<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED:
MAY 3, 1998
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: 0-21888
PETSMART, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3024325
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
19601 N. 27TH AVENUE
PHOENIX, ARIZONA 85027
(Address of principal executive offices, including Zip Code)
(602) 580-6100
(Registrant's telephone number, including area code)
NONE
(Former name, former address and former fiscal year,
if changed since last report)
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.
(1) Yes (X) No ( )
(2) Yes (X) No ( )
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date:
COMMON STOCK, $.0001 PAR VALUE, 115,788,223 SHARES AT JUNE 5, 1998
1
<PAGE> 2
PETSMART, INC.
INDEX
<TABLE>
<CAPTION>
Page
<S> <C>
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets at May 3, 1998
and February 1, 1998 3
Consolidated Statements of Operations
for the thirteen weeks ended
May 3, 1998 and May 4, 1997 4
Consolidated Statements of Cash Flows
for the thirteen weeks ended
May 3, 1998 and May 4, 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 11
Part II. Other Information
Item 1. Legal Proceedings 17
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
</TABLE>
2
<PAGE> 3
PETSMART, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
Unaudited
<TABLE>
<CAPTION>
MAY 3, FEBRUARY 1,
1998 1998
------------------ -----------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 99,511 $ 125,082
Receivables 48,308 45,853
Merchandise inventories 319,794 317,547
Prepaid expenses and other current assets 32,030 27,228
----------- -----------
Total current assets 499,643 515,710
Property held for sale and leaseback 2,245 2,212
Property and equipment, net 256,914 242,384
Other assets 79,096 79,381
----------- -----------
Total assets $ 837,898 $ 839,687
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 113,337 $ 114,692
Accrued payroll and employee benefits 19,935 18,559
Accrued occupancy expense 13,090 10,548
Accrued merger and restructuring costs 29,381 33,737
Other accrued expenses 30,197 29,980
Current maturities of capital leases 9,928 10,753
----------- -----------
Total current liabilities 215,868 218,269
6 3/4% Subordinated Convertible Notes 200,000 200,000
Capital lease obligations 65,748 68,008
Deferred rents 16,952 17,015
Other liabilities 1,731 1,701
----------- -----------
Total liabilities 500,299 504,993
---------- ----------
Stockholders' equity:
Preferred stock; $.0001 par value, 10,000 shares
authorized, none outstanding - -
Common stock; $.0001 par value; 250,000 shares
authorized, 115,673 and 115,629 shares issued and outstanding 11 11
Additional paid-in capital 385,060 383,338
Accumulated deficit (47,973) (48,126)
Cumulative foreign currency translation adjustments 501 (529)
------------- --------------
Total stockholders' equity 337,599 334,694
---------- ----------
Total liabilities and stockholders' equity $ 837,898 $ 839,687
=========== ===========
</TABLE>
The accompanying notes are an integral
part of these unaudited financial statements.
3
<PAGE> 4
PETSMART, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Unaudited
<TABLE>
<CAPTION>
FOR THE 13 WEEKS ENDED
----------------------
MAY 3, MAY 4,
1998 1997
-------------- ---------
<S> <C> <C>
Net sales $ 496,564 $ 412,654
Cost of sales 374,423 310,973
---------- ----------
Gross profit 122,141 101,681
Store operating expenses 98,047 77,139
Store preopening expenses 4,258 3,182
General and administrative expenses 14,806 9,419
Merger, business integration and restructuring costs - 9,631
-------------- ----------
Operating income 5,030 2,310
Interest income 482 50
Interest expense 5,264 2,712
----------- -----------
Income (loss) before income taxes 248 (352)
Income tax expense 95 394
------------- ------------
Net income (loss) 153 (746)
------------ -------------
Other comprehensive income, net of tax:
Foreign currency translation adjustments 1,030 379
------------ -------------
Other comprehensive income 1,030 379
------------ -------------
Comprehensive income (loss) $ 1,183 $ (367)
============= =============
Earnings per common share - basic:
Net income (loss) $ 0.00 $ (0.01)
============ =============
Earnings per common share - assuming dilution:
Net income (loss) $ 0.00 $ (0.01)
============ =============
</TABLE>
The accompanying notes are an integral
part of these unaudited financial statements.
4
<PAGE> 5
PETSMART, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Unaudited
<TABLE>
<CAPTION>
FOR THE 13 WEEKS ENDED
----------------------
MAY 3, MAY 4,
1998 1997
-------------- ----------
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income (loss) $ 153 $ (746)
Adjustments to reconcile net income (loss) to net cash
from (used in) operating activities -
Depreciation and amortization 10,300 8,357
Loss on disposal of property and equipment 578 124
Changes in assets and liabilities:
Receivables (11,633) (2,570)
Merchandise inventories (2,247) 26,534
Prepaid expenses and other current assets (4,802) (3,535)
Other assets (528) (1,258)
Accounts payable (7,916) (10,799)
Accrued payroll and employee benefits 1,376 215
Accrued occupancy expense 2,542 901
Accrued merger and integration charges (4,136) (3,764)
Other accrued expenses 217 (6,094)
Deferred rents (63) 388
Other liabilities 30 114
---------------- --------------
Net cash from (used in) operating activities (16,129) 7,867
-------------- ------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Purchases of leaseholds, fixtures and equipment (15,503) (6,574)
Purchases of property held for sale and leaseback (33) -
Proceeds from sales of property 72 -
--------------- -------------
Net cash (used in) investing activities (15,464) (6,574)
--------------- ------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 1,534 2,723
Borrowings from bank credit facility - 47,200
Repayment of bank credit facility - (31,200)
Increase (decrease) in bank overdraft 6,561 (9,739)
Tax benefit resulting from exercise of stock options 138 900
Payment on capital lease obligations (3,241) (2,781)
---------------- --------------
Net cash from financing activities 4,992 7,103
--------------- -----------
FOREIGN CURRENCY TRANSLATION GAINS 1,030 379
--------------- --------------
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (25,571) 8,775
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD 125,082 39,868
------------- ------------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 99,511 $ 48,643
============= ============
</TABLE>
The accompanying notes are an integral
part of these unaudited financial statements.
5
<PAGE> 6
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THIRTEEN WEEKS ENDED MAY 3, 1998
AND MAY 4, 1997
NOTE 1 - GENERAL:
The accompanying unaudited consolidated financial statements of
PETsMART, Inc. and Subsidiaries ("PETsMART" or "Company") have been
prepared in accordance with generally accepted accounting principles
for interim financial information. Accordingly, they do not include all
of the information and footnotes required by generally accepted
accounting principles for financial statements. In the opinion of
management, all adjustments considered necessary for a fair
presentation have been included.
The Company adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income," (SFAS 130), during the first
quarter of fiscal 1998. SFAS 130 establishes standards for reporting of
comprehensive income and its components. All prior periods have been
presented in accordance with SFAS 130. The income tax expense related
to items of other comprehensive income was approximately $644,000 and
$237,000 for first quarter 1998 and 1997, respectively.
Because of the seasonal nature of the Company's business, the results
of operations for the thirteen weeks ended May 3, 1998 and May 4, 1997
are not necessarily indicative of the results to be expected for the
full year. For further information, refer to the financial statements
and footnotes thereto for the fiscal year ended February 1, 1998,
included in the Company's Annual Report on Form 10-K (File No. 0-21888)
filed with the Securities and Exchange Commission on April 6, 1998.
NOTE 2 - EARNINGS PER SHARE:
PETsMART adopted Statement of Financial Accounting Standard No. 128,
"Earnings Per Share" ("SFAS 128") in fiscal 1997. SFAS 128 revised
standards for the computation and presentation of earnings per share,
requiring the presentation of both basic earnings per share and
earnings per share assuming dilution. All prior period earnings per
share data presented has been restated in accordance with SFAS 128.
Basic earnings per share are computed by dividing net income (loss) by
the weighted average of common shares outstanding during each period.
Earnings per share assuming dilution are computed by dividing net
income (loss) by the weighted average number of common shares
outstanding during the period after giving effect to dilutive stock
options and adjusted for dilutive common shares assumed to be issued on
conversion of PETsMART's subordinated convertible notes.
A reconciliation of the basic and diluted per share computations for
first quarter of fiscal 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THIRTEEN WEEKS ENDED
-------------------------------------------------------------------------
MAY 3, 1998 MAY 4, 1997
--------------------------------- ------------------------------------
WEIGHTED WEIGHTED
AVERAGE PER SHARE AVERAGE PER SHARE
INCOME (LOSS) SHARES AMOUNT INCOME (LOSS) SHARES AMOUNT
<S> <C> <C> <C> <C> <C> <C>
Net income (loss) $ 153 115,745 $ 0.00 $ (746) 114,295 $ (0.01)
------------- ---------- --------- ------------- ------- ----------
Earnings per common share 153 115,745 0.00 (746) 114,295 (0.01)
Effect of dilutive securities:
Options - 1,018 0.00 - - -
-------------- ----------- ---------- ------------- ------- -----------
Earnings per common share -
assuming dilution $ 153 116,763 $ 0.00 $ (746) 114,295 $ (0.01)
============= =========== ========= ============ ======= ===========
</TABLE>
6
<PAGE> 7
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THIRTEEN WEEKS ENDED MAY 3, 1998
AND MAY 4, 1997
At May 3, 1998, no shares of common stock had been issued upon
conversion of the subordinated convertible notes issued in November
1997. These notes are convertible into an aggregate of approximately
22.8 million shares of common stock. These shares were not included in
the calculation of diluted earnings per share for first quarter 1998
due to the anti-dilutive effect they would have on earnings per share
if converted.
NOTE 3 - BUSINESS COMBINATIONS:
During the fourth quarter of 1996, the Company acquired all of the
outstanding equity interests of Pet City Holdings plc for approximately
7,844,000 shares of PETsMART common stock, plus approximately 304,000
shares reserved for issuance upon exercise of Pet City stock options
assumed in the merger.
During the first fiscal quarter ended May 4, 1997, the Company recorded
merger and business integration charges related to the Pet City
acquisition of $9.6 million before income taxes. These charges included
costs associated with reformatting, refixturing, and remerchandising of
the acquired superstores to the format consistent with that of a
PETsMART superstore, including changing the tradename ($8.6 million),
and other costs of integration ($1.0 million). Throughout fiscal 1997,
the Company recorded a total of $13.6 million of similar business
integration costs, primarily store conversion costs, associated with
the Pet City merger.
NOTE 4 - MERGER AND RESTRUCTURING COSTS:
In the second fiscal quarter of 1997, the Company incurred charges of
$61.0 million to cover (i) the costs of closing nine underperforming
stores and relocating 24 stores previously identified as candidates for
closure over the next two years, (ii) the discontinuance of the
Discovery Center department within all stores, including the write-off
of related inventory and fixtures, (iii) provisions for the closure of
excess facilities, and (iv) other charges, including merger and
integration charges of $4.1 million as a result of the Pet City
acquisition and additional costs resulting from the Company's prior
acquisitions. Approximately $44.9 million of the $61.0 million total
charge was recorded as a separate restructuring charge during the
second quarter of 1997. Of the remaining $16.1 million, approximately
$9.4 million of related charges were recorded as cost of goods sold,
$3.3 million were recorded as store operating expenses, and $3.4
million were included in general and administrative expenses for the
second quarter of 1997. The $16.1 million of other one-time expenses
were comprised of the write-down or write-off of certain discontinued
Discovery Center merchandise from cost to net realizable value and
impaired assets, reserves for litigation and other matters. The $3.3
million of other expenses reflected as a component of store operating
expenses and the $3.4 million of one-time expenses reflected as general
and administrative expenses consist primarily of a change in estimated
self-insurance costs due to adverse loss developments in the Company's
worker's compensation experience, expenses related to the preliminary
stages of a consulting project for the new management information
system, certain costs of several litigation matters, as well as
expenses related to other miscellaneous matters.
The activity within the accrued merger and restructuring costs
liability account during the first quarter 1998 is summarized below (in
thousands):
<TABLE>
<CAPTION>
BALANCE AT ADDITIONAL PAYMENTS/ BALANCE AT
FEB. 1, 1998 EXPENSES ASSET WRITE-OFFS MAY 3, 1998
------------- ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Lease termination & real estate costs $ 33,390$ $ - $ (4,277) $ 29,113
Accrued business integration costs 347 - (79) 268
------------- ---------- ---------------- ------------
$ 33,737$ $ - $ (4,356) $ 29,381
============== ========== ================ ============
</TABLE>
7
<PAGE> 8
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THIRTEEN WEEKS ENDED MAY 3, 1998
AND MAY 4, 1997
NOTE 5 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:
In March 1998, the AICPA issued Statement of Position 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal
Use" ("SOP 98-1"). SOP 98-1 is effective for financial statements for
fiscal years beginning after December 15, 1998. Under the provisions of
SOP 98-1, software development is divided into three phases: the
preliminary project stage, which includes conceptual formulation and
selection of alternatives; the application development stage, which
includes design of chosen path, coding, installation of hardware and
testing; and the post-implementation/operation stage, which includes
training and application maintenance. Generally, only internal and
external costs incurred during the second phase, application
development stage, should be capitalized with the exception of data
conversion and training costs, which, when incurred during this phase,
should be expensed. The Company is substantially in compliance with the
provisions of SOP 98-1 and does not anticipate a material effect on its
financial statements.
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting
on the Costs of Start-up Activities" ("SOP 98-5"). SOP 98-5 is
effective for financial statements for fiscal years beginning after
December 15, 1998. Under the provisions of SOP 98-5, costs of start-up
activities, including organization costs, should be expensed as
incurred. The Company currently expenses its store preopening costs in
the period in which the store opens. The Company will adopt SOP 98-5 in
the first quarter of fiscal 1999 and does not anticipate a material
effect on earnings as a result of the adoption of SOP 98-5.
NOTE 6 - FINANCIAL INFORMATION BY BUSINESS SEGMENT:
PETsMART adopted Statement of Financial Accounting Standard No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131") at the beginning of fiscal 1998. SFAS 131 revised
standards for the reporting of information about operating segments of
public business enterprises. There was no change in the basis of
segmentation or in the measurement of segment profit or loss compared
to the 1997 fiscal year as a result of the adoption of SFAS 131.
The Company operates three reportable business segments. PETsMART North
American operations, the largest segment, includes all retail stores in
the United States and Canada, including veterinary services, along with
the warehousing and corporate functions that support them. The PETsMART
U.K. segment includes all retail stores in the United Kingdom,
including the warehousing and corporate functions specific to the U.K.
operations. The PETsMART DIRECT segment represents the Company's direct
marketing operations, including its separate corporate and warehousing
functions. This segmentation is consistent with the format reviewed by
the Company's management, in accordance with the provisions of SFAS
131.
8
<PAGE> 9
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THIRTEEN WEEKS ENDED MAY 3, 1998
AND MAY 4, 1997
Operating results and other financial data by business segment for the
thirteen weeks ended May 3, 1998 and May 4, 1997, were as follows:
<TABLE>
<CAPTION>
FOR THE 13 WEEKS ENDED
----------------------------
MAY 3, MAY 4,
1998 1997
------------ ----------
(in thousands)
<S> <C> <C>
Net Sales:
PETsMART North America $ 422,293 $ 350,516
PETsMART U.K. 48,568 33,873
PETsMART DIRECT - External customers 25,703 28,267
PETsMART DIRECT - Intersegment 2,488 1,369
Eliminations (2,488) (1,369)
------------ ----------
Total net sales $ 496,564 $ 412,656
=========== ===========
Operating Income:
PETsMART North America $ 7,914 $ 8,457
PETsMART U.K. (3,664) 1,080
PETsMART DIRECT 780 2,404
Merger, business integration and restructuring costs - (9,631)
-------------- -----------
Operating income 5,030 2,310
Interest income 482 50
Interest expense 5,264 2,712
----------- -----------
Income (loss) before income taxes $ 248 $ (352)
=========== ===========
</TABLE>
Total assets by business segment as of May 3, 1998, and February 1,
1998, were as follows:
<TABLE>
<CAPTION>
MAY 3, FEBRUARY 1,
1998 1998
------------ ----------
(in thousands)
<S> <C> <C>
PETsMART North America $ 705,015 $ 715,691
PETsMART U.K. 97,804 87,731
PETsMART DIRECT 35,079 36,265
----------- ------------
Total assets $ 837,898 $ 839,687
========== ==========
</TABLE>
Net sales in the PETsMART North America segment increased $71.8 million
or 20.5%, during the first thirteen weeks of fiscal 1998 as compared to
the same period in fiscal 1997. The main sources of this increase were
a net increase in the number of stores open in North America from 347
at May 4, 1997 to 410 at May 3, 1998, and a comparable store sales
increase of 6.4% for the first thirteen weeks of fiscal 1998. Operating
income in the PETsMART North America segment decreased $0.5 million
from the first quarter of fiscal 1997. This decrease reflects increased
store operating expenses resulting from the "Back-to-Basics"
initiatives, which included higher store payroll costs to improve
customer service and a return to historical advertising strategies, and
increased general and administrative expenses resulting from expenses
associated with closed stores and additional information systems costs
incurred in connection with systems initiatives.
9
<PAGE> 10
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THIRTEEN WEEKS ENDED MAY 3, 1998
AND MAY 4, 1997
Net sales for the first quarter 1998 increased $14.7 million, or
43.4%, from the first quarter 1997 in the PETsMART U.K. segment. The
number of open stores increased from 63 at May 4, 1997 to 89 at May 3,
1998. Comparable stores sales increased 1.0%. The U.K. segment
reported an operating loss of $3.7 million in the first quarter 1998
versus operating income of $1.1 million for the first quarter 1997.
The decline is the result of the disappointing U.K. comparable store
sales increases due to decreased advertising expenditures in 1998
versus last year when the Company was changing the trade name from Pet
City to PETsMART, higher occupancy costs, particularly in the new,
larger stores, the allocation of certain 1997 incremental advertising
costs as a component of merger, business integration and restructuring
costs, and increased warehouse and distribution costs.
The PETsMART DIRECT segment reported decreased net sales and operating
income in the first quarter 1998 compared to first quarter 1997. The
decreases in both areas reflect a decision to reduce circulation of
both the pet and equine catalogs during the first quarter of 1998.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could materially differ from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in this section, as well as in
the sections entitled Purchasing and Distribution, Competition, and Risk Factors
included in the Company's Form 10-K for the year ended February 1, 1998.
OVERVIEW
PETsMART is the largest operator of superstores specializing in pet
food, supplies and services in North America and the United Kingdom. At May 3,
1998, the Company operated 499 superstores, consisting of 395 superstores in the
United States, 89 superstores in the United Kingdom, and 15 superstores in
Canada. PETsMART's store base has grown rapidly since the Company's inception in
1986 through the opening of new stores and through the acquisitions of PETZAZZ
in March 1994, Petstuff in June 1995, Pet Food Giant in September 1995, and Pet
City in December 1996. The Company also acquired two leading catalog retailers,
Sporting Dog in May 1995 and State Line Tack in January 1996. All of these
transactions were accounted for as poolings of interest. Earnings per share are
presented in conformity with Statement of Financial Accounting Standards No.
128, "Earnings per Share."
The Company expects that future increases in net sales and net income,
if any, will be dependent on the opening of additional superstores and the
improved performance of new and existing superstores. In view of the increasing
maturity of its superstore base, as well as the planned opening of additional
superstores in existing markets and single-store markets, the Company
anticipates that its comparable store sales increases may be lower in future
periods. As a result of its expansion plans, the Company anticipates the timing
of new superstore openings, and related preopening expenses, and the amount of
revenue contributed by new and existing superstores may cause the Company's
quarterly results of operations to fluctuate. The Company has achieved less
favorable operating results in certain North American geographic regions it
recently entered than it has achieved historically in other regions. In
addition, because new superstores have higher payroll, advertising and other
store level expenses as a percentage of sales than mature superstores, the
impact of new superstore openings will also contribute to lower store operating
margins until they become established. The Company charges preopening costs
associated with each new superstore to earnings when the superstore is opened.
Therefore, the Company expects that the opening of large numbers of new
superstores in a given quarter will adversely impact its quarterly results of
operations for that period.
DEVELOPMENTS DURING FISCAL 1997
For the first half of fiscal 1997, the Company reported disappointing
operating results due to a combination of reduced inventory levels, which led to
out-of-stock conditions in certain key categories, and lost sales momentum as a
result of a departure from the Company's historically more effective advertising
programs. In June 1997, Samuel J. Parker, the Company's Chairman, resumed his
former role as Chief Executive Officer and began the implementation of a series
of "Back to Basics" initiatives intended to refocus the Company and to improve
financial performance. In connection with the implementation of these
initiatives and other considerations, PETsMART recorded restructuring expenses
and a charge for merger and business integration costs aggregating $61.0 million
before tax benefits in the second quarter of fiscal 1997, of which approximately
$40.0 million represented a cash charge. These charges consisted of $44.9
million in restructuring expenses related to the closure and relocation of
certain stores, the elimination of certain departments within PETsMART
superstores, and additional costs associated with certain of the Company's prior
acquisitions, and $16.1 million of other one-time charges which were recorded as
components of cost of goods sold, store operating expenses and general and
administrative expenses.
The $16.1 million of other one-time expenses in the second quarter of
fiscal 1997 were comprised of the write-down or write-off of certain
discontinued merchandise and impaired assets, and other matters. Of these
expenses, the $9.4 million that was reflected as a component of cost of goods
sold included the writedown of the Discovery Center inventory from cost to net
realizable value in connection with the discontinuance of that department, as
well as the writedown of certain non-Discovery Center inventory from cost to net
realizable value as a result of the decision to exit other product categories.
As a consequence of its "Back to Basics" initiatives and to better focus its
merchandise selections on pet-related products, the Company determined that its
"Discovery Center" merchandise, consisting primarily of educational and
human-oriented items, should be discontinued. Given the square footage and store
location devoted to this area, combined
11
<PAGE> 12
with the lower turnover and sell-through gross margin, management believed the
store area would be better utilized with different merchandise. The $3.3 million
of other expenses reflected as a component of store operating expenses and the
$3.4 million of one-time expenses reflected as general and administrative
expenses consist primarily of a change in estimated self-insurance costs due to
adverse loss developments in the Company's worker's compensation experience,
expenses related to the preliminary stages of a consulting project for the new
management information system, certain costs of several litigation matters, as
well as expenses related to other miscellaneous matters.
Of the $44.9 million in restructuring charges recorded in the second
quarter of fiscal 1997, approximately $30.0 million was related to the costs of
closing or relocating 33 stores, of which 31 were former PETZAZZ, Petstuff or
Pet Food Giant stores, approximately $8.5 million was related to the costs of
discontinuing the Discovery Center department in all superstores and the
write-down or write-off of related fixtures and approximately $4.1 million was
related to the Company's previous acquisitions. The remaining charges of $2.3
million included approximately $1.0 million of anticipated costs associated with
the Company's decision to complete the consolidation of the Ennis, Texas
distribution center into the Company's new Phoenix, Arizona facility and
approximately $1.3 million representing the write-off of the Company's
investments in certain other entities accounted for under the cost method, which
were impaired as a result of the Company's decision to exit certain departments
within the PETsMART superstores.
As a result of the acquisition of Pet City, the Company recorded
charges for merger and business integration costs of $13.6 million during fiscal
1997, primarily related to reformatting, refixturing, and remerchandising the
acquired stores to the PETsMART superstore format and other costs of
integration. The majority of these expenses related to an advertising program to
promote the new store image and format. The Company also recorded charges of
approximately $3.0 million for merger and business integration costs during
second quarter 1997 as a result of additional real estate costs incurred in
connection with certain of its previous acquisitions.
The activity within the accrued merger and restructuring costs liability account
during first quarter 1998 is summarized below (in thousands):
<TABLE>
<CAPTION>
BALANCE AT ADDITIONAL PAYMENTS/ BALANCE AT
FEB. 1, 1998 EXPENSES ASSET WRITE-OFFS MAY 3, 1998
------------ ---------- ---------------- -----------
<S> <C> <C> <C> <C>
Lease termination & real
estate costs $ 33,390 $ - $ (4,277) $ 29,113
Accrued business
integration costs 347 - (79) 268
----------- ---------- ------------ -----------
$ 33,737 $ - $ (4,356) $ 29,381
======== ========= ========= ========
</TABLE>
In November 1997, $200,000,000 of 6 3/4% Subordinated Convertible Notes
(the "Notes") were issued by the Company and sold to "qualified institutional
buyers" (as defined in Rule 144A of the Securities Act) in transactions exempt
from registration under the Securities Act, and in sales outside the United
States within the meaning of Regulation S under the Securities Act. The net
proceeds to PETsMART from the sale of the Notes were approximately $193,250,000.
The lost sales and earnings momentum experienced in the first half of
1997 continued to negatively affect results of operations and comparable store
sales throughout fiscal 1997. Specifically, comparable store sales increases for
the North American stores approximated 4% for the second half of fiscal 1997,
well below the Company's historical and anticipated levels, and gross margins
remained below historical norms due to the mix of merchandise sales, increased
occupancy and warehouse and distribution costs, higher personnel costs in
service areas of the business, and the effects of the Company's return to the
every-day-low pricing policy. Store operating expenses also increased during the
second half of fiscal 1997 due to the increased emphasis on customer service
which required increased payroll expenditures, and general and administrative
expenses also increased as a result of the activities related to the Company's
management information systems project. The Company does not anticipate these
costs to decrease significantly, if at all, during fiscal 1998.
12
<PAGE> 13
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to net
sales, unless otherwise indicated, of certain items included in the Company's
statement of operations:
<TABLE>
<CAPTION>
THIRTEEN WEEKS ENDED
--------------------
MAY 3, MAY 4,
1998 1997
-------- ------
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales 100.0% 100.0%
Cost of sales 75.4 75.4
------ ------
Gross profit 24.6 24.6
Store operating expenses 19.7 18.7
Store preopening expenses 0.9 0.8
General and administrative expenses 3.0 2.3
Merger, business integration and restructuring costs - 2.3
------ ------
Operating income (loss) 1.0 0.6
Interest income 0.1 0.0
Interest expense 1.1 0.7
------ ---
Income (loss) before income taxes 0.0 (0.1)
Income tax expense 0.0 0.1
------ ------
Net income (loss) 0.0% (0.2)%
======= ========
</TABLE>
FIRST QUARTER FISCAL 1998 COMPARED TO FIRST QUARTER FISCAL 1997
The following discussion of results of operations for first quarter
1998 and first quarter 1997 excludes the effects of the restructuring, merger
and business integration costs discussed above in "Developments During Fiscal
1997."
Net sales increased 20.3% to approximately $496.6 million for the
thirteen weeks ended May 3, 1998 from $412.7 million for the thirteen weeks
ended May 4, 1997. Comparable North American store sales increased 6.4% for the
quarter, and comparable United Kingdom store sales increased 1.0%. During the
first quarter, the Company opened 34 new superstores, including seven
replacement stores, and closed eight stores in North America and opened six
stores and closed one store in the United Kingdom. The Company had 499
superstores in operation at May 3, 1998 compared to 410 superstores open at May
4, 1997.
Gross profit, defined as net sales less cost of sales, including
distribution costs and store occupancy costs, remained constant as a percentage
of net sales at 24.6% for both first quarter 1998 and first quarter 1997. This
result principally reflected an improved merchandise mix, additional vendor
discounts and better shrink experience, offset by the return to Everyday Low
Pricing Strategy in North American stores, higher occupancy costs in certain new
locations, particularly in newer United Kingdom stores, increased United Kingdom
warehouse and distribution costs and higher personnel costs in veterinarian and
grooming operations.
Store operating expenses, which includes payroll and benefits,
advertising and other store level expenses, increased as a percentage of net
sales to 19.7% for first quarter 1998 from 18.7 % for first quarter 1997. The
increase reflected a continued commitment to increase service levels in both
North American and United Kingdom stores.
Store preopening expenses as a percentage of net sales increased to
0.9% for first quarter 1998, compared to 0.8% for first quarter 1997. Including
seven North American replacement stores and six new United Kingdom stores, 40
stores were opened during first quarter 1998. The average store preopening
expense of $106,000 per store in first quarter 1998 was higher than historical
levels due to the need to hire temporary setup personnel in certain tight labor
markets.
13
<PAGE> 14
General and administrative expenses as a percentage of sales increased
to 3.0% for first quarter 1998, as compared to 2.3% for first quarter 1997. The
increase was directly related to costs incurred in connection with the closure
of stores and additional management information system costs related to
worldwide systems initiatives.
The Company's operating income decreased to $5.0 million for first
quarter 1998 from $11.9 million for first quarter 1997, excluding the $9.6
million of merger and business integration charges recorded in first quarter
1997 related to the Pet City acquisition. Excluding the merger and integration
charges, operating income as a percentage of net sales decreased from 2.9% for
first quarter 1997 to 1.0% for first quarter 1998. This decrease was primarily
due to increased store operating expenses and general and administrative
expenses as described above. The decrease also was a result of disappointing
sales and gross margins in the United Kingdom stores.
Interest income increased to $0.5 million for first quarter 1998 from
$0.1 million for first quarter 1997 principally due to the increase in average
cash balances from the note offering completed in November 1997. Interest
expense increased to $5.3 million for the first quarter 1998 from $2.7 million
for first quarter 1997. The increase was also primarily related to the note
offering completed in November 1997.
For both fiscal 1998 and fiscal 1997, income taxes were provided at an
annual effective rate of 38.5%. The Company's income tax provision for the first
quarter 1997 reflected the nondeductibility of certain costs included in the
merger and business integration charges.
As a result of the foregoing, the Company reported net income of $0.2
million (or $0.00 per share - diluted) for first quarter 1998 compared to a net
loss of $0.7 million (or $0.00 per share - diluted) for the first quarter 1997.
Excluding the first quarter 1997 merger and business integration charges and the
related tax benefits, net income for first quarter 1997, on a comparable basis,
was $5.7 million (or $0.05 per share - diluted).
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations and expansion program to date
principally through cash flows from operations, the sale of equity and debt
securities, lease financing and borrowings under its credit facility. Additional
sources of financing have included vendor terms on inventory purchases.
At May 3, 1998, total assets were $837.9 million, of which $499.6
million were current assets. Cash and cash equivalents were $99.5 million.
Cash used in operations was $16.1 million for the thirteen weeks ended
May 3, 1998, compared to cash provided by operations of $7.9 million for the
same period of the prior year. Approximately $10.2 million of the net cash used
in operations during the thirteen weeks ended May 3, 1998 related to the timing
of inventory purchases and payments during the first quarter 1998 for inventory
balances required for the stores opened in first quarter 1998. Merchandise
accounts payable leveraging (the percentage of merchandise inventory financed by
vendor credit terms, e.g., accounts payable divided by merchandise inventory),
decreased to 35.4% at May 3, 1998, compared to 36.1% at February 1, 1998.
Inventory balances were approximately $319.8 million at May 3, 1998, and $317.5
million at February 1, 1998. Average North American store inventory, which
excludes the inventory of PETsMART Direct, decreased 5.9% to $665,000 per store
at May 3, 1998, from approximately $707,000 at February 1, 1998.
The Company has used cash in investing activities since inception to
purchase leaseholds, fixtures and equipment for new superstores and, to a lesser
extent, to purchase equipment and computer software in support of its
administrative functions. The Company has also used cash to purchase superstores
for sale and leaseback. Net cash used in investing activities was $15.5 million
for the thirteen weeks ended May 3, 1998.
Net cash flow from financing activities, primarily the change in the
Company's bank overdraft and proceeds from the exercise of employee stock
options, was $5.0 million for the thirteen weeks ended May 3, 1998.
The Company's primary long-term capital requirements are for opening
new superstores, the costs of closing redundant or inadequate superstores
identified in second quarter 1997, merger and business integration costs and
corporate investment, including costs associated with the development and
implementation of the Company's new information system and for working capital.
14
<PAGE> 15
All of the Company's superstores are leased facilities. The Company
estimates that the cash requirements after lease financing to open each new U.S.
prototype superstore, including store fixtures and equipment, leasehold
improvements, preopening costs and inventory is approximately $600,000. This
amount will typically include an average of approximately $50,000 for leasehold
improvements (an average of approximately $200,000 if the superstore site is a
rehabilitated unit), approximately $100,000 for preopening costs, and
approximately $450,000 for inventory, net of accounts payable. Approximately
$400,000 is required for store fixtures and equipment, which is typically
fully-funded through lease financing.
Based upon the Company's current plan to open approximately 42
additional North American superstores by the end of fiscal 1998, approximately
$42.0 million will be needed to finance the Company's new superstore openings in
the remainder of fiscal 1998, of which approximately $16.8 million will be
financed through equipment leases. The Company may also expend additional funds
to take advantage of opportunities that arise from time to time for the
acquisition of businesses or lease rights from tenants occupying retail space
that is suitable for a PETsMART superstore.
PETsMART is in the design/application development stage of developing
and implementing an integrated worldwide information system which will feature a
common set of applications. The Company estimates that its costs in connection
with the development and implementation of the new system, before giving
consideration to any lease financing that may be available, will be up to $20
million annually through fiscal 2000. The Company believes that certain hardware
and software components of the new system may be financed through lease
transactions, although there can be no assurance that the actual costs for the
new system will not exceed current estimates. There can be no assurance that the
new system can be developed, tested and implemented on a timely basis, or at
all, or that it will deliver the anticipated operational benefits in a reliable
manner. Failure to complete the new system on a timely basis could materially
adversely affect the Company's future operating results or its ability to
expand. In particular, should the new system not be operational, or should an
alternate solution not be implemented, by January 1, 2000, the Company may
experience software difficulties as a result of the so-called "Year 2000"
problem. In the event that additional financing is required to complete the
Company's new information system, there can be no assurance that such additional
financing will be available to the Company on acceptable terms.
Capital expenditures, net of construction allowances, were
approximately $15.5 million during first quarter 1998. Such expenditures were
used primarily for the opening of new superstores in North America and the
United Kingdom, the development and implementation of the Company's new
information system and the remodel and maintenance of the Company's existing
superstores.
Management believes that its existing cash and cash equivalents,
together with cash flow from operations, borrowing capacity under its bank
credit facility and available lease financing will provide adequate funds for
the Company's foreseeable working capital needs, planned capital expenditures
and debt service obligations. The Company's ability to fund its operations and
to make planned capital expenditures and scheduled debt payments, to refinance
indebtedness and to remain in compliance with all of the financial covenants
under its debt agreements depends on its future operating performance and cash
flow, which in turn are subject to prevailing economic conditions and to
financial, business and other factors, some of which are beyond the Company's
control.
SEASONALITY AND INFLATION
The Company's business is subject to some seasonal fluctuation and it
typically realizes a substantial portion of its net sales and operating profits
during the fourth fiscal quarter. In addition, sales of certain of the Company's
products and services designed to address pet health needs, such as flea and
tick problems, have been and may continue to be negatively impacted by the
introduction of alternative treatments, as well as by variations in weather
conditions. In addition, because PETsMART's superstores typically draw customers
from a large trade area, sales may be impacted by adverse weather or travel
conditions.
The Company's results of operations and financial position are
presented based upon historical cost. Although the Company cannot accurately
anticipate the effect of inflation on its operations, it does not believe
inflation is likely to have a material adverse effect on its net sales or
results of operations.
15
<PAGE> 16
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the AICPA issued Statement of Position 98-1, "Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP
98-1"). SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. Under the provisions of SOP 98-1, software
development is divided into three phases: the preliminary project stage, which
includes conceptual formulation and selection of alternatives; the application
development stage, which includes design of chosen path, coding, installation of
hardware and testing; and the post-implementation/operation stage, which
includes training and application maintenance. Generally, only internal and
external costs incurred during the second phase, application development stage,
should be capitalized with the exception of data conversion and training costs,
which, when incurred during this phase, should be expensed. The Company is
substantially in compliance with the provisions of SOP 98-5 and does not
anticipate a material effect on its financial statements.
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting
on the Costs of Start-up Activities" ("SOP 98-5"). SOP 98-5 is effective for
financial statements for fiscal years beginning after December 15, 1998. Under
the provisions of SOP 98-5, costs of start-up activities, including organization
costs, should be expensed as incurred. The Company currently expenses its store
preopening costs in the period in which the store opens. The Company will adopt
SOP 98-5 in the first quarter of fiscal 1999.
16
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On January 6, 1998, the Company was served with a complaint entitled
Miller v. Parker, et al. (Case No. CV 98-0020 PHX RCS) in the Federal District
Court for the District of Arizona, Phoenix Division by a putative class of
investors in PETsMART, Inc. securities. The lawsuit alleges, among other things,
that the Company and its officers and directors issued materially false
financial statements about the Company's flea and tick product inventory,
financial condition and results of operations. Several additional complaints by
putative class representatives alleging substantially the same allegations have
been filed in the District of Arizona. On May 18, 1998, the District Court
entered an order consolidating the securities class action litigation into a
single action entitled In Re PETsMART, Inc. Securities Litigation,
CIV-98-20-PHX-ROS (JBM), and appointing lead counsel. Plaintiffs have sixty days
from the date of the District Court's order to file an amended consolidated
complaint. The Company believes that the allegations presently on file by the
putative class representatives are without merit and the Company intends to
defend itself vigorously.
In addition, a former Pet City affiliate has retained counsel in the
United States and made allegations claiming that the Company misled the
shareholders of Pet City at the time of the acquisition of Pet City concerning
PETsMART's business, finances and prospects. On September 30, 1997, shortly
after the receipt of the allegations by PETsMART, Richard Northcott, the former
Chairman of Pet City, resigned as a director of the Company. No litigation has
been filed with respect to this matter, and the Company believes that the
allegations are without merit. Nevertheless, there can be no assurance that one
or more former Pet City affiliates will not initiate litigation seeking monetary
damages or an equitable remedy.
On March 28, 1998, a lawsuit was filed in Federal District Court in the
Middle District of Florida entitled Carucci et al. v. PETsMART, Inc. (Case No.
98-CV-340). This class-action complaint alleges unspecified damages based on
various alleged violations of the Fair Labor Standards Act, including alleged
failures to pay overtime premiums. On May 12, 1998, the Company answered the
complaint denying all material allegations. The parties filed a case management
report on June 3, 1998 which outlines the anticipated discovery.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - None.
(b) Reports on Form 8-K
During the thirteen weeks ended May 3, 1998, the Company filed the
following report on Form 8-K:
Current Report on Form 8-K, dated February 24, 1998, and filed on or
about February 25, 1998, in which the Company announced its earnings
for the fiscal year ended February 1, 1998.
17
<PAGE> 18
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, on June 16, 1998.
PETSMART, INC.
(Registrant)
/s/ Neil T. Watanabe /s/ Kenneth A. Conway
---------------- -----------------
Neil T. Watanabe Kenneth A. Conway
Executive Vice President and Vice President and
Chief Financial Officer Controller
(Principal Financial Officer) (Principal Accounting Officer)
18
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR TO DATE AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-02-1998
<PERIOD-END> MAY-03-1998
<CASH> 99,511
<SECURITIES> 0
<RECEIVABLES> 48,308
<ALLOWANCES> 0
<INVENTORY> 319,794
<CURRENT-ASSETS> 499,643
<PP&E> 377,136
<DEPRECIATION> 120,222
<TOTAL-ASSETS> 837,898
<CURRENT-LIABILITIES> 215,868
<BONDS> 265,748
0
0
<COMMON> 11
<OTHER-SE> 337,588
<TOTAL-LIABILITY-AND-EQUITY> 837,898
<SALES> 496,564
<TOTAL-REVENUES> 496,564
<CGS> 374,423
<TOTAL-COSTS> 374,423
<OTHER-EXPENSES> 117,111
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,264
<INCOME-PRETAX> 248
<INCOME-TAX> 95
<INCOME-CONTINUING> 153
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 153
<EPS-PRIMARY> 0.00
<EPS-DILUTED> 0.00
</TABLE>
