<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:
NOVEMBER 1, 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, 116,361,390 SHARES AT DECEMBER 11, 1998
1
<PAGE> 2
PETsMART, INC.
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets at November 1, 1998
and February 1, 1998 3
Consolidated Statements of Operations
for the thirteen and thirty-nine weeks ended
November 1, 1998 and November 2, 1997 4
Consolidated Statements of Cash Flows
for the thirty-nine weeks ended
November 1, 1998 and November 2, 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 12
Part II. Other Information
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
2
<PAGE> 3
PETsMART, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
Unaudited
<TABLE>
<CAPTION>
NOVEMBER 1, FEBRUARY 1,
1998 1998
----------- -----------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 119,912 $ 125,082
Receivables 46,748 45,853
Merchandise inventories 339,383 317,547
Prepaid expenses and other current assets 26,976 27,228
--------- ---------
Total current assets 533,019 515,710
Property held for sale and leaseback 9,253 2,212
Property and equipment, net 256,911 242,384
Other assets 80,680 79,381
--------- ---------
Total assets $ 879,863 $ 839,687
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 144,783 $ 114,692
Accrued payroll and employee benefits 23,673 18,559
Accrued occupancy expense 19,825 10,548
Accrued merger and restructuring costs 24,624 33,737
Other accrued expenses 20,093 29,980
Current maturities of capital leases 13,179 10,753
--------- ---------
Total current liabilities 246,177 218,269
6 3/4% Subordinated Convertible Notes 200,000 200,000
Capital lease obligations 72,413 68,008
Deferred rents 16,645 17,015
Other liabilities 1,715 1,701
--------- ---------
Total liabilities 536,950 504,993
--------- ---------
Stockholders' equity:
Preferred stock; $.0001 par value, 10,000 shares
authorized, none outstanding -- --
Common stock; $.0001 par value; 250,000 shares
authorized, 116,159 and 115,629 shares issued and outstanding 11 11
Additional paid-in capital 390,040 383,338
Accumulated deficit (44,320) (48,126)
Cumulative foreign currency translation adjustments (2,818) (529)
--------- ---------
Total stockholders' equity 342,913 334,694
--------- ---------
Total liabilities and stockholders' equity $ 879,863 $ 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 FOR THE 39 WEEKS ENDED
------------------------------ ------------------------------
NOV. 1, NOV. 2, NOV. 1, NOV. 2,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $ 521,191 $ 441,456 $ 1,527,601 $ 1,279,970
Cost of sales 395,572 337,378 1,158,247 977,764
----------- ----------- ----------- -----------
Gross profit 125,619 104,078 369,354 302,206
Store operating expenses 97,409 85,955 292,035 250,351
Store preopening expenses 862 1,916 8,396 7,925
General and administrative expenses 13,251 10,844 47,694 35,345
Merger, business integration and
restructuring costs -- 1,466 -- 55,988
----------- ----------- ----------- -----------
Operating income (loss) 14,097 3,897 21,229 (47,403)
Interest income 766 69 2,388 182
Interest expense (5,904) (3,492) (17,139) (9,608)
----------- ----------- ----------- -----------
Income (loss) before income taxes 8,959 474 6,478 (56,829)
Income tax expense (benefit) 3,628 294 2,672 (20,547)
----------- ----------- ----------- -----------
Net income (loss) 5,331 180 3,806 (36,282)
----------- ----------- ----------- -----------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments (780) 1,555 (2,289) 2,104
----------- ----------- ----------- -----------
Other comprehensive income (loss) (780) 1,555 (2,289) 2,104
----------- ----------- ----------- -----------
Comprehensive income (loss) $ 4,551 $ 1,735 $ 1,517 $ (34,178)
=========== =========== =========== ===========
Earnings per common share - basic:
Net income (loss) $ 0.05 $ 0.00 $ 0.03 $ (0.32)
=========== =========== =========== ===========
Earnings per common share - assuming dilution:
Net income (loss) $ 0.05 $ 0.00 $ 0.03 $ (0.32)
=========== =========== =========== ===========
</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 39 WEEKS ENDED
--------------------------
NOV. 1, NOV. 2,
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income (loss) $ 3,806 $ (36,282)
Adjustments to reconcile net income (loss) to net cash
from (used in) operating activities -
Depreciation and amortization 32,434 25,296
Loss on disposal of property and equipment 808 417
Changes in assets and liabilities:
Receivables (10,073) (8,750)
Merchandise inventories (21,692) (22,096)
Prepaid expenses and other current assets 252 (11,825)
Other assets (2,773) (15,557)
Accounts payable 17,068 2,822
Accrued payroll and employee benefits 5,114 403
Accrued occupancy expense 9,277 6,397
Accrued merger and restructuring costs (9,283) 23,286
Other accrued expenses (9,881) (16,596)
Deferred rents (370) 2,809
Other liabilities 14 161
--------- ---------
Net cash from (used in) operating activities 14,701 (49,515)
--------- ---------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Purchases of leaseholds, fixtures and equipment (29,531) (25,653)
Purchases of property held for sale and leaseback (5,564) (2,286)
Proceeds from sales of property 11,742 --
--------- ---------
Net cash used in investing activities (23,353) (27,939)
--------- ---------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 4,774 7,113
Borrowings from bank credit facility -- 117,100
Repayment of bank credit facility -- (44,100)
Increase in bank overdraft 13,023 4,208
Tax benefit resulting from exercise of stock options 427 1,540
Payments on capital lease obligations (12,453) (8,026)
--------- ---------
Net cash from financing activities 5,771 77,835
--------- ---------
FOREIGN CURRENCY TRANSLATION GAINS (LOSSES) (2,289) 2,104
--------- ---------
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (5,170) 2,485
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD 125,082 39,868
--------- ---------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 119,912 $ 42,353
========= =========
</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 AND THIRTY-NINE WEEKS ENDED NOVEMBER 1, 1998 AND NOVEMBER 2, 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 (benefit) related to items of other
comprehensive income was approximately $(531,000) and $973,000 for third quarter
1998 and 1997, respectively. For the thirty-nine weeks ended November 1, 1998
and November 2, 1997, the income tax expense (benefit) related to items of other
comprehensive income was approximately $(1,606,000) and $1,317,000,
respectively.
Because of the seasonal nature of the Company's business, the results of
operations for the thirteen weeks and thirty-nine weeks ended November 1, 1998
and November 2, 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 Standards 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 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 the
thirteen weeks and thirty-nine weeks ended November 1, 1998 and November 2, 1997
are as follows:
<TABLE>
<CAPTION>
THIRTEEN WEEKS ENDED
---------------------------------------------------------------------------------------
NOVEMBER 1, 1998 NOVEMBER 2, 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 $ 5,331 116,432 $ 0.05 $ 180 115,225 $ 0.00
------- ------- --------- ------- --------- ---------
Earnings per common share 5,331 116,432 0.05 180 115,225 0.00
Effect of dilutive securities:
Options -- 376 -- -- 628 --
------- ------- --------- ------- --------- ---------
Earnings per common share -
assuming dilution $ 5,331 116,808 $ 0.05 $ 180 115,853 $ 0.00
======= ======= ========= ======= ========= =========
</TABLE>
6
<PAGE> 7
PETsMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED NOVEMBER 1, 1998 AND NOVEMBER 2, 1997
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED
----------------------------------------------------------------------------------
NOVEMBER 1, 1998 NOVEMBER 2, 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) $ 3,806 116,115 $0.03 $(36,282) 114,642 $(0.32)
-------- -------- ----- -------- -------- -----
Earnings (loss) per common share 3,806 116,115 0.03 (36,282) 114,642 (0.32)
Effect of dilutive securities:
Options -- 752 -- -- -- --
-------- -------- ----- -------- -------- -----
Earnings (loss) per common share -
assuming dilution $ 3,806 116,867 $0.03 $(36,282) 114,642 $(0.32)
======== ======== ===== ======== ======== =====
</TABLE>
At November 1, 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 the thirteen and thirty-nine weeks ended November 1, 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).
During the second fiscal quarter ended August 3, 1997 and during the third
fiscal quarter ended November 2, 1997, the Company recorded $1.1 million and
$1.5 million, respectively, before income taxes, of merger and business
integration charges related to the Pet City acquisition. These charges included
costs associated with reformatting, refixturing and remerchandising the acquired
stores to the format consistent with that of a PETsMART superstore, and other
costs of integration. 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. The Company also recorded
approximately $3.0 million of merger and integration charges during second
quarter 1997 as a result of certain additional real estate costs incurred in
connection with certain of its previous acquisitions.
NOTE 4 - MERGER AND RESTRUCTURING COSTS:
In second quarter 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 a two year period, (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
7
<PAGE> 8
PETsMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED NOVEMBER 1, 1998 AND NOVEMBER 2, 1997
integration charges of $4.1 million as a result of the Pet City acquisition and
additional costs resulting from the Company's prior acquisitions (See Note 3).
Approximately $44.9 million of the $61.0 million total charge was recorded as a
separate restructuring charge during second quarter 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 second quarter
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 thirty-nine weeks of fiscal 1998 is summarized below (in
thousands):
<TABLE>
<CAPTION>
BALANCE AT ADDITIONAL PAYMENTS/ BALANCE AT
FEB. 1, 1998 EXPENSES ASSET WRITE-OFFS NOV. 1, 1998
------------ ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Lease termination & real estate costs $ 33,390 $ -- $ (8,986) $ 24,404
Accrued business integration costs 347 -- (127) 220
-------- -------- -------- --------
$ 33,737 $ -- $ (9,113) $ 24,624
======== ======== ======== ========
</TABLE>
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 upon adoption.
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.
8
<PAGE> 9
PETsMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED NOVEMBER 1, 1998 AND NOVEMBER 2, 1997
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for financial
statements for fiscal years beginning after June 15, 1999. This statement
establishes the accounting and reporting standards for derivative instruments
and hedging activities, requiring that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
them at fair value. It also provides for matching of the timing of gain or loss
recognition on the hedging instrument with the recognition of (i) the changes in
the fair value of the hedged asset or liability related to the hedged risk or
(ii) the hedged forecasted transaction earnings effect. The Company is
evaluating the effect SFAS 133 will have on its financial reporting and
disclosures and when the statement will be adopted.
NOTE 6 - FINANCIAL INFORMATION BY BUSINESS SEGMENT:
PETsMART adopted Statement of Financial Accounting Standards 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.
Operating results and other financial data by business segment for the thirteen
and thirty-nine weeks ended November 1, 1998 and November 2, 1997, were as
follows:
<TABLE>
<CAPTION>
FOR THE 13 WEEKS ENDED FOR THE 39 WEEKS ENDED
------------------------------ ------------------------------
NOV. 1, NOV. 2, NOV. 1, NOV. 2,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
(in thousands) (in thousands)
Net sales:
PETsMART North America $ 444,257 $ 375,121 $ 1,302,635 $ 1,086,969
PETsMART U.K 52,410 43,978 149,362 117,204
PETsMART DIRECT - External customers 24,524 22,357 75,604 75,797
PETsMART DIRECT - Intersegment 3,491 5,617 9,764 11,000
Eliminations (3,491) (5,617) (9,764) (11,000)
----------- ----------- ----------- -----------
Total net sales $ 521,191 $ 441,456 $ 1,527,601 $ 1,279,970
=========== =========== =========== ===========
</TABLE>
9
<PAGE> 10
PETsMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED NOVEMBER 1, 1998 AND NOVEMBER 2, 1997
<TABLE>
<CAPTION>
FOR THE 13 WEEKS ENDED FOR THE 39 WEEKS ENDED
------------------------ ------------------------
NOV. 1, NOV. 2, NOV. 1, NOV. 2,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
(in thousands) (in thousands)
Operating income (loss):
PETsMART North America $ 14,285 $ 6,039 $ 26,257 $ 20,079
PETsMART U.K (1,317) (666) (8,403) 986
PETsMART DIRECT 1,129 (10) 3,375 3,670
Merger, business integration and restructuring costs -- (1,466) -- (72,138)
-------- -------- -------- --------
Operating income (loss) 14,097 3,897 21,229 (47,403)
Interest income 766 69 2,388 182
Interest expense (5,904) (3,492) (17,139) (9,608)
-------- -------- -------- --------
Income (loss) before income taxes $ 8,959 $ 474 $ 6,478 $(56,829)
======== ======== ======== ========
</TABLE>
Total assets by business segment as of November 1, 1998, and February 1, 1998,
were as follows:
<TABLE>
<CAPTION>
NOV. 1, FEB. 1,
1998 1998
-------- --------
<S> <C> <C>
(in thousands)
PETsMART North America $748,025 $715,691
PETsMART U.K 93,518 87,731
PETsMART DIRECT 38,320 36,265
-------- --------
Total assets $879,863 $839,687
======== ========
</TABLE>
Net sales in the PETsMART North America segment increased $69.1 million, or
18.4%, during the third quarter 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 381 at November 2, 1997 to 439 at November
1, 1998, and a comparable store sales increase of 6.1% for the third quarter of
fiscal 1998. Operating income in the PETsMART North America segment increased
$8.2 million during the third quarter of fiscal 1998 as compared to the same
period in fiscal 1997, primarily reflecting improved gross product margins and
effective store cost containment initiatives.
Net sales for the third quarter 1998 increased $8.4 million, or 19.2%, from the
third quarter 1997 in the PETsMART U.K. segment. The number of open stores
increased from 77 at November 2, 1997 to 93 at November 1, 1998. Comparable
store sales decreased 4.1% during third quarter 1998. The U.K. segment reported
an operating loss of $1.3 million in the third quarter 1998 versus an operating
loss of $0.7 million for the third quarter 1997. The decline was the result of
the U.K. comparable store sales decreases that were impacted by the United
Kingdom's deteriorating economic environment and higher occupancy costs,
particularly in the new, larger stores opened primarily during fiscal 1997.
The PETsMART DIRECT segment reported an increase in net sales (to external
customers) of $2.2 million, or 9.7%, and an increase in operating income of $1.1
million in the third quarter 1998 compared to third quarter 1997. PETsMART
DIRECT's operating results improved from the prior year due to the continuation
of more productive catalog mailings, higher customer response rates, strong
expense controls, and initial sales from PETsMART DIRECT's Internet commerce
sites.
10
<PAGE> 11
PETsMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED NOVEMBER 1, 1998 AND NOVEMBER 2, 1997
For the thirty-nine weeks ended November 1, 1998, net sales in the PETsMART
North America segment increased $215.7, million or 19.8%, 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 381 at November 2,
1997 to 439 at November 1, 1998, and a comparable store sales increase of 6.8%
for the thirty-nine weeks ended November 1, 1998. Operating income in the
PETsMART North America segment increased $6.2 million, or 30.8% during the
thirty-nine weeks ended November 1, 1998 as compared to the same thirty-nine
week period of fiscal 1997. This increase reflects improved product margins and
good store expense controls, partially offset by increased general and
administrative expenses primarily resulting from $4.7 million of expenses
associated with legal and settlement costs and executive severance recorded in
second quarter 1998.
Net sales for the PETsMART U.K. segment increased $32.2 million, or 27.4%, in
the thirty-nine weeks ended November 1, 1998 as compared to the same period in
1997. The number of open stores increased from 77 at November 2, 1997 to 93 at
November 1, 1998. Comparable store sales for the thirty-nine week period
decreased 2.3%. The U.K. segment reported an operating loss of $8.4 million in
the thirty-nine week period ended November 1, 1998 versus operating income of
$1.0 million for the same period in 1997. The decline was the result of the
disappointing U.K. comparable store sales due to the deteriorating United
Kingdom economic conditions, 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, and
increased warehouse and distribution costs.
The PETsMART DIRECT segment reported slightly decreased net sales and operating
income in the thirty-nine week period ended November 1, 1998 compared to the
same period in 1997. The decreases in both areas reflected a decision to reduce
circulation of nonproductive catalogs during the first thirty-nine weeks of
fiscal 1998.
NOTE 7 - STOCK OPTION PLANS:
In October 1998, the Company exchanged certain stock options that were
previously granted to certain eligible individuals, which excluded senior
officers and directors, under the terms of the Company's 1995 Equity Incentive
Plan and 1997 Non-Officer Equity Incentive Plan. To be eligible to participate
in the exchange plan, 50% or more of a participant's options must have had an
exercise price of $16 or higher, and only option grants with an exercise price
of $16 or higher were exchanged. As a result of the exchange, options to
purchase 1,123,620 shares (at a weighted average exercise price of $18.8256)
were exchanged for options to purchase 650,560 shares with an exercise price
equal to the fair market value per share at that date ($6.9375 per share), and
the vesting term was modified and extended. No compensation expense was recorded
as a result of this exchange.
11
<PAGE> 12
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 November
1, 1998, the Company operated 532 superstores, consisting of 421 superstores in
the United States, 93 superstores in the United Kingdom, and 18 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 (loss) 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 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 currently charges preopening costs associated with each new
superstore to earnings when the superstore is opened. Beginning in fiscal 1999,
preopening costs will be expensed as incurred, in accordance with a recent AICPA
Statement of Position (see "Recent Accounting Pronouncements" section of this
report). 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 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 initiatives and to better focus its merchandise
selections on pet-related products, the Company determined
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<PAGE> 13
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 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 workers' 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 the
full fiscal year 1997 (including $12.2 million incurred through third quarter
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 the first thirty-nine weeks of fiscal 1998 is summarized below (in
thousands):
<TABLE>
<CAPTION>
BALANCE AT ADDITIONAL PAYMENTS/ BALANCE AT
FEB. 1, 1998 EXPENSES ASSET WRITE-OFFS NOV. 1, 1998
------------ ---------- ---------------- ------------
<S> <C> <C> <C> <C>
Lease termination & real
estate costs $ 33,390 $ -- $ (8,986) $ 24,404
Accrued business
integration costs 347 -- (127) 220
-------- -------- -------- --------
$ 33,737 $ -- $ (9,113) $ 24,624
======== ======== ======== ========
</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 of 1933, as
amended. The net proceeds to PETsMART from the sale of the Notes were
approximately $193,250,000.
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<PAGE> 14
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 THIRTY-NINE WEEKS ENDED
----------------------- ------------------------
NOV. 1, NOV. 2, NOV. 1, NOV. 2,
1998 1997 1998 1997 (a)
------- ------- ------- --------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 75.9 76.4 75.8 75.7
----- ----- ----- -----
Gross profit 24.1 23.6 24.2 24.3
Store operating expenses 18.7 19.5 19.1 19.3
Store preopening expenses 0.2 0.4 0.5 0.6
General and administrative expenses 2.5 2.5 3.1 2.5
Merger, business integration and restructuring costs . 0.3 . 4.4
----- ----- ----- -----
Operating income (loss) 2.7 0.9 1.4 (2.4)
Interest income 0.1 0.0 0.2 0.0
Interest expense 1.1 0.8 1.1 0.8
----- ----- ----- -----
Income (loss) before income taxes 1.7 0.1 0.4 (3.2)
Income tax expense (benefit) 0.7 0.1 0.2 (1.2)
----- ----- ----- -----
Net income (loss) 1.0% 0.0% 0.2% (2.0)%
===== ===== ===== =====
</TABLE>
(a) Excludes restructuring charges of $9.4 million, $3.3 million,
and $3.4 million recorded as components of cost of sales,
store operating expenses, and general and administrative
expenses, respectively. See "Developments During Fiscal 1997"
above.
THIRD QUARTER FISCAL 1998 COMPARED TO THIRD QUARTER FISCAL 1997
The following discussion of results of operations for third quarter
1998 and third quarter 1997 excludes the effects of the restructuring, merger
and business integration costs discussed above in "Developments During Fiscal
1997."
Net sales increased 18.1% to approximately $521.2 million for the
thirteen weeks ended November 1, 1998 from $441.5 million for the thirteen weeks
ended November 2, 1997. Comparable North American store sales increased 6.1% for
the quarter, and comparable United Kingdom store sales decreased 4.1%. During
third quarter 1998, the Company opened seven new superstores, relocated one
store, and closed one store in North America and opened five stores and closed
one store in the United Kingdom. The Company operated 532 superstores at
November 1, 1998 compared to 458 superstores open at November 2, 1997.
Gross profit, defined as net sales less cost of sales, including
distribution costs and store occupancy costs, increased as a percentage of net
sales from 23.6% for third quarter 1997 to 24.1% in third quarter 1998. This
result principally reflected improved product margins partially offset by higher
occupancy costs in certain new locations, particularly in newer United Kingdom
stores, increased warehouse and distribution costs and higher personnel costs in
grooming and veterinarian operations.
Store operating expenses, which includes payroll and benefits,
advertising and other store level expenses, decreased as a percentage of net
sales to 18.7% for third quarter 1998 from 19.5% for third quarter 1997. The
decrease reflected a planned reduction in North American advertising expenses
and an ongoing focus on expense management in the retail operations.
Store preopening expenses as a percentage of net sales decreased to
0.2% for third quarter 1998, compared to 0.4% for third quarter 1997. Including
one North American replacement store and five new United Kingdom stores, 13
stores were opened during third quarter 1998. The average store preopening
expense of $66,000 per store in third quarter 1998 was lower than historical
levels due to varying expenditures on United Kingdom grand openings. Average
North American preopening costs continued to approximate $100,000 per store.
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<PAGE> 15
General and administrative expenses as a percentage of sales remained
constant at 2.5% for third quarter 1998 and third quarter 1997.
The Company's operating income increased to $14.1 million for third
quarter 1998 from $5.4 million for third quarter 1997, excluding the $1.5
million of merger and restructuring charges recorded in third quarter 1997.
Excluding the merger and restructuring charges, operating income as a percentage
of net sales increased from 1.2% for third quarter 1997 to 2.7% for third
quarter 1998. This increase was primarily due to improved product margins and
store expense control, primarily a planned reduction in advertising.
Interest income increased to $0.8 million for third quarter 1998 from
$0.1 million for third quarter 1997 principally due to the increase in average
cash balances from the offering of Notes completed in November 1997, as well as
the planned reduction in per-store inventory during 1998. Interest expense
increased to $5.9 million for the third quarter 1998 from $3.5 million for third
quarter 1997. The increase was also primarily related to the note offering
completed in November 1997.
For third quarter 1998, income taxes were provided at an annual
effective rate of 40.5%. The increase in the comparable tax rates from the third
quarter of 1997 was caused by changes in foreign tax rates and mix of foreign
and domestic taxable income or loss. The Company's income tax provision for
third quarter 1997, after excluding the effects of the nondeductibility of
certain of the costs associated with the merger and restructuring charges
recorded, was provided at the Company's effective income tax rate from
operations of 38.5%.
As a result of the foregoing, the Company reported net income of $5.3
million (or $0.5 per share - diluted) for third quarter 1998 compared to net
income of $0.2 million (or $0.00 per share - diluted) for the third quarter
1997. Excluding the third quarter 1997 merger and restructuring charges and the
related tax benefits, net income for third quarter 1997, on a comparable basis,
was $1.2 million (or $0.01 per share - diluted).
THIRTY-NINE WEEKS ENDED NOVEMBER 1, 1998 COMPARED TO THIRTY-NINE WEEKS ENDED
NOVEMBER 2, 1997
The following discussion of results of operations for the thirty-nine
weeks ended November 1, 1998 and November 2, 1997 excludes the effects of the
restructuring, merger and business integration costs discussed above in
"Developments During Fiscal 1997."
Net sales increased 19.3% to approximately $1.53 billion for the
thirty-nine weeks ended November 1, 1998 from $1.28 billion for the thirty-nine
weeks ended November 2, 1997. Comparable North American store sales increased
6.8% for the period, and comparable United Kingdom store sales decreased 2.3%.
During the thirty-nine weeks ended November 1, 1998, the Company opened 70 new
superstores, including 12 replacement stores, and closed 15 stores in North
America and opened 12 stores and closed three stores in the United Kingdom. The
Company had 532 superstores in operation at November 1, 1998 compared to 458
superstores open at November 2, 1997.
Gross profit, defined as net sales less cost of sales, including
distribution costs and store occupancy costs, decreased as a percentage of net
sales to 24.2% for the thirty-nine week periods ended November 1, 1998 from
24.3% for the same period in 1997. This result principally reflected improved
product margins offset by higher occupancy costs in certain new locations,
particularly in newer United Kingdom stores, increased warehouse and
distribution costs and higher personnel costs in veterinarian operations.
Store operating expenses, which includes payroll and benefits,
advertising and other store level expenses, decreased slightly as a percentage
of net sales to 19.1% for the thirty-nine weeks ended November 1, 1998 from
19.3% for the thirty-nine weeks ended November 2, 1997.
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<PAGE> 16
Store preopening expenses as a percentage of net sales decreased to
0.5% for the thirty-nine weeks ended November 1, 1998, compared to 0.6% for the
same period in 1997. Including 12 North American replacement stores and 12 new
United Kingdom stores, 82 stores were opened during the first thirty-nine weeks
of fiscal 1998. The average store preopening expense of $102,000 per store in
the first thirty-nine weeks of fiscal 1998 was higher than historical levels due
to the need to hire temporary setup personnel in certain tight labor markets.
General and administrative expenses as a percentage of sales increased
to 3.1% for the thirty-nine weeks ended November 1, 1998, as compared to 2.5%
for the thirty-nine weeks ended November 2, 1997. The increase was directly
related to costs incurred in connection with the closure of stores, management
information system costs related to the Company's worldwide systems initiatives,
as well as $4.7 million of nonrecurring legal and settlement costs and executive
severance costs recorded in second quarter 1998. Excluding the legal and
severance costs, general and administrative costs as a percentage of sales were
2.8% for the first thirty-nine weeks of fiscal 1998.
The Company's operating income decreased to $21.2 million for the
thirty-nine weeks ended November 1, 1998 from $24.7 million for the thirty-nine
weeks ended November 2, 1997, excluding the $72.1 million of merger and
restructuring charges recorded in the thirty-nine weeks ended November 2, 1997.
Excluding the merger and restructuring charges, operating income as a percentage
of net sales decreased from 1.9% for the thirty-nine weeks ended November 2,
1997 to 1.4% for the thirty-nine weeks ended November 1, 1998. This decrease was
primarily due to increased cost of sales 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 $2.4 million for the thirty-nine weeks
ended November 1, 1998 from $0.2 million for the same fiscal period in 1997
principally due to the increase in average cash balances from the note offering
completed in November 1997, as well as the planned reduction in per-store
inventory during 1998. Interest expense increased to $17.1 million for the
thirty-nine weeks ended November 1, 1998 from $9.6 million for the thirty-nine
weeks ended November 2, 1997. The increase was also primarily related to the
note offering completed in November 1997.
For the thirty-nine weeks ended November 1, 1998, income taxes were
provided at an annual effective rate of 41.2%. This reflects an increase over
historical levels due to changes in foreign tax rates and mix of foreign and
domestic taxable income or loss. The Company's income tax provision for 1997
reflects the effects of the nondeductibility of certain of the costs associated
with the merger and restructuring charges recorded. Additionally, the statutory
reduction in the United Kingdom corporate tax rate enacted during second quarter
1997 required a $0.6 million charge to reflect the decrease in the deferred tax
asset due to the rate reduction. After excluding the effects of these items, the
Company's effective income tax rate from operations was 38.5% for the first
thirty-nine weeks of fiscal 1997.
As a result of the foregoing, the Company reported net income of $3.8
million (or $0.03 per share - diluted) for the thirty-nine weeks ended November
1, 1998 compared to a net loss of $36.3 million (or $0.32 per share - diluted)
for the same period in fiscal 1997. Excluding the 1997 merger and restructuring
charges and the related tax benefits, net income for the thirty-nine weeks ended
November 2, 1997, on a comparable basis, was $9.4 million (or $0.08 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 November 1, 1998, total assets were $879.9 million, of which $533.0
million were current assets. Cash and cash equivalents were $119.9 million.
Cash provided by operations was $14.7 million for the thirty-nine weeks
ended November 1, 1998, compared to cash used in operations of $49.5 million for
the same period of the prior year. Merchandise accounts payable leveraging (the
percentage of merchandise inventory financed by vendor credit terms, e.g.,
accounts payable divided by merchandise inventory), increased to 42.7% at
November 1, 1998, compared to 36.1% at February 1, 1998. Inventory balances were
approximately $339.4 million at November 1, 1998, and $317.5 million at February
1, 1998. Average North American store inventory, which excludes the inventory of
PETsMART DIRECT, decreased 5.1% and 8.8%, respectively, to $671,000 per store at
November 1, 1998, from approximately $707,000 at February 1, 1998, and from
approximately $736,000 at November
16
<PAGE> 17
2, 1997.
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 systems
initiatives. The Company has also used cash to purchase superstores for sale and
leaseback. Net cash used in investing activities was $23.4 million for the
thirty-nine weeks ended November 1, 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, net of principal payments on capital leases, was $5.8 million for the
thirty-nine weeks ended November 1, 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.
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 $525,000. This
amount will typically include an average of approximately $50,000 for leasehold
improvements (an average of approximately $400,000 if the superstore site is a
rehabilitated unit), approximately $100,000 for preopening costs, and
approximately $375,000 for inventory, net of accounts payable. Approximately
$450,000 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 four
additional North American superstores by the end of fiscal 1998, approximately
$3.9 million will be needed to finance the Company's new superstore openings in
the remainder of fiscal 1998, of which approximately $1.8 million will be
financed through equipment leases, a portion of which may not be received until
fiscal 1999. Also, based upon the Company's current plan to open approximately
26 new North American stores during the first fiscal quarter of 1999, a major
portion of the approximately $25.4 million needed to finance these openings will
likely be expended during the latter portion of fourth quarter 1998. 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 will be financed through lease
transactions, some of which have been completed. There can be no assurance that
the actual costs for the new system will not exceed current estimates, or 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 (see "Year 2000 Readiness"). 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 $29.5 million during the thirty-nine weeks ended November 1, 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
17
<PAGE> 18
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.
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 98-1 and does not
anticipate a material effect on its financial statements upon adoption.
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, will 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.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for
financial statements for fiscal years beginning after June 15, 1999. This
statement establishes the accounting and reporting standards for derivative
instruments and hedging activities, requiring that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure them at fair value. It also provides for matching of the
timing of gain or loss recognition on the hedging instrument with the
recognition of (i) the changes in the fair value of the hedged asset or
liability related to the hedged risk or (ii) the hedged forecasted transaction
earnings effect. The Company is evaluating the effect SFAS 133 will have on its
financial reporting and disclosures and when the statement will be adopted.
YEAR 2000 READINESS
The Year 2000 systems processing problem, as it is commonly known, is
caused by currently utilized computer systems, including several used by the
Company, being coded to only accept two-digit codes for the year field in a date
set of data. Beginning in the year 2000, these date fields must be able to
accept four-digit entries to distinguish 1900 base-year dates with 2000
base-year dates. The Company is and has been addressing the Year 2000 systems
issue through various initiatives, all of which are in progress. A new
integrated worldwide information system, which is Year 2000 compliant, is
currently in the development and implementation stages. The system is scheduled
to be operational for the North American retail operations during the first half
of fiscal 1999. Other initiatives in place include issue awareness programs,
inventory and identification of all Year 2000-sensitive components (including
hardware, software, and telecommunications), requesting of compliance status
statements from Company business partners, suppliers, and vendors, and testing
of all new and existing systems. Year 2000 compliance activities are expected to
be complete by October 1999. The Company estimates that its costs in connection
with the development and implementation of the new information system, before
giving consideration to any lease financing that may be available, will be up to
$20 million annually through fiscal year 2000, plus maintenance and upkeep costs
which are not expected to be material. Similar Year 2000 readiness programs are
in place in the Company's
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<PAGE> 19
United Kingdom and Catalog operational segments, with costs to address those
segment's Year 2000 issues not expected to be material.
There can be no assurance, however, that the new worldwide information
system can be developed, tested, and implemented on a timely basis or that it
will deliver the desired operational benefits. Nor can there be assurance that
the initiatives put in place to address the Year 2000 issues will identify and
remove all potential operational impacts. While significant economic detriment
from Year 2000 issues is not expected, there can be no assurance that there will
not be operational difficulties in the Company's stores, warehouses, or
corporate offices, the financial magnitude of which is not currently estimable.
The Year 2000 initiatives being conducted by the Company are expected to
significantly reduce the Company's level of uncertainty about the Year 2000
problem, including the Year 2000 compliance and readiness of external partners.
The Company believes that, with the implementation of new worldwide business
systems and the completion of its Year 2000 initiatives as scheduled, the
possibility of significant interruptions of normal operations will be reduced.
Although the Company believes contingency plans will not need to be utilized
based on progress to date, contingency plans have been developed for each
critical system. The specifics of the contingency plans vary depending on the
system and assessed risk of non-compliance and such plans are modified
periodically based on review and testing. The plans are comprised of activities
such as upgrading existing systems, reallocating internal resources, obtaining
additional external resources, and implementing temporary manual processes.
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<PAGE> 20
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, sales and use tax obligations, 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. On July 21, 1998, Plaintiff filed a consolidated amended complaint in
the District Court. On September 25, 1998, the Company and the individual
defendants filed a motion to dismiss the amended complaint. The Company believes
that the allegations in the amended complaint 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 Cavucci 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 court entered an order of
procedure and schedule for trial on July 20, 1998 which outlines all discovery
and trial dates. On November 30, 1998, PETsMART filed motions for partial
summary judgment on plaintiff's claim that in-store management positions were
misclassified as exempt under the Fair Labor Standards Act. These motions are
currently under the court's submission. To date, there have been no settlement
discussions.
The Company has been advised that, on November 20, 1998, a civil
lawsuit was filed by a competitor in the Ontario (Canada) General Court,
entitled Pet Valu, Inc., et al v. PETsMART, Inc. (Case No. 98 CV-159004). This
case seeks purported monetary damages of approximately US $63 million and claims
that this amount is subject to trebling, alleging that the Company engaged in
unfair competitive practices in the Ontario retail pet supply business. The
complaint also claims that the Company interfered with an alleged contract
between the plaintiff and one of its vendors. Since the lawsuit has not yet been
served on the Company, a formal response is not yet required. The Company
believes that the allegations in the lawsuit are without merit and intends to
defend itself vigorously.
20
<PAGE> 21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
During the thirteen weeks ended November 1, 1998, the Company filed no
reports on Form 8-K.
21
<PAGE> 22
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 December 11, 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)
22
<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
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-02-1998
<PERIOD-END> NOV-01-1998
<EXCHANGE-RATE> 1
<CASH> 119,912
<SECURITIES> 0
<RECEIVABLES> 46,748
<ALLOWANCES> 0
<INVENTORY> 339,383
<CURRENT-ASSETS> 533,019
<PP&E> 396,084
<DEPRECIATION> 139,173
<TOTAL-ASSETS> 879,863
<CURRENT-LIABILITIES> 246,177
<BONDS> 272,413
0
0
<COMMON> 11
<OTHER-SE> 342,902
<TOTAL-LIABILITY-AND-EQUITY> 879,863
<SALES> 1,527,601
<TOTAL-REVENUES> 1,527,601
<CGS> 1,158,247
<TOTAL-COSTS> 1,158,247
<OTHER-EXPENSES> 348,125
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 17,139
<INCOME-PRETAX> 6,478
<INCOME-TAX> 2,672
<INCOME-CONTINUING> 3,806
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,806
<EPS-PRIMARY> 0.03
<EPS-DILUTED> 0.03
</TABLE>
