board of Directors declared a quarterly cash dividend of $0.03 per share payable on May 21, 2004, to stockholders of record on April 30, 2004. F-30

  • Page 79
    INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders PETsMART, Inc. Phoenix, Arizona We have audited the consolidated Ã'nancial statements of PETsMART, Inc. and subsidiaries (the ""Company'') as of February 1, 2004 and February 2, 2003, and for each of the three Ã'scal years in the ...

  • Page 80
    ... AND QUALIFYING ACCOUNTS Balance at Beginning of Period Charged to Expense Deductions (In thousands) Balance at End of Period Description Valuation reserve deducted in the balance sheet from the asset to which it applies: Merchandise inventories: Fiscal year 2001, Lower of cost or market Allowance...

  • Page 81
    ...sales per square foot(5 198.52 Net sales growth 11.2% Increase in comparable store sales(6) ÏÏ 7.0% Selected Balance Sheet Data:(7) Merchandise inventories 309,140 Working capital 347,838 Total assets 1,376,695 Total debt(8 170,702 Total stockholders' equity 839,155 Current ratio 2.02 Long...

  • Page 82
    ...of Regulation S-K. Management believes that this presentation provides useful information to investors regarding the results of operations of its stores. (6) North American retail stores only, excludes catalog and Internet sales in all periods, and includes only stores open at least 52 weeks. Fiscal...