Petsmart 2006 Annual Report Download - page 42

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Income Tax Expense
In fiscal 2006, the $105.0 million income tax expense represents an effective rate of 36.2%, compared with
fiscal 2005 income tax expense of $106.7 million, which represents an effective tax rate of 36.9%.
During fiscal 2006, we settled an audit with the Internal Revenue Service. This included settlement of an
affirmative issue we raised during fiscal 2005 with respect to the characterization of certain losses. The settlement
resulted in an overall benefit of $3.4 million. We also recorded tax benefits of approximately $3.0 million primarily
due to the expiration of the statute of limitations for certain tax positions and additional federal and state tax credits.
During fiscal 2005, we recorded a reduction to income tax expense of approximately $6.1 million as the period
of assessment, during which additional tax may be imposed for years prior to fiscal 2002, expired for several
jurisdictions. As a result, we determined that approximately $6.5 million of tax contingency reserves were no longer
required, with approximately $0.4 million as an increase to additional paid-in-capital. We also recorded additional
tax expense of approximately $4.3 million resulting from corrections of our deferred tax assets.
Fiscal 2005 Compared to Fiscal 2004
Net Sales
Fiscal 2005 net sales increased $397.0 million, or 11.8%, to $3.8 billion, compared to net sales of $3.4 billion
in fiscal 2004, due to the addition of 100 net new stores and a 4.2% increase in comparable store sales for fiscal
2005. Our comparable store sales growth was 6.3% for fiscal 2004. We believe the decrease in our comparable store
sales growth rate during fiscal 2005 as compared to fiscal 2004 was due to general economic conditions, including
increased fuel prices, which caused a decrease in consumer spending. In addition, we lost 437 days of sales from
store closures due to the effect of hurricanes in the third quarter of fiscal 2005.
Services sales, which are included in our net sales and include grooming, training, boarding and day camp
operations, increased by 24.2%, or $58.2 million, to $298.9 million. This increase was primarily due to an increase
in grooming volume during fiscal 2005.
Gross Profit
Gross profit increased as a percentage of net sales to 31.2% for fiscal 2005, from 30.9% for fiscal 2004. The
increase reflects higher margins on product sales due to improved buying practices, our ongoing pricing strategies
and increased inventory levels resulting in more of our costs capitalized in inventory. These increases were partially
offset by various fixed and variable expenses in cost of sales including occupancy, warehousing and transportation
costs and inventory-related costs.
Store and occupancy costs increased as we opened more stores and opened our Illinois distribution facility.
Warehousing and transportation costs increased due to additional variable expenses from our Illinois distribution
facility and higher fuel prices. Inventory-related costs increased due to higher inventory shrinkage results and
higher obsolescence charges.
In addition, gross profit on our services decreased as a percentage of net sales due to the increase in variable
and infrastructure expenses associated with the opening of new PetsHotels.
Operating, General and Administrative Expenses
Operating, general and administrative expenses, or OG&A, decreased as a percentage of net sales to 22.9% for
fiscal 2005, from 23.2% for fiscal 2004. This decrease was primarily driven by decreases in compensation costs and
legal settlements; partially offset by increases in advertising and store opening expenses. Compensation costs
decreased as a result of a reduction in stock-based compensation recognized, charges incurred in fiscal 2004 related
to workers’ compensation reserves which were not incurred at the same levels in fiscal 2005 and lower bonus
expense recognized in fiscal 2005. Legal settlements recorded as a reduction of OG&A expenses were larger in
fiscal 2005 as compared to fiscal 2004 primarily due to a one-time legal settlement recorded in the first quarter of
fiscal 2005 and a Visa/Mastercard settlement recorded in the fourth quarter of fiscal 2005. Advertising expenses
30