10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 29, 2006

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 000-23574

PETCO ANIMAL SUPPLIES, INC.

(Exact name of registrant as specified in its charter)

Delaware	20-2148979
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
9125 Rehco Road, San Diego, California	92121
(Address of principal executive offices)	(Zip Code)

(858) 453-7845

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x                     Accelerated filer ¨                    Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨     No x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Title	Date	Outstanding
Common Stock, $0.001 Par Value	August 18, 2006	57,237,061

PETCO ANIMAL SUPPLIES, INC.

FORM 10-Q

For the Quarter Ended July 29, 2006

INDEX

			Page
Part I	Financial Information
	Item 1.	Unaudited Consolidated Financial Statements
		Consolidated Balance Sheets at July 29, 2006 and January 28, 2006	3
		Consolidated Statements of Operations for the Thirteen and Twenty-Six Weeks ended July 29, 2006 and July 30, 2005	4
		Consolidated Statements of Cash Flows for the Twenty-Six Weeks ended July 29, 2006 and July 30, 2005	5
		Notes to Unaudited Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
	Item 4.	Controls and Procedures	24
Part II	Other Information
	Item 1.	Legal Proceedings	25
	Item 1A.	Risk Factors	27
	Item 4.	Submission of Matters to a Vote of Security Holders	27
	Item 6.	Exhibits	28
Signatures			29

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Part I. Financial Information

Item 1. Unaudited Consolidated Financial Statements

PETCO ANIMAL SUPPLIES, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands, except per share data)

	July 29, 2006			January 28, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	23,420		$	39,524
Receivables, net		20,010			20,422
Merchandise inventories		195,853			183,336
Deferred tax assets		18,145			16,737
Other current assets		18,561			13,872
Total current assets		275,989			273,891
Fixed assets, at cost		791,040			750,640
Less accumulated depreciation		(409,725	)		(373,246	)
Fixed assets, net		381,315			377,394
Goodwill		41,898			40,227
Other assets		20,153			18,163
Total assets	$	719,355		$	709,675
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	88,509		$	90,834
Accrued salaries and employee benefits		80,941			76,321
Accrued expenses and other liabilities		84,256			82,373
Current portion of long-term debt		—			1,755
Total current liabilities		253,706			251,283
Senior credit facility		55,000			60,000
Senior subordinated notes payable		89,267			89,267
Deferred tax liabilities		16,936			22,579
Deferred rent and other liabilities		75,239			69,708
Total liabilities		490,148			492,837
Stockholders’ equity:
Preferred stock, $.01 par value, 5,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $.001 par value, 250,000 shares authorized, 57,232 and 57,890 shares issued and outstanding at July 29, 2006 and January 28, 2006, respectively		57			58
Additional paid-in capital		83,405			72,814
Retained earnings		145,745			143,966
Total stockholders’ equity		229,207			216,838
Total liabilities and stockholders’ equity	$	719,355		$	709,675

See accompanying notes to unaudited consolidated financial statements.

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PETCO ANIMAL SUPPLIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited, in thousands, except per share data)

	Thirteen weeks ended				Twenty-six weeks ended
	July 29, 2006		July 30, 2005		July 29, 2006		July 30, 2005
Net sales	$	531,134	$	482,746	$	1,052,126	$	962,340
Cost of sales and occupancy costs		363,257		322,744		715,421		640,285
Gross profit		167,877		160,002		336,705		322,055
Selling, general and administrative expenses		140,670		126,483		287,564		253,914
Merger-related costs		4,726		—		4,726		—
Operating income		22,481		33,519		44,415		68,141
Interest expense, net		3,680		3,619		7,172		7,205
Debt retirement costs		—		—		—		2,447
Earnings before income taxes		18,801		29,900		37,243		58,489
Income taxes		8,886		11,870		16,300		23,220
Net earnings	$	9,915	$	18,030	$	20,943	$	35,269
Net earnings per share:
Basic	$	0.17	$	0.31	$	0.36	$	0.61
Diluted	$	0.17	$	0.31	$	0.36	$	0.60
Shares used for computing net earnings per share:
Basic		57,188		57,778		57,414		57,742
Diluted		57,676		58,517		57,844		58,560

See accompanying notes to unaudited consolidated financial statements.

4

PETCO ANIMAL SUPPLIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, in thousands)

	Twenty-six weeks ended
	July 29, 2006			July 30, 2005
Cash flows from operating activities:
Net earnings	$	20,943		$	35,269
Depreciation and amortization		42,078			37,919
Amortization of debt issuance costs		147			120
Provision for deferred and other taxes		(6,796	)		(5,977	)
Stock based compensation		7,590			—
Impairments and write-offs of fixed and other assets		457			788
Non-cash write-off of debt issuance costs		—			56
Changes in assets and liabilities:
Receivables		411			(3,540	)
Merchandise inventories		(11,981	)		(13,998	)
Other assets		(5,756	)		(5,588	)
Accounts payable		(2,325	)		10,087
Accrued salaries and employee benefits		4,620			1,390
Accrued expenses and other liabilities		1,872			11,402
Deferred rent and other liabilities		5,532			9,911
Net cash provided by operating activities		56,792			77,839
Cash flows from investing activities:
Additions to fixed assets		(45,294	)		(68,815	)
Net cash invested in acquisitions		(3,912	)		—
Net cash used in investing activities		(49,206	)		(68,815	)
Cash flows from financing activities:
Borrowings under long-term debt agreements		259,300			28,100
Repayments of long-term debt		(266,056	)		(43,072	)
Debt issuance costs		(516	)		—
Repurchase of common stock		(19,164	)		—
Net proceeds from issuance of common stock		2,639			2,535
Excess tax benefit realized from stock-based compensation awards		107			—
Net cash used in financing activities		(23,690	)		(12,437	)
Net decrease in cash and cash equivalents		(16,104	)		(3,413	)
Cash and cash equivalents at beginning of year		39,524			36,815
Cash and cash equivalents at end of period	$	23,420		$	33,402

See accompanying notes to unaudited consolidated financial statements.

5

PETCO ANIMAL SUPPLIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited, in thousands, except per share data)

Note 1—General

PETCO Animal Supplies, Inc., a Delaware corporation, and its subsidiaries (collectively, the “Company” or “PETCO”), is a national specialty retailer of premium pet food, supplies and services with 817 stores in 49 states and the District of Columbia as of July 29, 2006. The Company’s products include pet food, supplies, grooming products, toys, novelty items and vitamins, small pets such as fish, birds and other small animals (excluding cats and dogs), and veterinary supplies.

In the opinion of management of PETCO, the unaudited consolidated financial statements presented herein contain all adjustments, consisting of normal recurring adjustments, necessary to fairly present the financial position, results of operations and cash flows of the Company as of July 29, 2006 and for the thirteen and twenty-six week periods ended July 29, 2006 and July 30, 2005. The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Certain prior period amounts have been reclassified to conform to the current period presentation.

Because of the seasonal nature of the Company’s business, the results of operations for the thirteen and twenty-six week periods ended July 29, 2006 and July 30, 2005 are not necessarily indicative of the results to be expected for the full year. The Company’s fiscal year ends on the Saturday closest to January 31, resulting in years of either 52 or 53 weeks. All references to a fiscal year refer to the fiscal year ending on the Saturday closest to January 31 of the following year. For example, references to fiscal 2006 refer to the fiscal year beginning on January 29, 2006 and ending on February 3, 2007.

All of the Company’s stores are aggregated into one reportable segment given the similarities in economic characteristics among the operations represented by the stores and the common nature of the products, customers and methods of distribution. For further information, see the consolidated financial statements and related footnotes for fiscal 2005 included in the Company’s Annual Report on Form 10-K (File No. 000-23574) filed with the Securities and Exchange Commission on March 31, 2006.

Note 2—Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), Share-Based Payment (“SFAS No. 123(R)”). SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and revises SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), and requires companies to expense the fair value of employee stock options and other forms of employee stock-based compensation. SFAS No. 123 allowed companies to disclose the pro forma effects of expensing the fair value of employee stock-based compensation in the footnotes to the financial statements. SFAS No. 123(R) applies to all stock-based compensation transactions with employees in which a company acquires services by issuing its stock or other equity instruments, except through arrangements resulting from employee stock ownership plans, or by incurring liabilities that are based on the company’s stock price. The Company adopted SFAS No. 123(R) on January 29, 2006 (the “date of adoption”), the beginning of its first quarter of fiscal 2006.

Prior to the first quarter of fiscal 2006, the Company accounted for its equity award plans using the intrinsic value method prescribed by APB No. 25 and related interpretations, and recognized compensation expense in the financial statements if the market price of the underlying stock exceeded the exercise price on the date of grant. Stock-based compensation costs were amortized to expense over the nominal vesting period of the option.

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Pursuant to SFAS No. 123, the Company disclosed the pro forma effects of expensing the fair value of employee stock-based compensation in the footnotes to the financial statements.

The Company adopted SFAS No. 123(R) using the modified-prospective approach. Accordingly, prior period amounts have not been restated. Under this application, the Company records stock-based compensation expense for all awards granted on or after the date of adoption and for the portion of previously granted awards that remained unvested at the date of adoption. Currently, the Company’s stock-based compensation relates to restricted stock units and stock options. The Company has no awards outstanding with market or performance conditions. Stock-based compensation is recognized as expense using the straight-line method over the vesting period of the award, which is generally also the requisite service period.

Upon the adoption of SFAS No. 123(R), the Company revised its approach to apply the non-substantive vesting period approach to all new share-based compensation awards granted after January 29, 2006. Under this approach, all compensation cost is recognized on the date of grant for awards issued to retirement-eligible employees, or over the period from the grant date to the date retirement eligibility is achieved, if that is expected to occur during the nominal vesting period. The Company continues to apply the nominal vesting period approach for the portion of unvested outstanding awards issued prior to the adoption of SFAS No. 123(R). Had the Company also applied the non-substantive vesting period approach to awards granted prior to the adoption date, compensation expense would have been approximately $0.1 million lower and $0.2 million lower for the thirteen week periods ended July 29, 2006 and July 30, 2005, respectively, and approximately $0.2 million lower and $1.6 million higher for the twenty-six week periods ended July 29, 2006 and July 30, 2005, respectively.

Under the provisions of SFAS No. 123(R), management is required to estimate expected pre-vesting forfeitures for share-based awards and only recognize expense for those awards that are expected to vest. Prior to the adoption of SFAS 123(R), pre-vesting forfeitures were recognized in the pro forma footnote expense as they occurred. Compensation expense recognized for the thirteen and twenty-six week periods ended July 29, 2006 has been reduced for estimated pre-vesting forfeitures. If the Company were to change its estimate of pre-vesting forfeitures, the amount of stock-based compensation could differ significantly from the amount recognized in the financial statements.

The following table details the effect on net earnings and earnings per share as if compensation expense had been recorded in the thirteen and twenty-six week periods ended July 30, 2005, based on the fair value determined under SFAS No. 123 (“pro forma”). The reported and pro forma net earnings and earnings per share for the thirteen and twenty-six week periods ended July 29, 2006 are the same since stock-based compensation expense has been recorded under the provisions of SFAS No. 123(R).

	Thirteen weeks ended					Twenty-six weeks ended
	July 29, 2006		July 30, 2005			July 29, 2006		July 30, 2005
Net earnings as reported	$	9,915	$	18,030		$	20,943	$	35,269
Stock-based compensation recorded using the intrinsic value method, net of tax		—		—			—		—
Stock-based compensation using the fair value method, net of tax		—		(1,339	)		—		(2,931	)
Pro forma net earnings	$	9,915	$	16,691		$	20,943	$	32,338
Basic earnings per share – as reported	$	0.17	$	0.31		$	0.36	$	0.61
Basic earnings per share – pro forma	$	—	$	0.29		$	—	$	0.56
Diluted earnings per share – as reported	$	0.17	$	0.31		$	0.36	$	0.60
Diluted earnings per share – pro forma	$	—	$	0.29		$	—	$	0.55

The Company recognized stock-based compensation expense for the thirteen week period ended July 29, 2006 of $2.7 million and a related income tax benefit of $1.0 million, resulting in a net stock-based compensation charge of $1.7 million, or $0.03 per basic and diluted share. For the twenty-six week period ended July 29, 2006, the

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Company recognized stock-based compensation expense of $7.6 million and a related income tax benefit of $2.7 million, resulting in a net stock-based compensation charge of $4.9 million, or $.08 per basic and diluted share.

Incentive Compensation Plans

Stock options granted under the 1994 Stock Option Plan are exercisable for up to ten years following the date of grant and generally vest 100% on the date which is three years from the date of grant. Stock options were last awarded under the 1994 Stock Option Plan in fiscal 2001 and no further grants will be made. As of July 29, 2006, there were 263 shares of common stock subject to options outstanding under the 1994 Stock Option Plan.

The 2002 Incentive Award Plan (the “Incentive Plan”) provides for the granting of stock-based compensation awards, including stock options, stock appreciation rights, restricted stock, deferred stock, dividend equivalents, performance awards, stock payments and other stock-related benefits to officers, employees, consultants and directors. Except with regard to grants to independent directors, the aggregate share limit under the Incentive Plan is equal to the sum of (1) 1,115 shares of common stock, plus (2) on March 1 of each year during the term of the Incentive Plan commencing on March 1, 2003, a number of shares of common stock equal to 2.0% of the total number of issued and outstanding shares of common stock outstanding as of the last day of the fiscal year immediately preceding such March 1. With respect to grants to the Company’s independent directors, the aggregate share limit under the Incentive Plan is equal to the sum of (1) 56 shares of common stock, plus (2) on March 1 of each year during the term of the Incentive Plan commencing on March 1, 2003, a number of shares of common stock equal to 0.1% of the total number of issued and outstanding shares of common stock as of the last day of the fiscal year immediately preceding such March 1. At July 29, 2006, 1,509 shares remained available for future grant under the Incentive Plan.

As of July 29, 2006, unrecognized compensation expense related to the unvested portion of the Company’s stock options and restricted stock units was $12.0 million and $4.4 million, respectively, which is expected to be recognized over a weighted-average period of 1.5 years and 2.6 years, respectively.

Stock Options

Stock options granted under the Incentive Plan generally vest 100% on the date which is three years from the date of the grant. Options expire ten years from the date of the grant. All option grants under the Incentive Plan have an exercise price equal to the market price of the underlying common stock on the date of grant.

The estimated weighted-average fair value per share of the options granted during the thirteen week periods ended July 29, 2006 and July 30, 2005 was $8.49 and $7.09, respectively. The estimated weighted-average fair value per share of the options granted during the twenty-six week periods ended July 29, 2006 and July 30, 2005 was estimated to be $8.34 and $12.87, respectively. The weighted-average fair value per share was calculated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

	Thirteen weeks ended		Twenty-six weeks ended
	July 29, 2006	July 30, 2005	July 29, 2006	July 30, 2005
Dividend yield	0.0%	0.0%	0.0%	0.0%
Expected volatility (1)	36.3%	29.5%	36.3%	29.5%
Risk-free interest rate (2)	4.7%	3.9%	4.7%	4.2%
Expected life (3)	5.5 years	2.9 years	5.4 years	5.7 years

(1) The expected volatility is estimated based on a simple average of the Company’s historical stock price volatility and volatility implied by publicly traded call options with terms greater than six months.

(2) Based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected life of the stock options.

(3) The expected life of stock options is estimated based on historical exercise experience on options granted subsequent to the Company’s February 2002 Initial Public Offering and projected exercise patterns for outstanding options.

8

Information about the Company’s stock option activity during the twenty-six week period ended July 29, 2006 is as follows:

	Shares		Weighted-average Exercise Price		Weighted-average Remaining Contractual Term	Aggregate Intrinsic Value
Options outstanding, beginning of year	3,988		$	26.58
Granted	579		$	20.23
Exercised	(172	)	$	15.22
Forfeited	(240	)	$	32.68
Expired	(69	)	$	26.14
Options outstanding, end of period	4,086		$	25.81	7.8	$	9,962
Options exercisable, end of period	1,354		$	16.41	6.4	$	9,036

The total intrinsic value of stock options exercised during the thirteen week periods ended July 29, 2006 and July 30, 2005 was $0.5 million and $1.4 million, respectively. For the twenty-six week periods ended July 29, 2006 and July 30, 2005, the total intrinsic value of stock options exercised was $1.1 million and $3.8 million, respectively. Net cash proceeds from the exercise of stock options were $1.0 million and $0.8 million and the associated income tax benefit realized was $0.2 million and $0.6 million for the thirteen week periods ended July 29, 2006 and July 30, 2005, respectively. Net cash proceeds from the exercise of stock options were $2.6 million and $2.5 million and the associated income tax benefit realized was $0.5 million and $1.4 million for the twenty-six week periods ended July 29, 2006 and July 30, 2005, respectively.

Restricted Stock Units

Restricted stock unit awards are issued and measured at market value on the date of grant and generally become exercisable in three equal annual installments beginning one year from the date of grant.

Information about the Company’s restricted stock unit activity during the twenty-six week period ended July 29, 2006 is as follows:

	Number of Restricted Shares		Weighted-average Grant Date Fair Value
Unvested restricted stock units, January 28, 2006	—			—
Granted	398		$	20.19
Vested	—			—
Forfeited	(18	)	$	20.19
Unvested restricted stock units, July 29, 2006	380		$	20.19

Note 3—Net Earnings Per Share

Basic net earnings per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net earnings per share includes dilutive common share equivalents comprised of shares issuable under the Company’s equity award compensation plans. Net earnings and the weighted-average number of common shares used to compute basic and diluted net earnings per share are presented below:

	Thirteen weeks ended				Twenty-six weeks ended
	July 29, 2006		July 30, 2005		July 29, 2006		July 30, 2005
Net earnings	$	9,915	$	18,030	$	20,943	$	35,269
Common shares, basic		57,188		57,778		57,414		57,742
Dilutive effect of stock options and restricted stock units		488		739		430		818
Common shares, diluted		57,676		58,517		57,844		58,560

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Options to purchase common shares that were outstanding, but were not included in the computation of diluted net earnings per share because of their anti-dilutive impact, were 2,825 and 2,830 for the thirteen and twenty-six week periods ended July 29, 2006, and 2,386 and 1,258 for the thirteen and twenty-six week periods ended July 30, 2005, respectively.

Note 4—Senior Credit Facility

The Company’s senior credit facility consists of a $350 million secured revolving credit facility (the “revolving credit facility”) expiring on March 31, 2011, although the Company has the option to extend the expiration for an additional one-year period, subject to the satisfaction of certain conditions. The Company also has the option to increase the amount of credit available under the revolving credit facility, subject to the satisfaction of certain conditions, by an additional $100 million.

Borrowings under the revolving credit facility are secured by substantially all of the personal property assets of the Company and its subsidiaries and bear interest at the Company’s option, at the agent bank’s base rate plus a margin of up to 0.5%, or LIBOR plus a margin of up to 1.625%, in each case based on the Company’s leverage ratio at the time. In addition, the Company has pledged all of the capital stock of its domestic subsidiaries to secure the Company’s obligations under the revolving credit facility. The Company incurs a fee of up to 1.8% on letters of credit issued under the revolving credit facility and a fee of up to 0.25% on the unused commitment under the revolving credit facility, which is reduced for any outstanding letters of credit. The credit agreement contains certain affirmative and negative covenants related to, among other things, indebtedness, capital expenditures, fixed charges coverage and total leverage. The revolving credit facility specifies a number of events of default (some of which are subject to applicable cure periods), including, among others, the failure to make payments when due, defaults under other agreements or instruments of indebtedness and noncompliance with covenants. Upon the occurrence of an event of default, the lenders may terminate the facility and declare all amounts outstanding to be immediately due and payable.

At July 29, 2006, the Company was in compliance with all of the covenants under the revolving credit facility, and the outstanding balance of the revolving credit facility was $55.0 million. Amounts outstanding under the revolving credit facility are due in full on March 31, 2011. The weighted-average interest rate at July 29, 2006 on the borrowings under the revolving credit facility was 6.3%. At July 29, 2006, the Company had outstanding $35.6 million in letters of credit used for general business purposes, which reduced the availability under the revolving credit facility to $259.4 million.

Note 5—Senior Subordinated Notes

The senior subordinated notes mature on November 1, 2011, and interest accrues at a rate of 10.75% per annum and is payable semi-annually in arrears. The Company may redeem the senior subordinated notes at its option at any time after November 1, 2006, in whole or in part, based upon an agreed upon schedule of redemption prices. The redemption prices begin at 105.375% of the principal amount at November 1, 2006 and decline thereafter through November 1, 2009. The indenture governing the senior subordinated notes specifies a number of events of default (many of which are subject to applicable cure periods), including, among others, the failure to make payments when due, defaults under other agreements or instruments of indebtedness and noncompliance with covenants. Upon the occurrence of an event of default, the holders of the notes may declare all amounts outstanding to be immediately due and payable.

In the first quarter of fiscal 2005 the Company repurchased $14.7 million in aggregate principal amount of its senior subordinated notes and recorded debt retirement costs totaling $2.4 million, consisting primarily of a prepayment premium. As of July 29, 2006, there was $89.3 million in aggregate principal amount of the senior subordinated notes outstanding.

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Note 6—Shareholders’ Equity

In March 2006, the Company’s Board of Directors authorized the repurchase of up to $100 million of its common stock. During the first quarter of fiscal 2006, the Company repurchased approximately 830 shares for a total price of approximately $19.2 million. The Company did not repurchase any shares during the second quarter of fiscal 2006.

Note 7—Agreement and Plan of Merger

On July 13, 2006, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Rover Holdings Corp., a Delaware corporation (the “Buyer”), and Rover Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of the Buyer. According to the terms of the Merger Agreement, Rover Acquisition Corp. will be merged with and into the Company, with the Company as the surviving corporation (the “Merger”). Pursuant to the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of the Company’s common stock, par value $0.001 per share, will be canceled and converted automatically into the right to receive $29.00 in cash, without interest. The aggregate purchase price approximates $1.8 billion, including assumed debt.

Completion of the Merger is subject to customary closing conditions including, among others, approval by the Company’s stockholders and the absence of any order or injunction prohibiting the consummation of the Merger. The Company currently anticipates completing the Merger by the fourth quarter of 2006. However, there can be no assurance that the Merger will be completed.

The Merger Agreement contains certain termination rights for both the Company and the Buyer. The Merger Agreement provides that, upon termination under specified circumstances, the Company would be required to pay the Buyer a termination fee of either $30 million or $50 million, depending on the conditions relating to the termination and, in addition, to reimburse the Buyer for an amount not to exceed $3 million for expenses incurred. The Company’s reimbursement of the Buyer would not reduce the amount of any required termination fee payable by the Company. The Merger Agreement further provides that, upon termination under specified circumstances, the Buyer would be required to pay the Company a termination fee of $50 million.

If consummated, the Merger will represent a change in control under the indenture governing the senior subordinated notes. Following any change of control, the indenture requires the Company to offer to repurchase the notes at an offer price in cash equal to 101% of the principal amount, plus accrued and unpaid interest. Further, upon any written request by Buyer, the Merger Agreement requires the Company to offer to purchase all of the notes on price terms that are acceptable to Buyer. Further, the Buyer may elect, immediately prior to the closing of the Merger, to require a covenant defeasance of the notes pursuant to the indenture governing the notes.

Note 8—Contingencies

In April 2005, the Company and certain senior Company officers were named as defendants in several purported class actions filed in United States District Court for the Southern District of California alleging violations of Sections 10 and 20 of the Securities Exchange Act of 1934. The named plaintiffs purport to represent a class of purchasers of the Company’s stock during the period November 18, 2004 to April 14, 2005, and allege that during such period the defendants misrepresented the Company’s financial position and that the plaintiff and the purported class of purchasers during that period were damaged in unspecified amounts by paying artificially and falsely inflated prices for the Company’s stock. In October 2005, a consolidated complaint was filed extending the class period from August 18, 2004 to August 25, 2005, adding additional but similar causes of action, and naming additional defendants, including other senior Company officers, several former and current members of the Company’s Board of Directors, and two former stockholders of the Company. On August 1, 2006 the Court issued its order granting in part and denying in part defendants’ motion to dismiss. The Court dismissed (a) the claims against the former stockholders and certain officers and directors and (b) certain

11

of plaintiffs’ alleged operational misrepresentation claims, but denied the motion to dismiss with respect to the alleged accounting misrepresentation claims made against the Company and certain of its directors and senior officers. It is expected that discovery will commence shortly after a discovery conference currently anticipated for September. The Company has tendered these matters to its insurance carriers.

In April 2005, an alleged owner of the Company’s stock, derivatively sued all of the Company’s directors and certain senior Company officers, purportedly on behalf of the Company, alleging that such officers and directors engaged in breaches of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment and other violations of California law during the period November 18, 2004 through April 22, 2005. The complaints, filed in Superior Court of the State of California for the County of San Diego and subsequently consolidated, seek to recover on behalf of the Company alleged unspecified damages sustained by the Company as a result of such alleged actions, treble damages, disgorgement of profits from the sale of the Company’s securities and benefits and compensation obtained by the individual defendants, and extraordinary equitable and/or injunctive relief as permitted by law. In August 2005, the defendants moved to dismiss the consolidated complaint on the ground that the stockholders had failed to make a demand on the Company’s Board and failed to adequately allege that a demand was excused. The Court granted the motion but gave the plaintiffs leave to amend. On July 7, 2006 the Court granted leave to plaintiffs to file a third amended complaint but expressly noted that it was without prejudice to defendants demurring to that amended complaint. A hearing on that demurrer is set for September 1, 2006. Plaintiffs have recently filed a motion for leave to file a fourth amended complaint and a hearing on that motion is scheduled for September 29, 2006. That motion seeks to add allegations against the Company’s Board of Directors relating to the recent acquisition announcement. Defendants anticipate plaintiffs withdrawing that motion but, if necessary, will oppose it on a variety of grounds. The Company has tendered these matters to its insurance carriers.

In June 2005, the Company was named as a defendant in a purported class action filed in the Superior Court of the State of California for the County of Los Angeles alleging violations of the California Labor Code. The named plaintiffs, Wayne Boyd, Anthony Castro, Gilbert Hernandez, and Daniel Lepkosky, purport to represent all current and former hourly, non-exempt employees of the Company’s California stores from June 27, 2001 to the present. These plaintiffs allege that during this period they were not paid all wages, were not paid overtime, were not authorized and permitted to take rest breaks as required by law, were not provided meal breaks as required by law, were not paid “reporting time” pay, and were not paid all wages upon separation from employment. The complaint seeks unspecified monetary damages in the form of unpaid wages, penalties and other relief. In March 2006, Plaintiffs Hernandez and Boyd requested that their claims against the Company be dismissed and the Court approved this request. The Court heard Plaintiff’s Motion for Class Certification on July 28, 2006. At the hearing, the Court denied class certification on Plaintiffs’ meal break claim and rest period claim, the reporting time claim having been abandoned. The Court took the motion under submission as to Plaintiffs’ overtime claim and scheduled a hearing date to determine the threshold legal issue of whether the Company is required to pay overtime for those employees who work in two different workdays during a single work shift. As a result of the Court’s ruling, the remaining two Plaintiffs may pursue only their individual claims for meal periods and rest breaks.

In March 2006, the Company was named as a defendant in a purported class action filed in the Superior Court of the State of California for the County of Santa Clara alleging violations of the California Labor Code. The named plaintiff, Martha Rodriguez, purports to represent all current and former General Managers of the Company’s California stores from March 20, 2002 to the present. This plaintiff alleges that she was improperly classified as exempt from overtime compensation, not given adequate itemized wage statements, and not provided the meal periods nor authorized and permitted to take the rest breaks required for non-exempt employees. The complaint seeks unspecified monetary damages in the form of unpaid wages, penalties and other relief.

12

In July 2006, two class action complaints were filed on behalf of our stockholders in Superior Court of California, County of San Diego, naming as defendants, among others, the Company and members of the Company’s Board of Directors. The complaints allege, among other things, that the Company’s directors breached their fiduciary duties in connection with the proposed merger transaction by approving a transaction that would purportedly provide certain Company stockholders and directors with preferential treatment at the expense of the Company’s other stockholders.

Although there can be no assurance that unfavorable outcomes in the foregoing matters would not have a material adverse effect on the Company’s financial position or results of operations, management believes the claims are without merit, strong defenses exist, and management intends to vigorously defend against these actions. The Company has not recorded any accrual for contingent liability associated with the legal proceedings described above based on management’s belief that a liability, while possible, is not probable. Further, any possible range of loss cannot be estimated at this time.

The Company is involved in other routine litigation arising in the ordinary course of its business. While the results of such litigation cannot be predicted with certainty, the Company believes that the final outcome of such matters will not have a material adverse effect on its consolidated financial position or results of operations in any future period.

Note 9—Supplemental Guarantor Condensed Consolidating Financial Information

Effective January 13, 2005, the Company implemented a new holding company structure. The restructuring was accomplished through a merger pursuant to which all of the stockholders of PETCO Animal Supplies, Inc. at the effective time of the merger became stockholders of the new parent holding company, and PETCO Animal Supplies, Inc. became a wholly-owned subsidiary of the new parent holding company and changed its name to PETCO Animal Supplies Stores, Inc. The business operations of the Company have not changed as a result of the restructuring. The new parent holding company has taken the PETCO Animal Supplies, Inc. name and trades under the same symbol on the NASDAQ National Market.

The Company’s senior subordinated notes are issued by PETCO Animal Supplies Stores, Inc. (the subsidiary issuer) and are guaranteed by the parent company and certain subsidiaries of the parent company (the guarantor subsidiaries) on a full and unconditional basis. Each of the guarantor subsidiaries is, directly or indirectly, 100% owned by the subsidiary issuer, and the guarantees are joint and several. One of the Company’s subsidiaries (the non-guarantor subsidiary) does not guarantee such debt.

The following tables present the condensed consolidating balance sheet information of PETCO Animal Supplies, Inc. as of July 29, 2006 and January 28, 2006, the related condensed consolidating statement of operation and of cash flow information for each of the thirteen and twenty-six week periods ended July 29, 2006 and July 30, 2005.

13

PETCO ANIMAL SUPPLIES, INC.

CONDENSED CONSOLIDATING BALANCE SHEET INFORMATION

July 29, 2006

(unaudited, in thousands)

	PETCO Animal Supplies, Inc. Parent Company Guarantor			PETCO Animal Supplies Stores, Inc. Subsidiary Issuer		Guarantor Subsidiaries			Non-Guarantor Subsidiary		Reclassifications and Eliminations			PETCO Animal Supplies, Inc. and Subsidiaries
ASSETS
Current assets:
Cash and cash equivalents	$	—		$	23,321	$	99		$	—	$	—		$	23,420
Receivables, net		—			3,859		16,151			—		—			20,010
Merchandise inventories		—			182,554		13,299			—		—			195,853
Deferred tax assets		—			18,145		—			—		—			18,145
Other current assets		—			16,725		1,836			—		—			18,561
Total current assets		—			244,604		31,385			—		—			275,989
Fixed assets, net		—			342,701		38,614			—		—			381,315
Goodwill		—			—		41,898			—		—			41,898
Intercompany investments and advances		164,911			431,684		—			—		(596,595	)		—
Other assets		—			18,855		1,298			—		—			20,153
Total assets	$	164,911		$	1,037,844	$	113,195		$	—	$	(596,595	)	$	719,355
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3		$	35,828	$	52,678		$	—	$	—		$	88,509
Intercompany payables		(64,299	)		443,669		(379,370	)		—		—			—
Accrued salaries and employee benefits		—			77,928		3,013			—		—			80,941
Accrued expenses and other liabilities		—			76,054		8,202			—		—			84,256
Current portion of long-term debt		—			5,600		(5,600	)		—		—			—
Total current liabilities		(64,296	)		639,079		(321,077	)		—		—			253,706
Senior credit facility		—			55,000		—			—		—			55,000
Senior subordinated notes payable		—			89,267		—			—		—			89,267
Deferred tax liabilities		—			16,936		—			—		—			16,936
Deferred rent and other liabilities		—			72,651		2,588			—		—			75,239
Total liabilities		(64,296	)		872,933		(318,489	)		—		—			490,148
Stockholders’ equity		229,207			164,911		431,684			—		(596,595	)		229,207
Total liabilities and stockholders’ equity	$	164,911		$	1,037,844	$	113,195		$	—	$	(596,595	)	$	719,355

14

PETCO ANIMAL SUPPLIES, INC.

CONDENSED CONSOLIDATING BALANCE SHEET INFORMATION

January 28, 2006

(in thousands)

	PETCO Animal Supplies, Inc. Parent Company Guarantor			PETCO Animal Supplies Stores, Inc. Subsidiary Issuer		Guarantor Subsidiaries			Non-Guarantor Subsidiary		Reclassifications and Eliminations			PETCO Animal Supplies, Inc. and Subsidiaries
ASSETS
Current assets:
Cash and cash equivalents	$	—		$	39,424	$	100		$	—	$	—		$	39,524
Receivables, net		—			3,171		17,251			—		—			20,422
Merchandise inventories		—			170,540		12,796			—		—			183,336
Deferred tax assets		—			16,737		—			—		—			16,737
Other current assets		—			13,844		28			—		—			13,872
Total current assets		—			243,716		30,175			—		—			273,891
Fixed assets, net		—			344,771		32,623			—		—			377,394
Goodwill		—			—		40,227			—		—			40,227
Intercompany investments and advances		143,967			400,583		—			—		(544,550	)		—
Other assets		—			16,575		1,588			—		—			18,163
Total assets	$	143,967		$	1,005,645	$	104,613		$	—	$	(544,550	)	$	709,675
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	—		$	31,923	$	58,911		$	—	$	—		$	90,834
Intercompany payables		(72,871	)		435,992		(363,121	)		—		—			—
Accrued salaries and employee benefits		—			73,708		2,613			—		—			76,321
Accrued expenses and other liabilities		—			73,624		8,749			—		—			82,373
Current portion of long-term debt		—			7,355		(5,600	)		—		—			1,755
Total current liabilities		(72,871	)		622,602		(298,448	)		—		—			251,283
Senior credit facility		—			60,000		—			—		—			60,000
Senior subordinated notes payable		—			89,267		—			—		—			89,267
Deferred tax liabilities		—			22,579		—			—		—			22,579
Deferred rent and other liabilities		—			67,230		2,478			—		—			69,708
Total liabilities		(72,871	)		861,678		(295,970	)		—		—			492,837
Stockholders’ equity		216,838			143,967		400,583			—		(544,550	)		216,838
Total liabilities and stockholders’ equity	$	143,967		$	1,005,645	$	104,613		$	—	$	(544,550	)	$	709,675

15

PETCO ANIMAL SUPPLIES, INC.

CONDENSED CONSOLIDATING STATEMENT OF OPERATION INFORMATION

For the thirteen week period ended July 29, 2006

(unaudited, in thousands)

	PETCO Animal Supplies, Inc. Parent Company Guarantor		PETCO Animal Supplies Stores, Inc. Subsidiary Issuer			Guarantor Subsidiaries			Non-Guarantor Subsidiary		Reclassifications and Eliminations			PETCO Animal Supplies, Inc. and Subsidiaries
Net sales	$	—	$	493,139		$	351,903		$	—	$	(313,908	)	$	531,134
Cost of sales and occupancy costs		—		351,465			283,023			—		(271,231	)		363,257
Gross profit		—		141,674			68,880			—		(42,677	)		167,877
Selling, general and administrative expenses		—		129,014			54,332			—		(42,676	)		140,670
Merger-related costs		—		4,726			—			—		—			4,726
Operating income		—		7,934			14,548			—		(1	)		22,481
Interest expense, net		—		3,740			(60	)		—		—			3,680
Earnings before income taxes		—		4,194			14,608			—		(1	)		18,801
Income taxes		—		8,886			—			—		—			8,886
Earnings before equity in earnings of subsidiaries		—		(4,692	)		14,608			—		(1	)		9,915
Equity in earnings of subsidiaries		9,916		14,608			—			—		(24,524	)		—
Net earnings	$	9,916	$	9,916		$	14,608		$	—	$	(24,525	)	$	9,915

PETCO ANIMAL SUPPLIES, INC.

CONDENSED CONSOLIDATING STATEMENT OF OPERATION INFORMATION

For the thirteen week period ended July 30, 2005

(unaudited, in thousands)

	PETCO Animal Supplies, Inc. Parent Company Guarantor		PETCO Animal Supplies Stores, Inc. Subsidiary Issuer		Guarantor Subsidiaries			Non-Guarantor Subsidiary		Reclassifications and Eliminations			PETCO Animal Supplies, Inc. and Subsidiaries
Net sales	$	—	$	448,138	$	322,959		$	—	$	(288,351	)	$	482,746
Cost of sales and occupancy costs		—		313,770		257,409			—		(248,435	)		322,744
Gross profit		—		134,368		65,550			—		(39,916	)		160,002
Selling, general and administrative expenses		—		117,093		49,306			—		(39,916	)		126,483
Operating income		—		17,275		16,244			—		—			33,519
Interest expense, net		—		3,666		(47	)		—		—			3,619
Earnings before income taxes		—		13,609		16,291			—		—			29,900
Income taxes		—		11,870		—			—		—			11,870
Earnings before equity in earnings of subsidiaries		—		1,739		16,291			—		—			18,030
Equity in earnings of subsidiaries		18,030		16,291		—			—		(34,321	)		—
Net earnings	$	18,030	$	18,030	$	16,291		$	—	$	(34,321	)	$	18,030

16

PETCO ANIMAL SUPPLIES, INC.

CONDENSED CONSOLIDATING STATEMENT OF OPERATION INFORMATION

For the twenty-six week period ended July 29, 2006

(unaudited, in thousands)

	PETCO Animal Supplies, Inc. Parent Company Guarantor		PETCO Animal Supplies Stores, Inc. Subsidiary Issuer			Guarantor Subsidiaries			Non-Guarantor Subsidiary		Reclassifications and Eliminations			PETCO Animal Supplies, Inc. and Subsidiaries
Net sales	$	—	$	976,243		$	696,089		$	—	$	(620,206	)	$	1,052,126
Cost of sales and occupancy costs		—		693,948			555,906			—		(534,433	)		715,421
Gross profit		—		282,295			140,183			—		(85,773	)		336,705
Selling, general and administrative expenses		—		264,134			109,203			—		(85,773	)		287,564
Merger-related costs		—		4,726			—			—		—			4,726
Operating income		—		13,435			30,980			—		—			44,415
Interest expense, net		—		7,293			(121	)		—		—			7,172
Earnings before income taxes		—		6,142			31,101			—		—			37,243
Income taxes		—		16,300			—			—		—			16,300
Earnings before equity in earnings of subsidiaries		—		(10,158	)		31,101			—		—			20,943
Equity in earnings of subsidiaries		20,943		31,101			—			—		(52,044	)		—
Net earnings	$	20,943	$	20,943		$	31,101		$	—	$	(52,044	)	$	20,943

PETCO ANIMAL SUPPLIES, INC.

CONDENSED CONSOLIDATING STATEMENT OF OPERATION INFORMATION

For the twenty-six week period ended July 30, 2005

(unaudited, in thousands)

	PETCO Animal Supplies, Inc. Parent Company Guarantor		PETCO Animal Supplies Stores, Inc. Subsidiary Issuer		Guarantor Subsidiaries			Non-Guarantor Subsidiary		Reclassifications and Eliminations			PETCO Animal Supplies, Inc. and Subsidiaries
Net sales	$	—	$	893,519	$	643,932		$	—	$	(575,111	)	$	962,340
Cost of sales and occupancy costs		—		624,377		511,641			—		(495,733	)		640,285
Gross profit		—		269,142		132,291			—		(79,378	)		322,055
Selling, general and administrative expenses		—		235,452		97,840			—		(79,378	)		253,914
Operating income		—		33,690		34,451			—		—			68,141
Interest expense, net				7,302		(97	)							7,205
Debt retirement costs		—		2,447		—			—		—			2,447
Earnings before income taxes		—		23,941		34,548			—		—			58,489
Income taxes		—		23,220		—			—		—			23,220
Earnings before equity in earnings of subsidiaries		—		721		34,548			—		—			35,269
Equity in earnings of subsidiaries		35,269		34,548		—			—		(69,817	)		—
Net earnings	$	35,269	$	35,269	$	34,548		$	—	$	(69,817	)	$	35,269

17

PETCO ANIMAL SUPPLIES, INC.

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOW INFORMATION

For the twenty-six week period ended July 29, 2006

(unaudited, in thousands)

	PETCO Animal Supplies, Inc. Parent Company Guarantor			PETCO Animal Supplies Stores, Inc. Subsidiary Issuer			Guarantor Subsidiaries			Non-Guarantor Subsidiary		Reclassifications and Eliminations			PETCO Animal Supplies, Inc. and Subsidiaries
Cash flows from operating activities:
Net earnings	$	20,943		$	20,943		$	31,101		$	—	$	(52,044	)	$	20,943
Adjustments to reconcile net earnings to net cash provided by operating activities		(4,525	)		10,779			(22,449	)		—		52,044			35,849
Net cash provided by operating activities		16,418			31,722			8,652			—		—			56,792
Cash flows from investing activities:
Additions to fixed assets		—			(36,641	)		(8,653	)		—		—			(45,294	)
Net cash invested in acquisitions		—			(3,912	)										(3,912	)
Net cash used in investing activities		—			(40,553	)		(8,653	)		—		—			(49,206	)
Cash flows from financing activities:
Borrowings under long-term debt agreements		—			259,300			—			—		—			259,300
Repayments of long-term debt		—			(266,056	)		—			—		—			(266,056	)
Debt issuance costs		—			(516	)										(516	)
Repurchase of common stock		(19,164	)		—											(19,164	)
Net proceeds from issuance of common stock		2,639			—			—			—		—			2,639
Excess tax benefit realized from stock-based compensation awards		107			—			—			—		—			107
Net cash used in financing activities		(16,418	)		(7,272	)		—			—		—			(23,690	)
Net decrease in cash and cash equivalents		—			(16,103	)		(1	)		—		—			(16,104	)
Cash and cash equivalents at beginning of year		—			39,424			100			—		—			39,524
Cash and cash equivalents at end of period	$	—		$	23,321		$	99		$	—	$	—		$	23,420

PETCO ANIMAL SUPPLIES, INC.

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOW INFORMATION

For the twenty-six week period ended July 30, 2005

(unaudited, in thousands)

	PETCO Animal Supplies, Inc. Parent Company Guarantor			PETCO Animal Supplies Stores, Inc. Subsidiary Issuer			Guarantor Subsidiaries			Non-Guarantor Subsidiary		Reclassifications and Eliminations			PETCO Animal Supplies, Inc. and Subsidiaries
Cash flows from operating activities:
Net earnings	$	35,269		$	35,269		$	34,548		$	—	$	(69,817	)	$	35,269
Adjustments to reconcile net earnings to net cash provided by operating activities		(35,269	)		35,744			(27,722	)		—		69,817			42,570
Net cash provided by operating activities		—			71,013			6,826			—		—			77,839
Cash flows from investing activities:
Additions to fixed assets		—			(61,894	)		(6,921	)		—		—			(68,815	)
Net cash used in investing activities		—			(61,894	)		(6,921	)		—		—			(68,815	)
Cash flows from financing activities:
Borrowings under long-term debt agreements		—			28,100			—			—		—			28,100
Repayments of long term debt		—			(43,072	)		—			—		—			(43,072	)
Net proceeds from issuance of common stock		—			2,535			—			—		—			2,535
Net cash used in financing activities		—			(12,437	)		—			—		—			(12,437	)
Net decrease in cash and cash equivalents		—			(3,318	)		(95	)		—		—			(3,413	)
Cash and cash equivalents at beginning of year		—			36,590			225			—		—			36,815
Cash and cash equivalents at end of period	$	—		$	33,272		$	130		$	—	$	—		$	33,402

18

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following information should be read in conjunction with the financial statements and the related notes included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with the financial statements and related notes for the year ended January 28, 2006 and the related “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the fiscal year ended January 28, 2006. We also urge you to review and consider our disclosures describing various risks that may affect our business, which are set forth in Exhibit 99.1 to this Quarterly Report on Form 10-Q.

Executive Summary

PETCO is a leading specialty retailer of premium pet food, supplies and services. At July 29, 2006, we operated 817 stores in 49 states and the District of Columbia. Our strategy is to offer our customers a complete assortment of pet-related products and services at fair prices, with superior levels of customer service at convenient locations. Our stores offer a fun, exciting shopping experience and generally range in size from 12,000 to 15,000 square feet.

During the twenty-six week period ended July 29, 2006, we increased our net sales by 9.3% over the prior year period, to $1.1 billion, and our net earnings were $20.9 million. We plan to further enhance our financial performance in future years: (1) with innovative store formats that offer superior customer service, convenience and a fun and exciting shopping environment; (2) through strategic expansion in both existing and new markets; (3) by targeting merchandising efforts to drive greater sales of premium pet foods, higher-margin pet accessories, supplies and services; (4) by generating comparable store net sales growth, partly through our continuing initiative of remodeling certain stores; (5) by expanding our store base, which offers economies of scale and purchasing efficiencies; and (6) with broad product offering of over 10,000 high quality pet-related products, most of which are not found in typical supermarkets or mass merchants.

We plan to increase our aggregate store square footage by approximately 8% to 10% per year on a long-term basis. Our year-over-year increase in square footage in fiscal 2005 was 11.8%, and our total store square footage at January 28, 2006 was approximately 11.3 million square feet. Our total store square footage at July 29, 2006 was approximately 11.8 million square feet. We plan to open approximately 90 new stores in fiscal 2006, or approximately 75 stores net of relocations and closings. In fiscal 2006, we intend to remodel up to 35 of our existing stores, and we plan to remodel additional existing stores in the future. We also plan to relocate certain existing stores and close certain under-performing stores. As a result of our store expansion strategy, operating results in any future year may reflect lower average store contribution and operating margins due to initially lower anticipated sales volumes of newer stores.

The pet food, supplies and services business is highly competitive. This competition can be categorized into three different segments: (1) supermarkets, warehouse clubs and mass merchants; (2) specialty pet store chains; and (3) traditional pet stores and independent service providers. Our strategy is to focus our assortment on specialty products and premium pet foods, which minimizes the potential overlap with supermarkets, warehouse clubs and mass merchants. We believe that we compete effectively within our various geographic areas. However, some of our competitors are much larger in terms of sales volume and have access to greater capital and management resources than we do.

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Results of Operations

The following table sets forth selected results of our operations expressed as a percentage of net sales for the periods indicated. As a result of operational and strategic changes, period-to-period comparisons of financial results may not be meaningful and the results of our operations for historical periods may not be indicative of our future results.

	Thirteen weeks ended		Twenty-six weeks ended
	July 29, 2006	July 30, 2005	July 29, 2006	July 30, 2005
Net sales	100.0%	100.0%	100.0%	100.0%
Cost of sales and occupancy costs	68.4	66.9	68.0	66.5
Gross profit	31.6	33.1	32.0	33.5
Selling, general and administrative expenses	26.5	26.2	27.3	26.4
Merger-related costs	0.9	—	0.4	—
Operating income	4.2	6.9	4.2	7.1
Interest expense, net	0.7	0.7	0.7	0.7
Debt retirement costs	—	—	—	0.3
Earnings before income taxes	3.5	6.2	3.5	6.1
Income taxes	1.7	2.5	1.5	2.4
Net earnings	1.9%	3.7%	2.0%	3.7%

Thirteen Week Periods Ended July 29, 2006 Compared With Thirteen Week Periods Ended July 30, 2005

Net sales increased 10.0% to $531.1 million for the thirteen-week period ended July 29, 2006 from $482.7 million for the thirteen-week period ended July 30, 2005. The increase in net sales resulted primarily from the comparable store net sales increase of 3.4% and the increase in our store square footage of approximately 9.8% from July 30, 2005 to July 29, 2006. We added 79 new stores since the prior year second quarter, or 63 stores net of relocations and closings. The increase in comparable store net sales accounted for approximately $16.4 million, or approximately 33.8%, of the net sales increase, while the net increase in our store base accounted for approximately $32.0 million, or approximately 66.2%, of the net sales increase. The comparable store net sales increase was primarily attributable to an increase in average sales per transaction and the contribution of newer stores.

As previously discussed in our 2005 annual report on Form 10-K, beginning in the first quarter of fiscal 2006, we report our comparable store net sales under a refined methodology, reflecting the impact of non-point-of-sale (“non-POS”) revenue transactions. The refined methodology reflects vendor’s sales incentives recorded as a reduction of sales. Refining the methodology for calculating our comparable store net sales percentage change does not impact reported net sales, net earnings or cash flows.

Gross profit, defined as net sales less cost of sales and store occupancy costs, increased 4.9% to $167.9 million for the thirteen-week period ended July 29, 2006 from $160.0 million for the prior year period. Gross profit was 31.6% compared to 33.1% in the prior year period. A decrease in gross profit of approximately 0.9% of net sales was due to increased store occupancy and distribution costs as a percentage of net sales primarily related to the Company’s increased number of store openings in recent years, higher utility costs and gas prices, as well as investments in the supply chain. The remaining decrease was due primarily to lower levels of vendor support, higher levels of inventory shrinkage and strong growth in lower-margin service and food sales.

Selling, general and administrative expenses increased 11.2% to $140.7 million for the thirteen-week period ended July 29, 2006 from $126.5 million in the prior year period. As a percentage of net sales, selling, general and administrative expenses increased to 26.5% from 26.2% in the prior year period. An increase of approximately 0.5% of net sales was related to stock-based compensation expense recorded upon the adoption of

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Statement of Financial Accounting Standards No. 123(R), Share-based Payments (“SFAS No. 123(R)”) in the first quarter of fiscal 2006. Partially offsetting this increase were decreases in store and corporate operating expenses as a percentage of net sales.

During the thirteen week period ended July 29, 2006, we incurred merger-related costs of approximately $4.7 million associated with the agreement and plan of merger announced in July 2006.

Operating income in the thirteen-week period ended July 29, 2006 decreased 32.9% to $22.5 million, or 4.2% of net sales, from $33.5 million, or 6.9% of net sales, in the prior year period.

Net interest expense was $3.7 million for the thirteen-week period ended July 29, 2006, compared with $3.6 million for the thirteen week period ended July 30, 2005.

Income taxes for the thirteen-week period ended July 29, 2006 were $8.9 million, compared with $11.9 million in the prior year period. Income taxes as a percentage of earnings before income taxes increased to 47.3% in the thirteen-week period ended July 29, 2006 from 39.7% in the prior year period. This increase is primarily due to the non-deductibility of merger-related costs for purposes of state and federal taxes, partially offset by a decrease associated with certain discrete tax items in the second quarter of fiscal 2006.

Net earnings in the thirteen-week period ended July 29, 2006 decreased 45.0% to $9.9 million, or $0.17 per diluted share, compared with net earnings of $18.0 million, or $0.31 per diluted share, in the prior year period.

Twenty-six Week Period Ended July 29, 2006 Compared With Twenty-six Week Period Ended July 30, 2005

Net sales increased 9.3% to $1.1 billion for the twenty-six week period ended July 29, 2006 from $962.3 million for the twenty-six week period ended July 30, 2005. The increase in net sales resulted primarily from the comparable store net sales increase of 2.8% and the increase in our square footage of 9.8% from July 30, 2005 to July 29, 2006. We added 79 new stores since the prior year second quarter, or 63 stores net of relocations and closings. The increase in comparable store net sales accounted for approximately $26.8 million, or 29.8%, of the net sales increase, while the net increase in our store base accounted for approximately $63.0 million, or 70.2%, of the net sales increase. The comparable store net sales increase was primarily attributable to an increase in average sales per transaction and the contribution of newer stores.

Gross profit, defined as net sales less cost of sales and store occupancy costs, increased 4.5% to $336.7 million for the twenty-six week period ended July 29, 2006 from $322.1 million for the prior year period. Gross profit was 32.0% compared to 33.5% in the prior year period. A decrease in gross profit of approximately 0.8% of net sales was due to increased store occupancy and distribution costs as a percentage of net sales primarily related to the Company’s increased number of store openings in recent years, higher utility costs and gas prices, as well as investments in supply chain. The remaining decrease was due primarily to lower levels of vendor support, higher levels of inventory shrinkage and strong growth in lower-margin service and food sales.

Selling, general and administrative expenses increased 13.3% to $287.6 million in the twenty-six week period ended July 29, 2006 from $253.9 million in the prior year period. As a percentage of net sales, selling, general and administrative expenses increased to 27.3% from 26.4% in the prior year period. An increase of approximately 0.7% of net sales was related to stock-based compensation expense recorded upon the adoption of Statement of Financial Accounting Standards No. 123(R), Share-based Payments (“SFAS No. 123(R)”) in the first quarter of fiscal 2006. The remaining increase was primarily due to planned increases in store-level payroll to support improved customer service.

During the twenty-six week period ended July 29, 2006, we incurred merger-related costs of approximately $4.7 million associated with the agreement and plan of merger announced in July 2006.

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Operating income in the twenty-six week period ended July 29, 2006 decreased 34.8% to $44.4 million, or 4.2% of net sales, from $68.1 million, or 7.1% of net sales, in the prior year period.

Net interest expense was $7.2 million for the twenty-six week periods ended July 29, 2006 and July 30, 2005.

During the twenty-six week period ended July 30, 2005, we incurred debt retirement costs totaling $2.4 million, consisting primarily of a purchase premium, related to the repurchase of $14.7 million in principal amount of our 10.75% senior subordinated notes in the first quarter of fiscal 2005.

Income taxes for the twenty-six week period ended July 29, 2006 were $16.3 million, compared with $23.2 million in the prior year period. Income taxes as a percentage of earnings before income taxes increased to 43.8% in the twenty-six week period ended July 29, 2006 from 39.7% in the prior year period. This increase is primarily due to the non-deductibility of merger-related costs for purposes of state and federal taxes, partially offset by a decrease associated with certain discrete tax items in the second quarter of fiscal 2006.

Net earnings in the twenty-six week period ended July 29, 2006 decreased 40.6% to $20.9 million, or $0.36 per diluted share, compared with net earnings of $35.3 million, or $0.60 per diluted share, in the prior year period.

Liquidity and Capital Resources

We finance our operations and store expansion program primarily through cash generated from operating activities. Net cash provided by operating activities was $56.8 million and $77.8 million for the twenty-six week periods ended July 29, 2006 and July 30, 2005, respectively. Our sales are substantially on a cash basis, and therefore provide a significant source of liquidity. We use net operating cash principally to purchase inventory, to fund our capital expenditures and to make interest payments on our debt. A portion of the inventory we purchase is financed through vendor credit terms.

We use cash in investing activities primarily to construct leasehold improvements and purchase fixtures and equipment for new stores, to remodel certain existing stores and, to a lesser extent, to purchase distribution center and office fixtures, equipment and computer hardware and software in support of our distribution and administrative functions. We estimate that our purchases of fixed assets for fiscal 2006 will be between $110 million and $115 million which includes the opening of approximately 90 new stores and the estimated cost of remodeling up to 35 existing stores. Cash used in investing activities was $49.2 million and $68.8 million for the twenty-six week periods ended July 29, 2006 and July 30, 2005, respectively, and consisted primarily of capital expenditures.

Net cash used in financing activities was $23.7 million for the twenty-six-week period ended July 29, 2006 and consisted primarily of net repayments on our revolving credit facility of $5.0 million and repurchases of common stock of $19.2 million. Net cash used in financing activities was $12.4 for the twenty-six week period ended July 30, 2005 and consisted primarily of the repurchase of $14.7 million in principal amount of our 10.75% senior subordinated notes.

Our senior credit facility consists of a $350 million secured revolving credit facility, which we refer to as the revolving credit facility. The revolving credit facility expires on March 31, 2011, although we have the option to extend the expiration of the revolving credit facility for an additional one-year period, subject to the satisfaction of certain conditions. We have the option to increase the amount of credit available under the revolving credit facility, subject to the satisfaction of certain conditions, by an additional $100 million.

Borrowings under the revolving credit facility are secured by substantially all of our personal property assets and bear interest, at our option, at the agent bank’s base rate plus a margin of up to 0.5%, or LIBOR plus a margin of up to 1.625%, in each case based on our leverage ratio at the time. In addition, we have pledged all of

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the capital stock of our domestic subsidiaries to secure our obligations under the revolving credit facility. We incur a fee of up to 1.8% on letters of credit issued under the revolving credit facility and a fee of up to 0.25% on the unused commitment under the revolving credit facility, which is reduced for any outstanding letters of credit. The credit agreement contains certain affirmative and negative covenants related to, among other things, indebtedness, capital expenditures, fixed charges coverage and total leverage. The revolving credit facility specifies a number of events of default (some of which are subject to applicable cure periods), including, among others, the failure to make payments when due, defaults under other agreements or instruments of indebtedness and noncompliance with covenants. Upon the occurrence of an event of default, the lenders may terminate the facility and declare all amounts outstanding under the revolving credit facility to be immediately due and payable.

At July 29, 2006, we were in compliance with all of the covenants under our revolving credit facility, and the outstanding balance of our revolving credit facility was $55.0 million. Amounts outstanding under our revolving credit facility are due in full on March 31, 2011. The weighted-average interest rate at July 29, 2006 on the borrowings under our revolving credit facility was 6.3%. At July 29, 2006, we had outstanding $35.6 million in letters of credit used for general business purposes, which reduced the availability under the revolving credit facility to $259.4 million.

We have outstanding $89.3 million in aggregate principal amount of our 10.75% senior subordinated notes which mature on November 1, 2011. Interest on the senior subordinated notes accrues at a rate of 10.75% per annum and is payable semi-annually in arrears. The indenture governing the senior subordinated notes specifies a number of events of default (many of which are subject to applicable cure periods), including, among others, the failure to make payments when due, defaults under other agreements or instruments of indebtedness and noncompliance with covenants. Upon the occurrence of an event of default, the holders of the senior subordinated notes may declare all amounts outstanding to be immediately due and payable. We may redeem the senior subordinated notes at our option at any time on or after November 1, 2006, in whole or in part, based upon an agreed upon schedule of redemption prices. The redemption prices begin at 105.375% of the principal amount at November 1, 2006 and decline thereafter through November 1, 2009. We may from time to time pursue additional repurchases of some or all of our senior subordinated notes in open market purchases, negotiated transactions or otherwise. The scope of such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. Such repurchases may have a material effect on our liquidity, financial condition and results of operations.

In March 2006, our Board of Directors authorized the repurchase of up to $100 million of our common stock. During the first quarter of fiscal 2006, we repurchased approximately 830,000 shares for a total price of approximately $19.2 million. We did not repurchase any shares during the quarter ended July 29, 2006.

Agreement and Plan of Merger

On July 13, 2006, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Rover Holdings Corp., a Delaware corporation (the “Buyer”), and Rover Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of the Buyer. According to the terms of the Merger Agreement, Rover Acquisition Corp. will be merged with and into PETCO, with PETCO as the surviving corporation (the “Merger”). Pursuant to the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of our common stock, par value $0.001 per share, will be canceled and converted automatically into the right to receive $29.00 in cash, without interest. The aggregate purchase price approximates $1.8 billion, including assumed debt.

Completion of the Merger is subject to customary closing conditions including, among others, approval by our stockholders and the absence of any order or injunction prohibiting the consummation of the Merger. We currently anticipate completing the Merger by the fourth quarter of 2006. However, there can be no assurance that the Merger will be completed.

The Merger Agreement contains certain termination rights for both PETCO and the Buyer. The Merger Agreement provides that, upon termination under specified circumstances, we would be required to pay the

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Buyer a termination fee of either $30 million or $50 million, depending on the conditions relating to the termination and, in addition, to reimburse the Buyer for an amount not to exceed $3 million for expenses incurred. Our reimbursement of the Buyer would not reduce the amount of any required termination fee payable by us. The Merger Agreement further provides that, upon termination under specified circumstances, the Buyer would be required to pay us a termination fee of $50 million.

If consummated, the Merger will represent a change in control under the indenture governing our senior subordinated notes. Following any change of control, the indenture requires us to offer to repurchase the notes at an offer price in cash equal to 101% of the principal amount, plus accrued and unpaid interest. Further, upon any written request by Buyer, the Merger Agreement requires us to offer to purchase all of the notes on price terms that are acceptable to Buyer. Further, the Buyer may elect, immediately prior to the closing of the Merger, to require a covenant defeasance of the notes pursuant to the indenture governing the notes.

Off-Balance Sheet Arrangements

At July 29, 2006, we had outstanding $35.6 million in letters of credit used for general business purposes, which reduce the availability under our revolving credit facility.

At July 29, 2006 and January 28, 2006, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, variable interest or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risks relating to our operations result primarily from changes in short-term London Interbank Offered Rates, or LIBOR, as our revolving credit facility utilizes a portfolio of short-term LIBOR contracts. These LIBOR contracts are fixed rate instruments for a period of between one and six months, at our discretion. Our portfolio of LIBOR contracts vary in length and interest rate, such that adverse changes in short-term interest rates could affect our overall borrowing rate when contracts are renewed. We periodically evaluate alternative hedging strategies, although currently we have no hedges outstanding. We do not enter into derivative financial instruments for trading or speculative purposes.

All of the $55.0 million in debt under our revolving credit facility as of July 29, 2006 was subject to variable interest rate fluctuations. Based on this debt level, a hypothetical 10% increase in variable rates from the applicable rate at July 29, 2006 would increase net interest expense by approximately $0.3 million on an annual basis, and would decrease both earnings and cash flows for that annual period by a corresponding amount. We cannot predict market fluctuations in interest rates and their impact on debt, nor can there be any assurance that long-term fixed-rate debt will be available at favorable rates, if at all. Consequently, future results may differ materially from estimated results due to adverse changes in interest rates or debt availability.

We did not have any significant foreign exchange or other market risk at July 29, 2006.

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file pursuant to the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management

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recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitation on the Effectiveness of Internal Control

Because of its inherent limitations, internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives and may not prevent or detect all misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become ineffective because of changes in conditions or that the degree of compliance with established policies or procedures may deteriorate.

Part II. Other Information

Item 1. Legal Proceedings

In April 2005, we and certain senior Company officers were named as defendants in several purported class actions filed in United States District Court for the Southern District of California alleging violations of Sections 10 and 20 of the Securities Exchange Act of 1934. The named plaintiffs purport to represent a class of purchasers of our stock during the period November 18, 2004 to April 14, 2005, and allege that during such period the defendants misrepresented our financial position and that the plaintiff and the purported class of purchasers during that period were damaged in unspecified amounts by paying artificially and falsely inflated prices for our stock. In October 2005, a consolidated complaint was filed extending the class period from August 18, 2004 to August 25, 2005, adding additional but similar causes of action, and naming additional defendants, including other senior Company officers, several former and current members of our Board of Directors, and two former stockholders. On August 1, 2006 the Court issued its order granting in part and denying in part defendants’ motion to dismiss. The Court dismissed (a) the claims against the former stockholders and certain officers and directors and (b) certain of plaintiffs’ alleged operational misrepresentation claims, but denied the motion to dismiss with respect to the alleged accounting misrepresentation claims made against us and certain directors and senior officers. It is expected that discovery will commence shortly after a discovery conference currently anticipated for September. We have tendered these matters to our insurance carriers.

In April 2005, an alleged owner of our stock, derivatively sued all of our directors and certain senior Company officers, purportedly on our behalf, alleging that such officers and directors engaged in breaches of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment and other violations of California law during the period November 18, 2004 through April 22, 2005. The complaints, filed in Superior Court of the State of California for the County of San Diego and subsequently consolidated, seek to recover on our behalf alleged unspecified damages sustained by us as a result of such alleged actions, treble damages, disgorgement of profits from the sale of our securities and benefits and compensation obtained by the individual defendants, and extraordinary equitable and/or injunctive relief as permitted by law. In August 2005, the defendants moved to dismiss the consolidated complaint on the ground that the stockholders had failed to

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make a demand on the Company’s Board and failed to adequately allege that a demand was excused. The Court granted the motion but gave plaintiffs leave to amend. On July 7, 2006 the Court granted leave to plaintiffs to file a third amended complaint but expressly noted that it was without prejudice to defendants demurring to that amended complaint. A hearing on that demurrer is set for September 1, 2006. Plaintiffs have recently filed a motion for leave to file a fourth amended complaint and a hearing on that motion is scheduled for September 29, 2006. That motion seeks to add allegations against our Board of Directors relating to the recent acquisition announcement. Defendants anticipate plaintiffs withdrawing that motion but, if necessary, will oppose it on a variety of grounds. We have tendered these matters to our insurance carriers.

In June 2005, we were named as a defendant in a purported class action filed in the Superior Court of the State of California for the County of Los Angeles alleging violations of the California Labor Code. The named plaintiffs, Wayne Boyd, Anthony Castro, Gilbert Hernandez, and Daniel Lepkosky, purport to represent all current and former hourly, non-exempt employees of our California stores from June 27, 2001 to the present. These plaintiffs allege that during this period they were not paid all wages, were not paid overtime, were not authorized and permitted to take rest breaks as required by law, were not provided meal breaks as required by law, were not paid “reporting time” pay, and were not paid all wages upon separation from employment. The complaint seeks unspecified monetary damages in the form of unpaid wages, penalties and other relief. In March 2006, Plaintiffs Hernandez and Boyd requested that their claims against the Company be dismissed and the Court approved this request. The Court heard Plaintiff’s Motion for Class Certification on July 28, 2006. At the hearing, the Court denied class certification on Plaintiffs’ meal break claim and rest period claim, the reporting time claim having been abandoned. The Court took the motion under submission as to Plaintiffs’ overtime claim and scheduled a hearing date to determine the threshold legal issue of whether we are required to pay overtime for those employees who work in two different workdays during a single work shift. As a result of the Court’s ruling, the remaining two Plaintiffs may pursue only their individual claims for meal periods and rest breaks.

In March 2006, we were named as a defendant in a purported class action filed in the Superior Court of the State of California for the County of Santa Clara alleging violations of the California Labor Code. The named plaintiff, Martha Rodriguez, purports to represent all current and former General Managers of our California stores from March 20, 2002 to the present. This plaintiff alleges that she was improperly classified as exempt from overtime compensation, not given adequate itemized wage statements, and not provided the meal periods nor authorized and permitted to take the rest breaks required for non-exempt employees. The complaint seeks unspecified monetary damages in the form of unpaid wages, penalties and other relief.

In July 2006, two class action complaints were filed on behalf of our stockholders in Superior Court of California, County of San Diego, naming as defendants, among others, us and members of our Board of Directors. The complaints allege, among other things, that our directors breached their fiduciary duties in connection with the proposed merger transaction by approving a transaction that would purportedly provide certain stockholders and directors with preferential treatment at the expense of our other stockholders.

Although there can be no assurance that unfavorable outcomes in the foregoing matters would not have a material adverse effect on our financial position or results of operations, management believes the claims are without merit, strong defenses exist, and management intends to vigorously defend against these actions. We have not recorded any accrual for contingent liability associated with the legal proceedings described above based on management’s belief that a liability, while possible, is not probable. Further, any possible range of loss cannot be estimated at this time.

We are involved in other routine litigation arising in the ordinary course of our business. While the results of such litigation cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our consolidated financial position or results of operations.

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Item 1A. Risk Factors

Certain Cautionary Statements

Some of the statements in this Quarterly Report on Form 10-Q, including, but not limited to, Part I, Item 2—”Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part I, Item 4—”Controls and Procedures,” are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are therefore entitled to the protection of the safe harbor provisions of these laws. We generally identify forward-looking statements in this Quarterly Report by using words like “believe,” “intend,” “target,” “expect,” “estimate,” “may,” “should,” “plan,” “project,” “contemplate,” “anticipate,” “predict” or similar expressions. You can also identify forward-looking statements by discussions of strategy, plans or intentions. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These factors include, without limitation, those set forth in Exhibit 99.1 to this Quarterly Report on Form 10-Q, and the factors discussed in Part I, Item 1A—”Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 28, 2006. No undue reliance should be placed on forward-looking statements. We disclaim any intent or obligation to update these forward-looking statements.

Item 4. Submission of Matters to a Vote of Security Holders

We held our Annual Meeting of Stockholders on June 8, 2006 at the San Diego Marriott Del Mar in San Diego, California. Stockholders of record at the close of business on April 27, 2006 were entitled to notice of and to vote in person or by proxy at the annual meeting. As of the record date there were 57,989,503 shares of common stock outstanding and entitled to vote. At the annual meeting, the stockholders of the company voted on the election of two directors to hold office until the 2009 Annual Meeting of Stockholders and the appointment of KPMG LLP as the Company’s independent registered public accounting firm for the fiscal year ending February 3, 2007. At the annual meeting, each of the two directors nominated by management was elected and the appointment of KPMG LLP for fiscal 2007 was ratified. Details of the votes cast at the meeting are set forth below, including the number of votes for, the number of votes against and withheld, the number of abstentions and the number of broker non-votes, as applicable:

1. To elect two directors to serve until the 2009 Annual Meeting of Stockholders and until their successors are duly elected and qualified:

	Votes For	Votes Against or Withheld
Brian K. Devine	54,078,974	938,273
John G. Danhakl	54,578,302	438,945

In addition to the election of Messrs. Devine and Danhakl, whose term of office expires at the 2009 Annual Meeting of Stockholders, the following directors who were not elected at the annual meeting have continuing terms of office as specified below:

Name of Director	Year of Annual Meeting at Which Term Expires
David Ching	2007
Charles W. Duddles	2007
James M. Myers	2007
David B. Appel	2008
Sandra N. Bane	2008
Julian C. Day	2008
Peter Maslen	2008

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2. The stockholders ratified the appointment by the Company’s Audit Committee of KPMG LLP as our independent registered public accounting firm for our fiscal year ending February 3, 2007.

Votes For	Votes Against or Withheld	Abstentions	Broker Non-votes
53,217,950	1,796,846	2,451	—

Item 6. Exhibits

Exhibit No.	Description
2.1	Agreement and Plan of Merger, dated as of July 13, 2006, by and among PETCO Animal Supplies, Inc., Rover Holdings Corp. and Rover Acquisition Corp. (incorporated by reference to Current Report on Form 8-K filed July 14, 2006
10.1	Second Amendment to Employment Agreement dated July 13, 2006 by and between PETCO Animal Supplies, Inc. and Brian K. Devine (incorporated by reference to Current Report on Form 8-K filed July 14, 2006).
10.2	Second Amendment to Employment Agreement dated July 13, 2006 by and between PETCO Animal Supplies, Inc. and James M. Myers (incorporated by reference to Current Report on Form 8-K filed July 14, 2006).
10.3	Second Amendment to Employment Agreement dated July 13, 2006 by and between PETCO Animal Supplies, Inc. and Bruce C. Hall (incorporated by reference to Current Report on Form 8-K filed July 14, 2006).
10.4	Amended and Restated Retention Agreement dated July 13, 2006 by and between PETCO Animal Supplies, Inc. and Rodney Carter (incorporated by reference to Current Report on Form 8-K filed July 14, 2006).
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Section 1350 Certifications
99.1	Cautionary Statements Regarding Forward-looking Statements

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

PETCO ANIMAL SUPPLIES, INC.
By:	/s/ JAMES M. MYERS
	James M. Myers Chief Executive Officer (Principal Executive Officer) Date: August 23, 2006
By:	/s/ RODNEY CARTER
	Rodney Carter Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) Date: August 23, 2006

29

EX-31.1

EXHIBIT 31.1

Certification of Chief Executive Officer Pursuant

to Section 302 of the Sarbanes-Oxley Act of 2002

I, James M. Myers, Chief Executive Officer of PETCO Animal Supplies, Inc., certify that:

1. I have reviewed this quarterly report on Form 10-Q of PETCO Animal Supplies, Inc. for the fiscal quarter ended July 29, 2006;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 23, 2006

/s/ JAMES M. MYERS

James M. Myers

Chief Executive Officer

EX-31.2

EXHIBIT 31.2

Certification of Chief Financial Officer Pursuant

to Section 302 of the Sarbanes-Oxley Act of 2002

I, Rodney Carter, Chief Financial Officer of PETCO Animal Supplies, Inc., certify that:

1. I have reviewed this quarterly report on Form 10-Q of PETCO Animal Supplies, Inc. for the fiscal quarter ended July 29, 2006;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 23, 2006

/S/ RODNEY CARTER

Rodney Carter

Senior Vice President and Chief Financial

Officer

EX-32.1

EXHIBIT 32.1

Section 1350 Certification of Chief Executive Officer

Pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of PETCO Animal Supplies, Inc. (the “Company”) hereby certifies that:

(i) the accompanying Quarterly Report on Form 10-Q of the Company for the fiscal quarter ended July 29, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: August 23, 2006	/s/ JAMES M. MYERS
	James M. Myers Chief Executive Officer

Section 1350 Certification of Chief Financial Officer

Pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of PETCO Animal Supplies, Inc. (the “Company”) hereby certifies that:

(i) the accompanying Quarterly Report on Form 10-Q of the Company for the fiscal quarter ended July 29, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: August 23, 2006	/s/ RODNEY CARTER
	Rodney Carter Senior Vice President and Chief Financial Officer

The foregoing certifications are being furnished solely to accompany the Report pursuant to 18 U.S.C. § 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

A signed original of the written statements required by Section 906 have been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-99.1

EXHIBIT 99.1

Cautionary Statements Regarding Forward-looking Statements

From time to time, we may make written or oral forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are therefore entitled to the protection of the safe harbor provisions of these laws. We generally identify forward-looking statements by using words like “believe,” “intend,” “target,” “expect,” “estimate,” “may,” “should,” “plan,” “project,” “contemplate,” “anticipate,” “predict,” or similar expressions. You can also identify forward-looking statements by their inclusion in discussions of strategy, plans or intentions. No undue reliance should be placed on forward-looking statements. We disclaim any intent or obligation to update these forward-looking statements. These statements involve known and unknown risks, uncertainties or other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from those expressed or implied by these forward-looking statements. These factors include, but are not limited to, the following:

• If we are unable to profitably open and operate new stores, maintain the profitability of our existing stores and successfully complete our store remodel program, our business, financial condition and results of operations may be harmed.

• We may be unable to successfully execute our expansion strategy or manage and sustain our growth and, as a result, our business may be harmed.

• Our level of debt may limit the cash flow available for our operations and place us at a competitive disadvantage.

• The agreements governing our debt impose restrictions on our business.

• Our failure to satisfy covenants in our debt instruments would cause a default under those instruments.

• The loss of any of our three key vendors, or of our exclusive distribution arrangements with our vendors, would negatively impact our business.

• Competition in the markets in which we operate is strong and if we are unable to compete effectively, our ability to generate sales may suffer and our operating income and net earnings would decline.

• A prolonged economic downturn could result in reduced sales and lower revenues and profitability.

• Our operating results could be harmed if we are unable to integrate acquired companies into our operations.

• We have made investments in the past and may make investments in the future without being able to achieve an adequate return, if any, on our investment.

• If we are required to restructure our operations to comply with regulations governing our business, it could have a material effect on our business and operations.

• Negative publicity arising from claims that we do not properly care for animals we sell could adversely affect how we are perceived by the public and reduce our revenues and profitability.

• We depend on key personnel, and if we lose the services of any of our principal executive officers, including Mr. Devine, our Chairman, Mr. Myers, our Chief Executive Officer, and Mr. Hall, our President and Chief Operating Officer, we may not be able to run our business effectively.

• We have been named as a party to several class action and derivative action lawsuits, and we may be named in additional litigation, all of which could require time and attention from certain members of management and result in significant legal expenses. An unfavorable outcome in one or more of these lawsuits could have a material adverse effect on our business, financial condition, results of operations and cash flows.

• Terrorism and the uncertainty of war may have a material adverse effect on our operating results.

• Future sales of shares of our common stock in the public market may depress our stock price.

• The price of our common stock may be volatile.

• Our stock price may be adversely affected because our results of operations may fluctuate from quarter to quarter.

• Takeover defense provisions may adversely affect the market price of our common stock.

• We incur significant expenses as a result of being a public company.

• Our pending merger transaction may involve unexpected costs, our business may suffer as a result of uncertainty surrounding the merger, we may be unable to obtain stockholder approval required to consummate the merger, or other factors may impact our business in the interim or our ability to close the merger transaction, including, but not limited to:

• whether or not the conditions to complete the merger are satisfied, including the receipt of the required stockholder or regulatory approvals;

• whether the financing required to complete the merger is obtained on the terms expected by, or other terms reasonably acceptable to, the buyer and its affiliates;

• the occurrence of any event, change or other circumstance that could give rise to the termination of the merger agreement;

• the outcome of any legal proceedings instituted against us and others in connection with the proposed merger;

• the failure of the merger to close for any other reason;

• the amount of the costs, fees, expenses and charges related to the merger;

• business uncertainty and contractual restrictions during the pendency of the merger;

• competition generally and the increasingly competitive nature of our industry; and

• stock price and interest rate volatility.

For more information about these risks, see the discussion under the heading “Certain Cautionary Statements” in Part I, Item 1A—Risk Factors of our Annual Report on Form 10-K for the fiscal year ended January 28, 2006 filed with the Securities and Exchange Commission, which is incorporated herein by reference, and the Preliminary Proxy Statement filed on August 11, 2006 regarding the pending merger transaction.