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The following is an excerpt from a DEF 14A SEC Filing, filed by PETSMART INC on 5/7/2007.
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PETSMART INC - DEF 14A - 20070507 - EXECUTIVE_COMPENSATION

Determining Executive Compensation

      When evaluating executive compensation, the Compensation Committee considers, in part:

  • pay for individual and company performance;
     
  • alignment with the stated compensation philosophy;
     
  • the need to attract and retain quality leadership;
     
  • relative internal equity between officers;
     
  • appropriate cost management; and
     
  • continued focus on corporate governance.

      This process includes a review of PetSmart’s entire compensation program, and an analysis for each executive officer of all elements of compensation as compared to individual and PetSmart’s performance and objectives. The Compensation Committee works directly with Hay Group to determine compensation for the Chief Executive Officer. The Chief Executive Officer makes compensation recommendations to the Compensation Committee for the remaining executive officers for its review and approval. The Senior Vice President, People is responsible for the design and implementation of all of PetSmart’s compensation programs as approved by the Compensation Committee or its delegee.

      The Compensation Committee utilizes compensation consultants to analyze our executive compensation compared to the consultant’s own proprietary retail-specific survey as well as the approved peer group. The proprietary retail industry survey includes over 70 retailers and provides data by job title controlling for differences in responsibility and revenue. The Compensation Committee determines our peer group using the following criteria:

  • publicly-held specialty retailers with a similar level of performance, net income growth and total shareholder return;
     
  • revenues typically from one-half to twice that of PetSmart;
     
  • a multi-channel retail structure with an emphasis on hard goods;
     
  • specific characteristics matching PetSmart’s current or potential business model; and/or
     
  • potential competitors for executive talent.

      This peer group is reviewed periodically by the Compensation Committee and may change from time to time based on the current competitive environment. The current peer group is comprised of the following companies:

  • Advance Auto Parts
  • AutoZone
  • Barnes & Noble
  • Borders Group
  • CarMax
  • Dick’s Sporting Goods
  • Dollar General
  • Dollar Tree Stores
  • Family Dollar Stores
  • Foot Locker
  • Guitar Center, Inc.
  • Office Max
  • Payless Shoes
  • Ross Stores
  • Talbots
  • Williams-Sonoma
  • Zale

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      Benchmarking is one component in determining executive officer compensation. The Compensation Committee compares each element of compensation separately and in the aggregate to compensation at certain companies PetSmart benchmarks against, sometimes referred to as our peer group, as well as a larger retail comparator group. As compared to benchmarks in the 2006 study, base salaries for our executives trend slightly below the 50 th percentile. Our target annual performance incentives create total cash compensation that is at or slightly below the 50 th percentile for most positions. Our total direct compensation trends between the 75 th and 90 th percentile resulting from long term incentive equity grants between the 75 th and 90 th percentile. We provide limited benefits and perquisites. The Compensation Committee believes our executive compensation packages are reasonable when considering our business strategy, compensation philosophy, and the competitive market.

Design and Elements of our Compensation Program

      The four elements of executive compensation for our executive officers, including the named executive officers, are: (1) base salary, (2) annual performance incentive, (3) long-term equity incentive compensation consisting of stock options and restricted stock, and (4) benefits. These elements are designed to:

  • ensure that PetSmart executives have clear goals and accountability with respect to PetSmart’s performance;
     
  • ensure pay for performance and encourage responsible business growth;
     
  • establish pay opportunities that are competitive with prevailing industry practices, our stage of growth and the labor markets in which we operate;
     
  • align incentive and equity compensation with PetSmart’s strategy and the long-term interests of PetSmart stockholders; and
     
  • assist PetSmart with attraction, retention and motivation of key executive talent.

      Each of the four elements are discussed below in greater detail:

      1. Base Salary. The base salary for executive officers is set annually by reviewing, in order of importance, the skills and performance levels of individual executives, the needs of PetSmart, and the competitive pay practices of companies with which we compete for executive talent. In determining individual base salaries, the Compensation Committee considers job experience, individual performance, and the internal value of the position. Base salary for new executive officers is also set utilizing the above criteria, and after considering the length and breadth of the individual’s experience within the retail industry and specific functional area.

      The base salaries paid to our named executive officers are set forth in the Summary Compensation Table. For fiscal year 2006, the Chief Executive Officer’s base pay was slightly below the 50 th percentile of the market. For the remaining named executive officers, base pay was at or slightly below the 50 th percentile. For fiscal year 2007, the Chief Executive Officer’s base pay has been set at $950,000, which is slightly below the 50 th percentile of the market. For the remaining executive officers base pay is generally set at the 50 th percentile for fiscal year 2007. We believe that the base salary paid to our executive officers during fiscal year 2006 and as set for fiscal year 2007 achieves our executive compensation objectives, compares favorably to our peer group and is within our target of providing base salary at or near the market median.

      2. Annual Performance Incentive. The annual performance incentive is designed to motivate executives to attain short-term objectives that align with long-term business goals. Our policy is to have a significant portion of an executive’s total cash compensation tied to PetSmart’s overall performance. At the beginning of each fiscal year, under the Executive Short-Term Incentive Plan, or the ESTIP, the Compensation Committee assigns each executive officer an incentive target equal to a specified percentage of his or her annual base salary. The Chief Executive Officer’s incentive target is 100%, the President and Chief Operating Officer’s target is 75%, and the target for the remaining executive officers is 50%.

      The ESTIP, which was last approved by the stockholders in 2002 and is proposed to be reapproved at the 2007 Annual Meeting, is designed and administered in a manner intended to qualify incentive awards to our executive officers as “performance-based compensation.” This is intended to allow PetSmart to fully deduct for federal income

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tax purposes the compensation paid under the ESTIP. The incentive targets and the performance metrics for each executive are determined by the Compensation Committee at the beginning of each fiscal year based on the executive’s position and responsibilities.

      For purposes of evaluating performance the Compensation Committee may adjust GAAP results for specific nonrecurring extraordinary items we do not consider core to our operating business, for example certain litigation expenses, insurance recoveries or restructuring activities. In addition, the Compensation Committee has discretion to pay out awards above 200% of base pay in the form of equity.

Fiscal Year 2006

      For fiscal year 2006 the incentive payout to our executive officers was a function of three performance goal measures:

  • PetSmart’s overall performance relative to an earnings per share target;
     
  • return on invested capital; and
     
  • increase in sales.

      The Compensation Committee believes earnings per share is the best indicator to our stockholders of overall business health. Return on invested capital ensures PetSmart’s executive officers focus on creating efficient growth. In a period of rapid expansion, sales growth focuses executive officers on both strengthening PetSmart’s core business and developing new and innovative services. The ESTIP provides for alternative stockholder approved performance goal measures, including net income, customer satisfaction, increase in stock price, return on equity, and return on assets. We have selected some of these in the past and may select some of these in the future based upon our strategic initiatives. For example, customer satisfaction (as determined by an independent professional survey research firm) was a measure utilized in the ESTIP prior to 2006. It was removed because the remaining incremental achievement opportunity was no longer considered significant enough to warrant inclusion in a performance-based incentive pay plan. Increase in sales was added in 2006 as our services business gained momentum.

      The Compensation Committee typically sets realistic but challenging targets for each measure. Targets were based on a formulaic improvement over the previous year’s results tied directly to PetSmart’s strategic plan as well as published guidance given to our stockholders and the investor community. Each measure contained a payout opportunity between 50% and 300% of the target award. The 200% and 300% payouts represent increasingly challenging incremental improvements over the target award. A minimum earnings per share achievement of 90% of target was required in order for any payout to occur from the ESTIP. This also acted as the 50% payout target for the earnings per share measure.

      The total incentive achievement for fiscal year 2006, for Messrs. Francis, Moran and Kullman was at 86.5% and for Ms. Fitzgerald, and Mr. Lenhardt, at 89.0% of their incentive target. Over the past three years ESTIP performance exceeded target levels each year including two years slightly above 100% and one year slightly above 200%. The performance reduction in 2006 is a factor of the increasing weight of return on invested capital as a component of the total incentive payout along with lower achievement in both earnings per share and return on invested capital.

Fiscal Year 2007

      Fiscal year 2007 continues our 2006 philosophy. The same measures will be used but the weighting has been revised to increase the emphasis on capital investment efficiency in support of our new store and PetsHotel expansion strategies. Additionally, weights were standardized for all executive officers to encourage a cross-functional team focus. As in fiscal year 2006, a minimum earnings per share achievement of 90% of target must be met in order for any payout to occur from the ESTIP and each measure contains a payout opportunity between 50% and 300% of the target award.

      3. Equity-Based Incentive Compensation. Equity-based incentive compensation is provided to certain employees, including executive officers, to link a portion of compensation to the long-term financial success of PetSmart and as a retention tool. Equity compensation is comprised of both stock options and restricted stock, which are subject to time based vesting. The Compensation Committee believes stock options are inherently performance-based as the executive officer does not receive any benefit unless the stock price rises after the date the option is

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granted. Restricted stock is generally awarded as a retention vehicle and to support the attraction of leadership talent. However, restricted stock also serves to align our executive officers with the long-term interests of our shareholders through the use of four year cliff vesting and the Officer and Director Stock Ownership Guidelines. See page 9 for a discussion of these guidelines.

      Historically, stock awards have been granted through the 2003 Equity Incentive Plan, or the 2003 Plan, and our 1997 Equity Incentive Plan, or the 1997 Plan. In June 2006, our stockholders approved the combination of these two plans into the 2006 Equity Incentive Plan, or the 2006 Plan, from which future stock awards are expected to be granted.

      The stock options under the 1997 Plan and 2003 Plan historically have a ten-year maximum term from the date of grant, or earlier if employment terminates. Stock option grants are subject to vesting requirements. Commencing in fiscal year 2006 the maximum term for stock options was reduced to seven years. The grant date of such awards is always on or after the date the Compensation Committee or its delegate approves the grants. Options historically have vested over a period of four years with 25% of the shares vesting on the one-year anniversary of the date of grant and the remaining 75% of the shares vesting each month thereafter on a ratable basis over a period of 36 months in accordance with their terms. In January 2005, vesting was changed for future grants to 25% on consecutive yearly anniversaries of the date of grant. Executive officers were granted options to purchase an aggregate of 527,093 shares during fiscal year 2006. Grants to our named executive officers comprised 26.05% of all equity awards granted. In granting options under the 2006 Plan, the Compensation Committee takes into account each executive’s responsibilities, relative position at PetSmart, and past grants.

      In fiscal year 2006, we continued to grant restricted stock to executive officers in addition to stock options. These grants generally become 100% vested on the fourth anniversary of the date of grant. We believe that this vesting schedule acts as a significant retention tool and also links the compensation of our executive officers with the long-term interests of our stockholders. The earlier vesting of restricted stock may occur in the event of a change in control or, in some cases, in the event of an executive retirement that is pursuant to the requirements as set forth in the grant documents.

      Historically, an annual equity award was granted to all eligible participants, including executive officers, within the first two weeks after the close of our fiscal year. Commencing in February 2008, we intend to grant annual equity awards following the release of our year-end financial results. From time to time, the Compensation Committee may also approve additional equity awards to executive officers to recognize exceptional performance, the assumption of additional responsibilities or for retention purposes. Prior to fiscal year 2007, the exercise price of stock option grants was determined by reference to the closing price of our common stock on the last trading day prior to the date of grant. However, the Compensation Committee approved an amendment to the 2006 Plan effective in fiscal year 2007, to determine the exercise price of stock option by reference to the closing price of our common stock on the date of grant.

      Consistent with our compensation philosophy, in fiscal year 2006, equity grants to the named executive officers generally reflected the 90 th percentile of the market with the exception of Mr. Francis, whose award was slightly above the 75 th percentile. As a result, total direct compensation for the named executive officers on average trended between the 75 th percentile and 90 th percentile. The specific equity grants awarded to the named executive officers are set forth in the “ Summary Compensation Table .” Equity grants in fiscal year 2007, which occurred in February 2007, continued this philosophy.

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      4. Benefits. We provide benefit programs to executive officers and to other employees. The following table generally illustrates such benefit plans and identifies those employees who may be eligible to participate:

    Certain Managers  
    and high-level individual  
Benefit Plan Executive Officers contributors Other Full Time Employees
      401(k) Plan   ü ü ü
      Medical/Dental/Vision Plans   ü ü ü
      Life and Disability Insurance (1)   ü ü ü
      Employee Stock Purchase Plan   ü ü ü
      Short Term Incentive Plan (2)   ü ü ü
      Equity Incentive Plans   ü ü Not Offered
      Change in Control and Severance Plan (3)   ü ü Not Offered
      Deferred Compensation Plan (4)   ü ü Not Offered
      Supplemental Early Retirement Plan   Not Offered Not Offered Not Offered
      Employee Stock Ownership Plan   Not Offered Not Offered Not Offered
      Defined Benefit Pension Plan   Not Offered Not Offered Not Offered
____________________

(1)       PetSmart provides company-paid Long-Term Disability insurance to eligible full-time employees with a monthly benefit in the amount of 60% of qualified salary to a maximum of $10,000 per month. All of PetSmart’s officers receive Company-paid Long-Term Disability coverage that provides a monthly benefit of 66.67% of qualified salary to a maximum of $15,000 per month.
 
(2) PetSmart has two short-term incentive plans, the Executive Short Term Incentive Plan, or ESTIP, and the Short Term Incentive Plan, or STIP. The ESTIP covers our executive officers, while the STIP is for all other eligible employees. The incentive targets and the company performance metrics for the ESTIP and the STIP are determined by the Compensation Committee at the beginning of each fiscal year based on the position and responsibility of each employee.
 
(3) Details of the Change in Control and Severance Plan may be found below.
 
(4) PetSmart has implemented a Deferred Compensation Plan that allows executive officers and certain management-level employees to defer receipt of certain salary and cash bonus payments on a pre-tax basis. The amount deferred under the Deferred Compensation Plan may be indexed to certain approved investment funds. PetSmart matches a percentage of employee deferrals up to a maximum employee deferral of 10% of the salary of the employee. The actual amount PetSmart matches is a function of PetSmart’s overall performance relative to an earnings per share target. PetSmart also provides a 401(k) restoration match equal to 50% of the participant’s annual deferral amount up to 6% of the participant’s annual base salary reduced by the amount of any matching contributions made to the 401(k) Plan.

      We believe perquisites for executive officers should be extremely limited in scope and value. As a result, PetSmart has historically given nominal perquisites. The following table generally illustrates the perquisites we do and do not provide and identifies those employees who may be eligible to receive them:

Types of Perquisites Executive Officers Certain Managers Full Time Employees
      Employee Discount   ü ü ü
      Financial Planning Allowance (1)   ü ü Not Offered
      Automobile Allowance   Not Offered Not Offered      Not Offered (2)
      Country Club Memberships   Not Offered Not Offered Not Offered
      Personal Use of Company Aircraft   Not Offered Not Offered Not Offered
      Security Services   Not Offered Not Offered Not Offered
      Dwellings for Personal Use (3)   Not Offered Not Offered Not Offered
____________________

(1)       We provide our officers with a limited taxable reimbursement allowance for professional services such as financial planning, life insurance, estate planning and tax preparation. See the “ Summary Compensation Table ” for details regarding actual levels provided to executive officers.

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(2)       Certain field employees receive reimbursement, in accordance with the Internal Revenue Code, for various costs incurred in connection with utilization of their personal vehicle for business travel that is in addition to typical business expenses.
 
(3) We do not provide dwellings for personal use other than short-term temporary housing related to relocation.

Severance and Change in Control Arrangements

      We have entered into agreements with our executive officers providing severance and change in control benefits, the terms of which are described below under “ Employment and Severance Agreements .” We believe these severance and change in control benefits are an essential element of our overall executive compensation package and assist us in recruiting and retaining talented individuals and aligning the executive officer’s interests with the interests of our stockholders.

Change in Control Arrangements

      With respect to change of control benefits, we provide severance compensation if an executive officer is terminated in connection with a change of control transaction. These change of control benefits that are structured on a “double-trigger” basis, meaning that before an executive officer can receive severance compensation: (1) a change of control must occur and (2) three months prior to or within 36 months following the change in control, the executive officer’s employment must be terminated for good reason or without cause. These provisions were included to motivate our executive officers to act in the best interests of our stockholders by removing the distraction of post-change of control uncertainties faced by the executive officers with regard to their continued employment and compensation. We believe that double-trigger change of control severance compensation is attractive to maintain continuity and retention of key management personnel and is consistent with our compensation philosophy. We also provide single trigger acceleration of 50% of outstanding stock awards and “double trigger” full acceleration of such stock awards in the event of a covered termination pursuant to our Executive Change in Control and Severance Benefit Plan.

Severance Arrangements

      We also believe that the other severance benefits described below are appropriate, particularly with respect to a termination by PetSmart without cause. In that scenario, both PetSmart and the executive officer have a mutually-agreed-upon severance package that is in place prior to any termination event. We believe this arrangement provides PetSmart with greater flexibility to make a change in executive management if such a change is in the stockholders’ best interests.

Limitation on Deduction of Compensation Paid to Certain Executive Officers

      Section 162(m) of the Internal Revenue Code denies a deduction to any public corporation such as PetSmart for compensation paid in a taxable year to certain executive officers to the extent that compensation exceeds $1 million. Compensation exceeding $1 million may be deducted only if it is “performance-based compensation” within the meaning of Section 162(m).

      The ESTIP and the 2006 Plan have been designed in a manner to permit the grant of cash bonus awards and stock options to the named executive officers that qualify as “performance-based compensation.” PetSmart believes that the tax deduction of compensation is an important factor in setting executive compensation policy. PetSmart makes an effort to structure individual compensation and compensation programs to allow it to fully deduct compensation in accordance with Section 162(m). However, if compliance with Section 162(m) conflicts with the PetSmart compensation philosophy, or what is believed to be in the best interests of PetSmart and its stockholders, we may conclude that paying non-deductible compensation is more consistent with that philosophy and in the best interests of PetSmart and our stockholders. For example, in prior years we approved awards of restricted stock to certain executive officers, including Mr. Francis, all subject to four-year cliff vesting. It is likely that any deduction in connection with the award could be limited by the application of Section 162(m). We believe the award forms an important part of our executive officers’ total compensation and incentive program, notwithstanding the possible application of the Section 162(m) deduction limitation.

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