Petsmart 2003 Annual Report Download - page 56

PETsMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)
Vendor Rebates and Promotions
The Company receives income from certain merchandise suppliers in the form of rebates and promotions.
Agreements are made with each individual merchandise supplier and income is earned as buying levels are
met and/or cooperative advertising is placed. Rebate income is recorded as a reduction of cost of sales, and
cooperative promotional income is recorded as a reduction of operating expenses. The uncollected amounts of
vendor rebate and promotional income remaining in receivables in the accompanying consolidated balance
sheets as of February 1, 2004, and February 2, 2003, were approximately $1,293,000 and $1,263,000,
respectively. Unearned rebates recorded as a reduction of inventory in the accompanying consolidated balance
sheets were approximately $385,000 and $962,000 as of February 1, 2004, and February 2, 2003, respectively.
Merchandise Inventories and Cost of Sales
Merchandise inventories are stated at the lower of cost or market. Cost is determined using the Ñrst-in,
Ñrst-out method based on moving average costs and includes certain procurement and distribution costs
relating to the processing of merchandise. The Company maintains reserves for lower of cost or market, as well
as shrinkage.
Total procurement and distribution costs charged to inventory during Ñscal 2003, 2002, and 2001 were
$169,579,000, $156,926,000, and $126,784,000, respectively. Procurement and distribution costs remaining in
inventory as of February 1, 2004 and February 2, 2003, were $30,262,000 and $25,442,000, respectively.
Cost of sales includes the following types of expenses: direct costs associated with the products sold,
including inbound freight; salaries of the groomers and trainers and other costs 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 stores perform physical inventories once a year and, in between physical inventories, stores
perform cycle counts on certain inventory items. The forward distribution centers and distribution centers
perform cycle counts encompassing all inventory items every quarter. Therefore, as of the end of each
reporting period, there will be stores with certain inventory items that have not been counted. Due to the
holiday season at the end of the Ñscal year, the stores do not perform physical inventories during the last
quarter of the Ñscal year, but continue to perform counts on certain inventory items. As of the end of each
reporting period, the Company estimates the inventory shrinkage reserve by applying a rolling two-year
historical shrink rate against the volume of merchandise sales since the last inventory. During 2002, the
Company changed the historical shrink rate from a three-year historical trend to a two-year trend because the
Company believes the actual shrink results in 2000 were skewed by the eÅects of the implementation of its
business software, and are not indicative of the current results. The implementation of the business software
signiÑcantly impacted distribution and replenishment processes causing out of stock and overstock conditions
and signiÑcant book to physical inventory adjustments, which continued into 2000. These issues caused
signiÑcant Öuctuations in 1999 and 2000 shrink rates that are not reÖective of current experience. Due to the
reformatting of stores, a stabilization of business software, and improved store inventory management
procedures, the Company believes that recording the shrink estimate based on a two-year trend is an
appropriate reÖection of the continuing changes in the business. As of February 1, 2004 and February 2, 2003,
approximately $10,055,000 and $10,243,000, respectively, were recorded for inventory shrinkage reserves.
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