FOOL CONFERENCE CALL SYNOPSIS*
By Debora Tidwell (TMF Debit)

PETsMART, Inc.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PETM)") else Response.Write("(Nasdaq: PETM)") end if %>
10000 N. 31st Avenue, Suite C100
Phoenix, AZ 85051
(602) 944-7070
http://www.petsmart.com

UNION CITY, CA (June 6, 1997)/FOOLWIRE/ --- PETsMART, Inc. reported their first quarter 1997 results on May 27th. From PETsMART's standpoint they described the quarter as interesting, challenging, and also productive in many ways. They hit record revenues during the quarter recording $412 million in sales versus $330 million for the same period last year which represents a 24.8% increase.

COMP STORE SALES. Their North American stores reported a 7% comparable store growth rate and their UK stores reported a 6.1% growth rate. While these comp number results would be considered very worthy results for almost any retailer, they are below PETsMART's historical norms and their internal expectations of themselves. Their transactions were up 5.3% year over year meaning that the implicit inflation in their product mix for the first quarter was 1.7% which is significantly below the CPI index of 2.7%. So, they are living in a deflationary product environment because of their comps and efforts in driving down retail prices. Pet City is less than 10% of the total sales of the combined, fully consolidated entities.

NET INCOME. For the first quarter the company reported net income from operations of $5.7 million which is $0.05 per share. This does exclude the anticipated $9.6 million merger and integration charge related to their December 1996 acquisition of Pet City Holdings plc in the United Kingdom.

EXPANSION. During the first quarter the company opened 29 new North American superstores which included the relocation of two existing stores, and also 7 superstores in the UK. Among the new stores they opened in the UK, their first large-format PETsMART stores were opened first in Swindon which is a 19,000 square foot relocation of the first ever Pet City stores and then later in April a 26,000 square foot store near Wimbledon. The first store replaces their previously highest volume store within the Pet City chain and their most mature UK trade area. The good news is that the store opening was very successful and in spite of the fact that it is a very mature trade area, they are trading at more than 30% improvement over the same period last year. The other store is the largest and most dominant pet supply store outside of North America and does feature complete PETsMART decor packages, expanded livestock presentations, the introduction of several hundred new PETsMART products including grooming, veterinary services, pet photography, and also their Three Dog Bakery dog biscuit bakeries. The store opened with remarkable success and is the highest volume grand opening in the entire corporate history of their business, so they are very excited about that.

IMPACT ON US SALES. Closer to the US, during the first quarter a number of factors affected their sales growth which made achieving their earnings goals very difficult during the first quarter. Three primary drivers contributed to this. First was a structural shift in the method consumers use to treat and prevent fleas and ticks on their cats and dogs. Second, there was a larger than desired reduction in their in-stock inventory levels which caused out-of-stock sales very late in the first quarter. Also, there was a shift in their advertising strategies from their late 1996 very direct-incentive oriented messages toward a more institutional and emotional type advertising in both their print and broadcast ads.

DISCUSSION OF FLEA & TICK MARKET. Historically the flea and tick market has been estimated to be approximately an $800 million market of the $4 billion total pet supply industry. The product categories for PETsMART include flea collars, flea shampoos, flea powders, flea dip, sprays, indoor foggers, and backyard sprays. All of these products are designed to help the consumer deal with unwanted pests on the animals and in their household. This class of goods has historically represented up to 10% of their sales in certain geographies during this period of time and is driven by the Spring bloom in fleas and ticks. Fleas and ticks tend to come with the flowers. It is a trip driver for their stores and is also a very high gross margin product line. Flea and tick products come in a highly concentrated selling period. Historically this period has run from April to early August depending on seasonal weather patterns.

SHIFT IN FLEA & TICK PREVENTION. In 1996 two leading pharmaceutical companies introduced a pharmaceutical pill alternative as a flea and tick prevention method. This product is prescribed by veterinarians as opposed to the sprays and foggers which are sold as over-the-counter alternatives. The consumer benefits are really very profound. It is an effective product and is also, for the consumer, easy to administer and it avoids a regimen of indoor and outdoor chemicals which, to some consumers, is distasteful. This year, these same pharmaceutical companies launched what they deem to be a very effective consumer advertising plan and caused a surprisingly high level of awareness around the consumer about these new products.

NEW FLEA & TICK PRODUCTS GOOD STRATEGICALLY. From a strategic level, PETsMART is very supportive of this new product line because it is good for the consumer and downrange it does strengthen their bond with their clients in their veterinary hospitals. But, it does obviously present a tactical interim challenge as they only, of their 400 plus stores right now, have company owned pet hospitals in 80 of them right now. About 200 PETsMART stores in aggregate do offer veterinary services. Look for them over time to do two things. First, continue to grow their own indigenous base and acquire independent operators. Then they have to deal with the corresponding decline in the traditional OTC remedies that consumers have historically elected to use for flea and tick prevention.

INVENTORY REDUCTIONS CAUSED LOSS OF SALES. The second main issue they dealt with in the quarter was their inventory reductions which did cause loss of sales. Because of the 1996 expansion of their Columbus distribution center, the startup of their Phoenix distribution center in 1996, their 1996 entry into Canada, and the staging of their first quarter 1997 stores, they finished 1996 with unusually high inventory levels. This was delivered and planned. It was their 1997 plan to walk-down store inventory levels on average by about $75,000 at cost per store. During the first quarter their actual performance was to reduce inventories by $110,000 per store, or 50% more than they planned during the entire year and they accomplished it in 13 weeks versus 52 weeks.

WHAT HAPPENED WITH INVENTORY MANAGEMENT. Their business runs a central automated inventory management and replenishment system and this is a system that, based on the history of product movement and certain forecasts and desired target-level inventories at store levels, the system forecasts and orders product for them. As the business decided to begin to reduce inventories they adjusted the internal inventory parameters in their computer system to buy less product than they sold so they ended up with the desired result of lower inventories. They did learn through the process that their system works well in a steady-state environment with stable inventory levels, but the system did not compensate as they expected during this reduction process and in fact accelerated their reduction of inventories far beyond their expectations. It is their opinion that the problem was due to human intervention, not the software. The systems are working and have worked well over the past 8 years.

UNACCEPTABLE OUT-OF-STOCK LEVELS. The ending result of getting too aggressive in adjusting the parameters the system uses was that they ended the quarter with an unacceptable level of out-of-stocks, particularly skewed to their high volume stores. It cut across all of their product lines, both consumables and supply items. Their current status in terms of their inventory management process is that they have made significant progress in returning to what they believe to be the appropriate in-stock levels. Their consumable products are noticeably better in stock and their supply items or hard goods are making progress but they have about four weeks to go until they get back to historical in-stock levels in that product line.

INVENTORY LEVELS GOOD HERE. On a go-ahead basis they do intend to stabilize inventory on a current per store basis where they are right now. These are historically their normal levels. This event obviously caused a loss of sales and resulting gross margin late in the quarter. It also impacted their ability to collect certain vendor cash discounts, rebates, and co-op ad funds that are driven by their purchase contracts with their suppliers. Beyond that, GAAP accounting principles require that they capitalize certain buying and inventory handling costs. As they reduced inventories, this drove a unicap process that caused certain accounting charges to their earnings. In total, Q4 1996 inventories ended at about $300 million. At the end of Q1 1997 they were at $274 million with the addition of a net 34 new stores. Looking at that on an implicit reduction, it yields about a $45 million implicit reduction in inventories.

NEW ADS NOT WORKING. The third issue they counted on earlier is their advertising shift. They did shift in the first quarter of 1997 to a much more emotional message with their consumer, away from the more high-impact item price-oriented message that they were using during the fourth quarter of 1996. They are concerned that their message might have been too soft in a very important time to build sales. They have already made June and July media changes that return them to historically proven areas for their businesses. This week they are completing some market research on the message and the delivery of that message with a consumer panel. In addition to that, they have embarked on an ad agency search and will be doing a complete agency review.

SUMMARY. In total, they are disappointed that they did not execute their inventory plan or advertising plan up to their own expectations. Additionally they had been impacted by the shift in the flea and tick business to the pill although they do believe downrange this is very good strategically for their business.

WHAT THEY WILL DO. Moving ahead, their management team is very focused on their core North American retail business. They are strengthening their advertising content and their media and they are making very substantial progress in solving their out-of-stock problem caused by their inventory reductions. Long-term they do believe that the inventory reduction is a positive despite the short-term economic pain it has caused. Long term they are also pleased with the overall performance of their new stores. They are very happy in particular with the results of their UK store conversions from Pet City to PETsMART. They have added some new decor to those stores. Their new marketing plan converted those stores to an everyday low price basis. They are very excited about the consumer reaction to their larger format stores. This does validate the idea that they had before that the PETsMART concept is highly transportable to the UK.

NEW INVENTORY TARGETS. They were asked what the thought process was behind setting the new inventory per store targets and what their new target for inventory per store is going forward. In terms of target inventory levels, they are very satisfied where they are right now in terms of the inventory levels. It is lower than their annual targets for 1997 reductions but they lived through the pain so they feel they may as well enjoy the go-ahead benefits. From that standpoint, PETsMART has historically enjoyed a very high if not the highest return on investment store model, so from that standpoint they understand a major part of that driver is the aggregate investment in inventory. From that standpoint they are happy at the inventory level they're at. So, they are going to try to stay there as opposed to try to build it up. It is a per store inventory level, so there will be a modest increase as they open new stores in their total aggregate inventory for the year.

CUSTOMER RECOVERY AND MARKET SHARE GROWTH. They were asked about customer recovery (getting customers back who went elsewhere due to the out-of-stock situation). They responded that looking at customer recovery, without doubt this business intends to be flat-out very aggressive in, not only their class of trade, but also other classes of trade to ensure they continue to get comparable store growth. They explained that, as a business, they run the highest volume stores in their class of trade. So, as they comp at 7% on a $90,000 per week store, that generates a market share year-over-year growth of $6300. Other retailers who do significantly less volume than PETsMART on a per store per week basis comping at 10% might only grow at $2600-$2700 per store per week. Therefore, PETsMART continues to gain market share at a much more rapid pace than their like competition. From that standpoint they are dedicated to make sure that they not only recognize that a comp number by itself has to be looked at in the context of market share growth but also looked at in terms of the aggregate dollar additions you are able to get out of the market. From that standpoint, they feel they are the undisputed leader in being able to build marketshare in their class of trade.

REMODELING PROGRAM. They continue to be confident about their older store remodeling program they are embarking on right now to add higher margin service areas to their business, in particular focusing on adding veterinary hospitals and enlarged grooming salons to their older stores. This is a solid future strategy in their mind that is building their service business from a base of zero in 1989 to an ultimate goal of 20% of total store sales. It is obviously very high margin business for them, very difficult to compete with from a competitive standpoint, and clearly differentiates them from other classes of trade.

CONFIDENT ABOUT BUSINESS OUTLOOK. They feel they are the undisputed dominant worldwide retailer of pet food, pet supplies and services. They have an excellent consumer franchise, a very strong store growth program, and fundamentally strong business strategy and feel very confident about the future prospects for the business.

TONE OF BUSINESS. Asked to comment about the tone of business in the last several weeks the company responded that the tone of their business, as they continue to be concerned about the flea and tick business, they are still watching that very carefully as they go ahead. How the flea and tick market unfolds this year will have a heavy impact on their total performance in the second quarter. Looking at performances geographically, the places that are flat-out the weakest areas for the business right now are the places that have very significant year-over-year drops in the flea and tick business. As an example, on a comparable basis, their California stores on flea and tick merchandise are down 43% year over year which is a very significant shift in a very large market for them. They will watch that very carefully but they are headed into the peak period right now. There was very severe weather recently in the Midwest and they are not clear what impact that will have also, so they will watch that very carefully. They wouldn't guide analysts higher on comp store performance than what was seen in the first quarter. They are hopeful for higher comp store performance in Q3 due to the flea and tick season ending, but indicated that it is hard to predict at this point.

QUESTION ON GROSS MARGIN DECLINE. They were asked if the gross margin decline was also due to the flea and tick products. They responded that as you look at their gross profit for Q1 this year versus last year, there are 3 drivers behind the shift. A very substantial part of that shift is driven by the flea and tick market. In total about 25% of the change year over year is from mix changes in flea and tick and some from out of stock in their North American stores. The remainder of it comes from a business shift and the fact that their total consolidated UK business as a percent of total is much higher than last year on a consolidated basis and on a corresponding basis, their catalog business is lower. So the internal merchandise margins of each business are very satisfactory with the notable exception of the flea and tick problem but because their business has shifted to be more retail oriented because of the higher growth of their retail sales dollars versus their catalog dollars, they see that shift. About 25% was due to flea & tick, about 33% is due to unicap, and the remainder is a shift in their business mix.

PROGRESS ON EXPENSES. In terms of store level expenses and G&A expenses, they are very pleased with the progress they have made year over year. There was a 200 basis point improvement in store level expenses and they also had a very substantial improvement in their G&A expenses. Their year-over-year investment in store labor is almost identical on a rate-to-sales basis, so they spent as many dollars on a rate-to-sales basis in terms of store service and store labor as they did last year. The decline in the operating expenses was a combination of expense control and wasn't specifically targeted at payroll but was an overall realization that they needed to keep their expenses under control as they went through the quarter. Going forward, they are committed to year-over-year improvements in operating expenses, but will not do so at the expense of needed in-store personnel and customer service people.

MONITORING CUSTOMER SERVICE. They do two things to monitor customer service at store level. First every one of their store director's compensation program is tied into customer service. They have a mystery shop process that PETsMART runs out of their store support group in Phoenix. They bring people into the store to grade the shopping experience. Looking at PETsMART's consumer satisfaction trend over the last 18 months, consumer satisfaction at PETsMART has gone up about 15% from where they were 18 months ago. The company also employs outside market research agencies that do tracking studies in major metropolitan areas that benchmark not only PETsMART's performance, but also contrast their performance from a customer satisfaction standpoint, an in-stock standpoint, a friendliness standpoint, a pricing standpoint, a variety standpoint, convenience, knowledge, etc. to other operators in their industry and other places where consumers can buy their class of goods. They have had some discussion and some modest experimentation with instant feedback loops at store level, some of the technology has not been as advanced as they probably ultimately need, but they may do more in that area.

CATALOG BUSINESS. They were asked about their catalog business and why it is a lower percentage of sales. They said that their catalog business is a very good and profitable business. The strategic reasons they bought that business two years ago were two-fold. One, it gave them instant access to database marketing capabilities which they thought was very important. Second, they identified the equestrian market as a major opportunity. Arithmetically the equestrian market in terms of species is the second largest pet market in the country, dog is number one, equestrian is number two and cat is number three. Because they run such high-volume, large format stores, it was obvious that they had a good opportunity to also offer that class of goods in their stores. The acquisition of State Line Tack came with it the premier catalog in their class of goods and in addition to that the premier management in terms of horse and equestrian merchandise. As you look at how they are using those catalogs today, it is less focused on catalog growth and more focused on using the catalogs to grow their retail store business. Looking at the new merchandising concepts they have had, in particular their large format stores in Southern California, a high focus of that activity was using that catalog business to support their stores. They are very satisfied with their catalog performance. They are combining both of the companies, Sporting Dog and State Line Tack, into a single entity they call PETsMART Direct, under unified management and that process is well under way.

* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.