<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Amendment No. 1
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED:
OCTOBER 31, 1999
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)
(623) 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, 111,688,698 SHARES AT DECEMBER 16, 1999
1
<PAGE> 2
PETSMART, INC.
INDEX
<TABLE>
<CAPTION>
Page
<S> <C> <C>
Part I. Financial Information
Item 1. Unaudited Financial Statements
Consolidated Balance Sheets at October 31, 1999
and January 31, 1999 3
Consolidated Statements of Operations
for the thirteen and thirty-nine weeks ended
October 31, 1999 and November 1, 1998 4
Consolidated Statements of Cash Flows
for the thirty-nine weeks ended
October 31, 1999 and November 1, 1998 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risks 19
Part II. Other Information
Item 1. Legal Proceedings 20
Item 5. Unaudited Pro Forma Condensed Consolidated
Financial and Operating Data 21
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
</TABLE>
2
<PAGE> 3
PETSMART, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
Unaudited
<TABLE>
<CAPTION>
OCTOBER 31, JANUARY 31,
1999 1999
----------- -----------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 38,624 $ 153,336
Receivables 51,554 49,235
Merchandise inventories 419,462 336,058
Prepaid expenses and other current assets 32,729 27,943
--------- ---------
Total current assets 542,369 566,572
Property held for sale and leaseback 10,372 9,395
Property and equipment, net 275,898 270,332
Other assets 112,957 85,700
--------- ---------
Total assets $ 941,596 $ 931,999
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Notes payable to bank $ 17,000 $ --
Accounts payable 208,068 148,915
Accrued payroll and employee benefits 31,555 24,799
Accrued occupancy expense 14,980 15,580
Accrued merger, business integration and restructuring costs 11,139 19,833
Other accrued expenses 41,837 44,704
Current maturities of capital lease obligations 15,035 16,434
--------- ---------
Total current liabilities 339,614 270,265
6 3/4% Subordinated Convertible Notes 200,000 200,000
Capital lease obligations 69,957 79,771
Deferred rents 17,521 16,656
Other liabilities 504 489
--------- ---------
Total liabilities 627,596 567,181
--------- ---------
Stockholders' equity:
Preferred stock; $.0001 par value, 10,000 shares
authorized, none outstanding -- --
Common stock; $.0001 par value; 250,000 shares
authorized, 117,239 and 116,461 shares issued and outstanding 12 12
Additional paid-in capital 398,138 394,799
Deferred compensation (2,053) (2,503)
Accumulated deficit (52,490) (24,857)
Accumulated other comprehensive loss (4,397) (2,633)
Less: treasury stock at cost, 5,550 shares at October 31, 1999 (25,210) --
--------- ---------
Total stockholders' equity 314,000 364,818
--------- ---------
Total liabilities and stockholders' equity $ 941,596 $ 931,999
========= =========
</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
----------------------------- ------------------------------
OCT. 31, NOV. 1, OCT. 31, NOV. 1,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $ 511,836 $ 521,191 $ 1,540,311 $ 1,527,601
Cost of sales 379,867 395,572 1,138,551 1,158,247
----------- ----------- ----------- -----------
Gross profit 131,969 125,619 401,760 369,354
Store operating expenses 102,365 97,409 306,731 292,035
Store preopening expenses 381 862 4,800 8,396
General and administrative expenses 13,246 13,251 42,630 47,694
Loss on disposal of subsidiary (34,221) -- (43,607) --
----------- ----------- ----------- -----------
Operating income (loss) (18,244) 14,097 3,992 21,229
Interest income 503 766 2,524 2,388
Interest expense (6,103) (5,904) (17,363) (17,139)
----------- ----------- ----------- -----------
Income (loss) before equity in loss of PETsMART.com,
income tax expense (benefit) and cumulative effect of a
change in accounting principle (23,844) 8,959 (10,847) 6,478
Equity in loss of PETsMART.com (9,880) -- (11,282) --
----------- ----------- ----------- -----------
Income (loss) before income tax expense (benefit) and
cumulative effect of a change in accounting principle (33,724) 8,959 (22,129) 6,478
Income tax expense (benefit) (495) 3,628 4,976 2,672
----------- ----------- ----------- -----------
Income (loss) before cumulative effect of
a change in accounting principle (33,229) 5,331 (27,105) 3,806
Cumulative effect of a change in accounting
principle, net of tax -- -- (528) --
----------- ----------- ----------- -----------
Net income (loss) (33,229) 5,331 (27,633) 3,806
----------- ----------- ----------- -----------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments 731 (780) (1,764) (2,289)
----------- ----------- ----------- -----------
Comprehensive income (loss) $ (32,498) $ 4,551 $ (29,397) $ 1,517
=========== =========== =========== ===========
Earnings per common share - basic:
Income (loss) before cumulative effect of a change
in accounting principle $ (0.29) $ 0.05 $ (0.23) $ 0.03
Cumulative effect of a change in accounting
principle, net of tax -- -- (0.01) --
----------- ----------- ----------- -----------
Net income (loss) $ (0.29) $ 0.05 $ (0.24) $ 0.03
=========== =========== =========== ===========
Earnings per common share - assuming dilution:
Income (loss) before cumulative effect of a change $ (0.29) $ 0.05 $ (0.23) $ 0.03
in accounting principle
Cumulative effect of a change in accounting
principle, net of tax -- -- (0.01) --
----------- ----------- ----------- -----------
Net income (loss) $ (0.29) $ 0.05 $ (0.24) $ 0.03
=========== =========== =========== ===========
</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
-------------------------------
OCT. 31, NOV. 1,
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income (loss) $ (27,633) $ 3,806
Adjustments to reconcile net income (loss) to net cash
from (used in) operating activities -
Depreciation and amortization 35,114 32,434
Loss on disposal of property and equipment 2,267 808
Loss on disposal of subsidiary 29,000 --
Equity in loss of PETsMART.com 11,282 --
Tax benefit resulting from exercise of stock options 68 427
Changes in assets and liabilities:
Receivables (13,008) (10,073)
Merchandise inventories (86,480) (21,692)
Prepaid expenses and other current assets (4,786) 252
Other assets (1,492) (2,773)
Accounts payable 67,926 17,068
Accrued payroll and employee benefits 6,101 5,114
Accrued occupancy expense (600) 9,277
Accrued merger, business integration and restructuring costs (8,694) (9,283)
Other accrued expenses (2,867) (9,881)
Deferred rents 865 (370)
Other liabilities 15 14
--------- ---------
Net cash from operating activities 7,078 15,128
--------- ---------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Purchases of leaseholds, fixtures and equipment (65,413) (29,531)
Purchases of property held for sale and leaseback (977) (5,564)
Investment in equity holdings (29,585) --
Proceeds from sales of property 473 11,742
--------- ---------
Net cash used in investing activities (95,502) (23,353)
--------- ---------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 3,271 4,774
Purchase of treasury stock (25,210) --
Borrowings from bank credit facility 23,000 --
Repayment on bank credit facility (6,000) --
Increase (decrease) in bank overdraft (8,773) 13,023
Payment on capital lease obligations (10,812) (12,453)
--------- ---------
Net cash from (used in) financing activities (24,524) 5,344
--------- ---------
FOREIGN CURRENCY TRANSLATION LOSSES (1,764) (2,289)
--------- ---------
DECREASE IN CASH
AND CASH EQUIVALENTS (114,712) (5,170)
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD 153,336 125,082
--------- ---------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 38,624 $ 119,912
========= =========
</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 OCTOBER 31, 1999 AND NOVEMBER 1, 1998
(UNAUDITED)
- --------------------------------------------------------------------------------
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, consisting of normal recurring accruals,
considered necessary for a fair presentation have been included.
Because of the seasonal nature of the Company's business, the results
of operations for the thirteen weeks and thirty-nine weeks ended
October 31, 1999 and November 1, 1998 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 January 31, 1999, included in the Company's Annual Report on
Form 10-K (File No. 0-21888) filed with the Securities and Exchange
Commission on April 26, 1999.
NOTE 2 - TREASURY STOCK:
On June 1, 1999, the Company announced that its Board of Directors had
approved a program to repurchase up to an aggregate of $25,000,000 of
its Common Stock. The repurchases may be made from time to time on the
open market at prevailing market prices or in negotiated transactions
off the market. As of October 31, 1999, approximately $25.0 million
(before commissions) had been used to repurchase an aggregate of
5,550,000 shares of the Company's Common Stock under this program.
Treasury stock is presented in the Company's Consolidated Balance
Sheets, at cost, as a reduction of stockholders' equity.
NOTE 3 - EQUITY IN PETSMART.COM:
During the second and third quarters of fiscal 1999, the
Company made investments in PETsMART.com, an electronic commerce pet
product retailer, resulting in 49.9% equity ownership in that entity.
The investment is accounted for under the equity method. The Company's
proportionate share of losses from PETsMART.com, which began operations
in June 1999, was $9.9 million for the thirteen weeks ended October 31,
1999, and $11.3 million for the thirty-nine weeks ended October 31,
1999.
NOTE 4 - CHANGE IN ACCOUNTING PRINCIPLE:
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 adopted SOP 98-5 at the beginning of the first
quarter of fiscal 1999. Prior to its adoption of SOP 98-5, the Company
expensed its store preopening costs in the month in which the store
opened. The charge against earnings during the first quarter of fiscal
1999 related to this change in accounting principle was $888,000,
before taxes, and was recorded as a cumulative effect of a change in
accounting principle.
6
<PAGE> 7
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED OCTOBER 31, 1999 AND NOVEMBER 1, 1998
(UNAUDITED)
- --------------------------------------------------------------------------------
NOTE 5 - COMPREHENSIVE INCOME (LOSS):
The income tax expense (benefit) related to items of other
comprehensive income (loss) was approximately $574,000 and $(531,000)
for third quarter 1999 and 1998, respectively. For the thirty-nine
weeks ended October 31, 1999 and November 1, 1998, the income tax
benefit related to items of other comprehensive income (loss) was
approximately $(1,386,000) and $(1,607,000), respectively
NOTE 6 - EARNINGS PER SHARE:
Basic earnings per share is computed by dividing net income (loss) by
the weighted average of common shares outstanding during each period.
Diluted earnings per share is 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 earnings per share
computations for the thirteen weeks and thirty-nine weeks ended October
31, 1999 and November 1, 1998 are as follows:
<TABLE>
<CAPTION>
THIRTEEN WEEKS ENDED
-----------------------------------------------------------------------------------------
OCTOBER 31, 1999 NOVEMBER 1, 1998
----------------------------------------- ------------------------------------------
WEIGHTED WEIGHTED
AVERAGE PER SHARE AVERAGE PER SHARE
INCOME (LOSS) SHARES AMOUNT INCOME (LOSS) SHARES AMOUNT
------------ -------- --------- ------------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Earnings (loss) per common
share - basic $ (33,229) 114,599 $ (0.29) $ 5,331 116,432 $ 0.05
Effect of dilutive securities:
Options -- -- -- -- 376 --
------------ -------- --------- ------------- -------- ---------
Earnings (loss) per common
share - diluted $ (33,229) 114,599 $ (0.29) $ 5,331 116,808 $ 0.05
============ ======== ========= ============= ======== =========
</TABLE>
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED
-----------------------------------------------------------------------------------------
OCTOBER 31, 1999 NOVEMBER 1, 1998
----------------------------------------- ------------------------------------------
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) before cumulative
effect of an accounting change $ (27,105) 115,701 $ (0.23) $ 3,806 116,115 $ 0.03
Cumulative effect of an accounting
change (528) 115,701 (0.01) -- 116,115 --
------------ -------- --------- ------------- -------- ---------
Earnings (loss) per common
share - basic (27,633) 115,701 (0.24) 3,806 116,115 0.03
Effect of dilutive securities:
Options -- -- -- -- 752 --
------------ -------- --------- ------------- -------- ---------
Earnings (loss) per common
share - diluted $ (27,633) 115,701 $ (0.24) $ 3,806 116,867 $ 0.03
============ ======== ========= ============= ======== =========
</TABLE>
7
<PAGE> 8
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED OCTOBER 31, 1999 AND NOVEMBER 1, 1998
(UNAUDITED)
- --------------------------------------------------------------------------------
At October 31, 1999, 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 October 31, 1999 or November 1, 1998 due to the
anti-dilutive effect they would have on earnings per share if
converted.
NOTE 7 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:
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,
2000. 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
will adopt SFAS 133 in the first quarter of fiscal 2001 and does not
expect a material effect on its financial statements as a result of
adoption.
NOTE 8 - FINANCIAL INFORMATION BY BUSINESS SEGMENT:
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 (see Note 9). 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.
8
<PAGE> 9
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED OCTOBER 31, 1999 AND NOVEMBER 1, 1998
(UNAUDITED)
- --------------------------------------------------------------------------------
Operating results and other financial data by business segment for the
thirteen and thirty-nine weeks ended October 31, 1999 and November 1,
1998, were as follows:
<TABLE>
<CAPTION>
FOR THE 13 WEEKS ENDED FOR THE 39 WEEKS ENDED
------------------------------ ------------------------------
OCT. 31, NOV. 1, OCT. 31, NOV. 1,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
(in thousands) (in thousands)
Net sales:
PETsMART North America $ 485,949 $ 444,257 $ 1,462,918 $ 1,302,635
PETsMART U.K. -- 52,410 -- 149,362
PETsMART DIRECT - External customers 25,887 24,524 77,393 75,604
PETsMART DIRECT - Intersegment 5,977 3,491 14,844 9,764
Eliminations (5,977) (3,491) (14,844) (9,764)
----------- ----------- ----------- -----------
Total net sales $ 511,836 $ 521,191 $ 1,540,311 $ 1,527,601
=========== =========== =========== ===========
Operating income (loss):
PETsMART North America $ 15,056 $ 14,285 $ 45,624 $ 26,257
PETsMART U.K. -- (1,317) -- (8,403)
PETsMART DIRECT 921 1,129 1,975 3,375
----------- ----------- ----------- -----------
Operating income 15,977 14,097 47,599 21,229
Interest income 503 766 2,524 2,388
Interest expense (6,103) (5,904) (17,363) (17,139)
Net loss from operations of subsidiary disposal (34,221) -- (43,607) --
----------- ----------- ----------- -----------
Income (loss) before equity in loss
of PETsMART.com and income tax
expense (benefit) $ (23,844) $ 8,959 $ (10,847) $ 6,478
=========== =========== =========== ===========
</TABLE>
Total assets by business segment as of October 31, 1999, and January
31, 1999, were as follows:
<TABLE>
<CAPTION>
OCT. 31, JAN. 31,
1999 1999
-------- --------
<S> <C> <C>
(in thousands)
PETsMART North America $823,410 $787,667
PETsMART U.K. 61,668 99,720
PETsMART DIRECT 56,518 44,612
-------- --------
Total assets $941,596 $931,999
======== ========
</TABLE>
9
<PAGE> 10
PETSMART, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THIRTEEN AND THIRTY-NINE WEEKS ENDED OCTOBER 31, 1999 AND NOVEMBER 1, 1998
(UNAUDITED)
- --------------------------------------------------------------------------------
NOTE 9 - SUBSEQUENT EVENT:
The Company consummated a sale of its United Kingdom subsidiary (the
"Transaction") with a third party on December 15, 1999. The Transaction was
structured as a stock sale, whereby the Company sold 100% of the stock in the
subsidiary in exchange for cash of approximately $49 million less debt of
approximately $7 million. The net assets of the subsidiary at October 31, 1999
were approximately $68 million. In connection with the Transaction, the Company
has recorded a net loss of $29 million including a write-down of the net assets
of $26 million and transaction fees of approximately $3 million. As the Company
and its Board of Directors reached a measurement date prior to the issuance of
the quarterly financial statements for the thirty-nine weeks ended October 31,
1999, the net loss on the Transaction has been reflected in the quarterly
results of operations for the thirty-nine weeks ended October 31, 1999.
Additionally, the Company has reflected the subsidiary's results of operations,
excluding the related tax effects, for the thirteen week and the thirty-nine
week period ended October 31, 1999 in net loss from operations of subsidiary
disposal in the accompanying consolidated statement of operations.
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 Distribution, Information Systems, Competition, and
Business Risks included in the Company's Form 10-K for the year ended January
31, 1999.
OVERVIEW
PETsMART is the largest operator of superstores specializing in pet
food, supplies and services in North America and the United Kingdom. At October
31, 1999, the Company operated 577 superstores, consisting of 464 superstores in
the United States, 93 superstores in the United Kingdom, and 20 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. Effective July 5, 1999,
the Company transferred operational control of the United States veterinary
clinics owned by PETsMART Veterinary Services, Inc. to its third-party operator,
Medical Management International, Inc.
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's
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.
Commencing with the first quarter of fiscal 1999, the Company charges preopening
costs associated with each new superstore to earnings as the costs are incurred.
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.
SALE OF SUBSIDIARY
The Company consummated a sale of its United Kingdom subsidiary (the
"Transaction") with a third party on December 15, 1999. The Transaction was
structured as a stock sale, whereby the Company sold 100% of the stock in the
subsidiary in exchange for cash of approximately $49 million less debt of
approximately $7 million. The net assets of the subsidiary at October 31, 1999
were approximately $68 million. In connection with the Transaction, the Company
has recorded a net loss of $29 million including a write-down of the net assets
of $26 million and transaction fees of approximately $3 million. As the Company
and its Board of Directors reached a measurement date prior to the issuance of
the quarterly financial statements for the thirty-nine weeks ended October 31,
1999, the net loss on the Transaction has been reflected in the quarterly
results of operations for the thirty-nine weeks ended October 31, 1999.
Additionally, the Company has reflected the subsidiary's results of operations,
excluding the related tax effects, for the thirteen week and the thirty-nine
week period ended October 31, 1999 in net loss from operations of subsidiary
disposal in the accompanying consolidated statement of operations.
11
<PAGE> 12
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship to net sales
of certain items included in the Company's Consolidated Statement of Operations.
For comparative operational performance, the results of operations, excluding
income taxes, for the United Kingdom subsidiary have been reclassified as "Net
loss from operations of subsidiary disposal" for the thirteen weeks ended and
the thirty-nine weeks ended November 1, 1998 to conform to the current year
presentation:
<TABLE>
<CAPTION>
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
-------------------- -----------------------
OCT. 31, NOV. 1, OCT. 31, NOV 1,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 74.2 75.6 73.9 75.2
------ ------ ------ ------
Gross profit 25.8 24.4 26.1 24.8
Store operating expenses 20.0 18.4 19.9 19.0
Store preopening expenses 0.1 0.1 0.3 0.5
General and administrative expenses 2.6 2.5 2.8 3.2
Loss on disposal of subsidiary 6.7 0.4 2.8 0.7
------ ------ ------ ------
Operating income (loss) (3.6) 2.9 0.3 1.5
Interest income 0.1 0.2 0.2 0.2
Interest expense 1.2 1.2 1.1 1.2
------ ------ ------ ------
Net loss from operations of subsidiary disposal
Income (loss) before equity in loss of PETsMART.com,
income tax expense (benefit) and cumulative effect of a
change in accounting principle (4.7) 1.9 (0.7) 0.5
Equity in loss of PETsMART.com (1.9) -- (0.7) --
------ ------ ------ ------
Income (loss) before income tax expense (benefit) and
cumulative effect of a change in accounting principle (6.6) 1.9 (1.4) 0.5
Income tax expense (benefit) (0.1) 0.8 0.3 0.2
------ ------ ------ ------
Income (loss) before cumulative effect of
a change in accounting principle (6.5) 1.1 (1.8) 0.2
Cumulative effect of a change in accounting principle -- -- 0.0 --
------ ------ ------ ------
Net income (loss) (6.5)% 1.1% (1.8)% 0.2%
====== ====== ====== ======
</TABLE>
THIRD QUARTER FISCAL 1999 COMPARED TO THIRD QUARTER FISCAL 1998
Net sales increased 9.2% to approximately $511.8 million for the
thirteen weeks ended October 31, 1999 from $468.8 million for the thirteen weeks
ended November 1, 1998. Excluding the United States veterinary clinics net sales
from third quarter 1998, total net sales increased 12.3% on a comparable basis.
Comparable North American store sales increased 5.1% for the quarter. During
third quarter 1999, the Company opened 12 new superstores, including three
replacement stores, and closed one store in North America. The Company had 484
superstores in operation in North America at October 31, 1999 compared to 439
superstores open at November 1, 1998.
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 24.4% for third quarter 1998 to 25.8% in third quarter 1999. This
result principally reflected improved product margins and sales mix changes,
offset by increased warehouse and distribution costs.
Store operating expenses, which includes payroll and benefits,
advertising and other store level expenses, increased as a percentage of net
sales to 20.0% for third quarter 1999 from 18.4% for third quarter 1998. The
increase reflected increased payroll and benefits due to labor requirements for
the conversion to the Company's new information system and point-of-sale
register system, and a planned increase in North American advertising expenses.
12
<PAGE> 13
Store preopening expenses as a percentage of net sales was 0.1% for
both third quarter 1999 and third quarter 1998. For the stores that opened
during the third quarter of 1999, the average preopening expense incurred was
approximately $95,000 per store, which is consistent with the Company's prior
experience. Including three replacement stores, 12 stores were opened in North
America during the third quarter of 1999, versus 8 stores opened in North
America in third quarter 1998.
General and administrative expenses as a percentage of sales increased
to 2.6% for third quarter 1999, as compared to 2.5% for third quarter 1998. This
increase relates to costs incurred during the implementation of the Company's
new information systems, including payroll and benefits and equipment costs.
Loss on disposal of subsidiary in the third quarter of 1999 was $34.2
million, including $29.0 million of loss and transaction related expenses on the
sale of the Company's United Kingdom subsidiary, $2.2 million of United Kingdom
closed store costs, and $3.0 million of loss from operations in the United
Kingdom segment. During the third quarter of 1998, the United Kingdom segment
incurred a $1.7 million loss from operations.
The Company's operating income (loss) decreased to a $18.2 million loss
for third quarter 1999 from $13.7 million of income for third quarter 1998.
Operating income (loss) as a percentage of net sales decreased from 2.9% for
third quarter 1998 to (3.6)% for third quarter 1999. This decrease was primarily
due to the loss on disposal of subsidiary and operational losses of the U.K.
segment, as well as increased store operating expenses and general and
administrative costs as described above.
Interest income decreased to $0.5 million for third quarter 1999 from
$0.7 million for third quarter 1998 principally due to the decrease in average
cash balances during third quarter 1999 as compared to third quarter 1998.
Interest expense increased to $6.1 million for the third quarter 1999 from $5.5
million for third quarter 1998 due to usage of the Company's line of credit
facility during third quarter 1999.
Equity in the loss of PETsMART.com, in which the Company has a 49.9%
equity investment, represents the Company's proportionate share of losses from
PETsMART.com, which began operations in June 1999. The Company's portion of
PETsMART.com's losses for the third quarter of 1999 was $9.9 million.
For third quarter 1999, income taxes were provided at an annual
effective rate of 44.0%, compared to 40.5% for third quarter 1998. The increase
in the effective tax rate is a result of the exclusion of the Company's equity
in the earnings (loss) of PETsMART.com in taxable income. As PETsMART.com's
earnings or losses will be excluded from the Company's consolidated income tax
return, the Company's effective tax rate will be impacted. Also, the loss on the
sale of the United Kingdom subsidiary is not deductible for tax purposes until a
capital gain is recognized to offset the capital loss. Therefore, excluding the
$9.9 million loss from PETsMART.com and the $29.0 million loss on the sale of
the United Kingdom subsidiary incurred in third quarter 1999, the Company's
effective tax rate would have been 41%. The fluctuation in this rate as compared
to the 40.5% for the prior year comparable period was caused by changes in
foreign tax rates and mix of foreign and domestic taxable income or loss. The
1999 rate also incorporates projected 1999 losses from the Company's investment
in PETsMART.com, the tax benefit related to which is not available to the
Company.
As a result of the foregoing, the Company reported a net loss of $33.2
million (or $0.29 per share - basic) for third quarter 1999 compared to net
income of $5.3 million (or $0.05 per share - basic) for the third quarter 1998.
The following table summarizes the earnings per share impact of the
Company's electronic business joint venture and the disposal of the United
Kingdom retail subsidiary:
<TABLE>
<CAPTION>
Thirteen weeks ended
------------------------------------
October 31, 1999 November 1, 1998
---------------- ----------------
<S> <C> <C>
North America Retail & Catalog Operations $ 0.08 $ 0.06
PETsMART.com (0.09) --
United Kingdom Retail Operations (0.28) (0.01)
---------- ----------
Total earnings per share - basic $ (0.29) $ 0.05
========== ==========
</TABLE>
13
<PAGE> 14
THIRTY-NINE WEEKS ENDED OCTOBER 31, 1999 COMPARED TO THIRTY-NINE WEEKS ENDED
NOVEMBER 1, 1998
Net sales increased 11.8% to approximately $1.54 billion for the
thirty-nine weeks ended October 31, 1999 from $1.38 billion for the thirty-nine
weeks ended November 1, 1998. Excluding the United States veterinary clinics net
sales from both 1999 and 1998, total net sales increased 13.1% on a comparable
basis. Comparable North American store sales increased 4.8% for the period.
During the thirty-nine weeks ended October 31, 1999, the Company opened 56 new
superstores, including six replacement stores, and closed 13 stores in North
America. The Company had 484 superstores in operation in North America at
October 31, 1999 compared to 439 superstores open at November 1, 1998.
Gross profit, defined as net sales less cost of sales, including
distribution costs and store occupancy costs, increased as a percentage of net
sales to 26.1% for the thirty-nine week period ended October 31, 1999 from 24.8%
for the same period in 1998. This result principally reflected improved product
margins and sales mix changes offset partially by increased warehouse and
distribution costs.
Store operating expenses, which includes payroll and benefits,
advertising and other store level expenses, increased as a percentage of net
sales to 19.9% for the thirty-nine weeks ended October 31, 1999 from 19.0% for
the thirty-nine weeks ended November 1, 1998. This increase was principally due
to a planned increase in advertising expenses during the first three fiscal
quarters of 1999 as compared to the same period in fiscal 1998, as well as
increased payroll and benefits during the third quarter due to labor
requirements for the conversion to the Company's new information system and
point-of-sale register system.
Store preopening expenses as a percentage of net sales decreased to
0.3% for the thirty-nine weeks ended October 31, 1999, compared to 0.5% for the
thirty-nine weeks ended November 1, 1998. A portion of first quarter 1999's
preopening expenses were recorded as a cumulative effect of a change in
accounting principle, which affected the year-over-year comparability of the
store preopening expense component of the Company's Consolidated Statements of
Operations. For the stores that opened during the first thirty-nine weeks of
fiscal 1999, the average preopening expense incurred was approximately $95,000
per store, which is consistent with the Company's prior experience.
General and administrative expenses as a percentage of sales were 2.8%
of sales for the thirty-nine weeks ended October 31, 1999, as compared to 3.2%
for the thirty-nine weeks ended November 1, 1998. Excluding approximately $2.7
million of expenses related to professional fees incurred in connection with the
Company's evaluation of strategic alternatives for its UK operations during the
thirty-nine weeks ended October 31, 1999, and excluding legal and severance
costs incurred during the thirty-nine weeks ended November 1, 1998, general and
administrative expenses decreased from 2.8% of sales to 2.6% of sales on a
comparable basis. This decrease is due primarily to lower North American closed
store expenses versus the comparable prior year period.
Loss on disposal of subsidiary for the thirty-nine weeks ended October
31, 1999 was $43.6 million, including $29.0 million of loss and transaction
related expenses on the sale of the Company's United Kingdom subsidiary, $3.5
million of United Kingdom closed store costs and executive severance costs, and
$11.1 million of loss from operations in the United Kingdom segment. During the
third quarter of 1998, the United Kingdom segment incurred a $9.6 million loss
from operations.
The Company's operating income decreased to $4.0 million for the
thirty-nine weeks ended October 31, 1999 from $20.0 million for the thirty-nine
weeks ended November 1, 1998. This decrease was primarily due to the loss or
disposal of subsidiary and operational losses of the U.K. segment, offset in
part by increased gross profit and decreased preopening expenses as described
above.
Interest income increased slightly to $2.5 million for the thirty-nine
weeks ended October 31, 1999 from $2.4 million for the same fiscal period in
1998. Interest expense increased to $17.4 million for the thirty-nine weeks
ended October 31, 1999 from $15.9 million for the thirty-nine weeks ended
November 1, 1998.
Equity in the loss of PETsMART.com, in which the Company has a 49.9%
equity investment, represents the Company's proportionate share of loss from
PETsMART.com, which began operations in June 1999. The Company's portion of
PETsMART.com's losses from the date operations began though the end of the
fiscal third quarter of 1999 was $11.3 million.
14
<PAGE> 15
For the thirty-nine weeks ended October 31, 1999, income taxes were
provided at an annual effective rate of 44.0%, compared to 41.2% for the same
period in 1998. The increase in the effective tax rate is a result of the
exclusion of the Company's equity in the earnings (loss) of PETsMART.com in
taxable income. As PETsMART.com's earnings or losses will be excluded from the
Company's consolidated income tax return, the Company's effective tax rate will
be impacted. Also, the loss on the sale of the United Kingdom subsidiary is not
deductible for tax purposes until a capital gain is recognized to offset the
capital loss. Therefore, excluding the $11.3 million loss from PETsMART.com
incurred in the second and third quarters of 1999, and the $29.0 million loss on
the sale of the United Kingdom subsidiary incurred in third quarter 1999, the
Company's effective tax rate would have been 41%. The fluctuation in this rate
as compared to the 38.5% for the prior year comparable period was caused by
changes in foreign tax rates and mix of foreign and domestic taxable income or
loss. The 1999 rate also incorporates projected 1999 losses from the Company's
investment in PETsMART.com, the tax benefit related to which is not available to
the Company.
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 adopted SOP 98-5 at the
beginning of the first quarter of fiscal 1999. Prior to its adoption of SOP
98-5, the Company expensed its store preopening costs in the month in which the
store opened. The charge against earnings during the first quarter of fiscal
1999 related to this change in accounting principle was $0.9 million, before
taxes, and was recorded as a cumulative effect of a change in accounting
principle.
As a result of the foregoing, the Company reported a net loss of $27.6
million (or $0.24 per share - basic) for the thirty-nine weeks ended October 31,
1999 compared to net income of $3.8 million (or $0.03 per share - basic) for the
same period in fiscal 1998.
The following table summarizes the earnings per share impact of the
Company's electronic business joint venture and the disposal of the United
Kingdom retail subsidiary:
<TABLE>
<CAPTION>
Thirty-nine weeks ended
------------------------------------
October 31, 1999 November 1, 1998
---------------- ----------------
<S> <C> <C>
North America Retail & Catalog Operations $ 0.20 $ 0.07
PETsMART.com (0.10) --
United Kingdom Retail Operations (0.34) (0.04)
---------- --------
Total earnings per share - basic $ (0.24) $ 0.03
========== ========
</TABLE>
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.
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 of 1933, as amended (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.
On June 1, 1999, the Company announced that its Board of Directors had
approved a program to repurchase up to an aggregate of $25,000,000 of its Common
Stock. The repurchases could be made from time to time on the open market at
prevailing market prices or in negotiated transactions off the market. As of
October 31, 1999, all of the approved $25 million had been used to repurchase a
total of 5,550,000 shares of the Company's Common Stock, at an average price of
$4.50, under this program.
The Company consummated a sale of its United Kingdom subsidiary with a
third party on December 15, 1999. This transaction provided the Company cash
proceeds of approximately $49 million, less debt of approximately $7 million.
The Company has obtained an amendment to its credit facility to allow for the
recognition of the transaction loss on the sale of its UK subsidiary in various
covenant calculations.
15
<PAGE> 16
At October 31, 1999, total assets were $941.6 million, of which $542.4
million were current assets. Of these amounts, $61.7 million and $32.1 million,
respectively, related to United Kingdom assets sold after the third quarter
reporting date. Cash and cash equivalents were $38.6 million.
Cash provided by operations was $7.1 million for the thirty-nine weeks
ended October 31, 1999, compared to cash provided by operations of $15.1 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 49.6% at
October 31, 1999, compared to 44.3% at January 31, 1999. Inventory balances were
approximately $419.5 million at October 31, 1999, and $336.1 million at January
31, 1999. Average North American store inventory, which excludes the inventory
of PETsMART DIRECT, increased 15.9% to $765,000 per store at October 31, 1999,
from approximately $660,000 at January 31, 1999. This increase was the result of
seasonal import orders received ahead of the holiday selling period to avoid
overseas shipment delays experienced in the previous year, additional
merchandise ordered to remove risk of fourth quarter out-of-stock conditions
caused by instability in the new SAP replenishment system experienced during the
third quarter, and the start-up of the forward distribution center in Ennis,
Texas.
The Company uses cash in investing activities 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 also uses cash to purchase superstores for sale and leaseback, and
during fiscal year 1999 has used cash to invest in equity holdings of
PETsMART.com. Net cash used in investing activities was $95.5 million for the
thirty-nine weeks ended October 31, 1999, compared to $23.4 million used in the
same period in the prior year.
Net cash flow used in financing activities, primarily the change in the
Company's bank overdraft, payment on capital lease obligations, the repurchase
of the Company's common stock, and activity in the Company's line of credit
facility, was $24.5 million for the thirty-nine weeks ended October 31, 1999.
Net cash of $5.3 million was provided by these activities during 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,
corporate investment, including costs associated with the continued 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 $975,000. 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
leased.
The Company has begun to open 19,000 square foot superstore locations,
primarily in single-store markets and as fill-in locations in existing markets.
The Company expects that these smaller stores will comprise a growing percentage
of its new store locations in future years as the Company's real estate strategy
matures. These locations are generally leased facilities and cash requirements
for these locations will typically include approximately $325,000 for inventory,
net of accounts payable, approximately $100,000 for preopening costs, and an
average of approximately $50,000 for leasehold improvements. Approximately
$375,000 is required for store fixtures and equipment, which is typically
financed through leasing.
Based upon the Company's current plan to open 2 new North American
superstores during the remainder of fiscal 1999, approximately $1.9 million will
be needed to finance these openings. Also, based upon the Company's current plan
to open approximately 25 new North American stores during the first fiscal
quarter of 2000, a major portion of the approximately $24.4 million needed to
finance these openings will likely be expended during the latter portion of
fourth quarter 1999. 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 completed its implementation of an integrated North America
information system, which features a common set of applications, during second
quarter 1999. The Company estimates that its costs in connection with the
continued development and implementation of system enhancements, before giving
consideration to any lease financing that may be available, will be up to $20
million annually through fiscal 2000. The Company continues to replace and
upgrade its existing point-of-sale equipment. This project was completed in all
North American stores in the middle of the fiscal fourth quarter of 1999. Total
expenditure for hardware and software related to the POS project are estimated
to be $7 million to $9 million, and will be financed through a lease
transaction.
16
<PAGE> 17
Capital expenditures, net of construction allowances, were
approximately $65.4 million during the thirty-nine weeks ended October 31, 1999.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
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, 2000. 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 will adopt SFAS 133 in the first quarter of fiscal
2001 and does not expect a material effect on its financial statements as a
result of adoption.
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, including vendor, departmental applications,
core applications, and infrastructure, all of which are at or near completion. A
new integrated North American information system, which is already Year 2000
compliant, was implemented during the second quarter 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 before the end of December 1999. The Company estimates that its costs
in connection with the continued enhancement 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 Catalog operational segment, with costs
to address those segment Year 2000 issues not expected to be material.
17
<PAGE> 18
There can be no assurance, however, that the new North American
information system 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
North American 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.
18
<PAGE> 19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company is subject to the risk of fluctuating interest rates in the
ordinary course of business on certain assets including cash and cash
equivalents, and on borrowings under its revolving credit arrangement. The
Company has entered into interest rate swaps to lower its funding costs and
reduce its exposure to changes in short-term interest rates. Under these
arrangements, the Company may convert variable rate lease payments and
borrowings at a fixed rate of approximately 6.6%. The Company does not expect
changes in fair value of the arrangements to have a significant effect on the
Company's operations, cash flow or financial position.
19
<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 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), amended complaint in the District Court. The Company
and the individual defendants filed a motion to dismiss the consolidated amended
complaint, and on June 3, 1999, the Court entered an order granting the motion
to dismiss. Plaintiff's were given 60 days to amend the complaint but did not do
so. The Company filed a request that the case be dismissed and an order
dismissing case with prejudice was entered on September 3, 1999. The Plaintiffs
filed a timely notice of appeal but no briefing has yet been filed and no
hearing set before the Court of Appeals.
In addition, certain former Pet City affiliates have retained counsel
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. No litigation has been filed with respect to this
matter, and the Company believes that the allegations are without merit. The
parties have entered into an agreement tolling the Statute of Limitations
pertaining to this potential dispute. 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 (FLSA), 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 four motions for partial
summary judgment on Plaintiffs claim that four in-store management positions
were improperly classified as exempt under FLSA. These motions were denied. On
or about July 30, 1999, Plaintiffs filed a motion seeking Class Certification
and Court-Supervised Notice to Potential Collective Action Members. The Court
denied this motion on September 28, 1999. Plaintiffs filed a motion seeking
Class Certification and Court-Supervised Notice to Potential Collective Action
Members in the Company's four Orlando area stores on November 23, 1999. The
Company opposed the motion and the Court has the matter under review. The Court
ordered the parties to participate in a mediation, which will be held on
December 15, 1999. Trial on this matter is currently scheduled for February 1,
2000, and the Company intends to continue to defend itself vigorously.
20
<PAGE> 21
ITEM 5. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL AND OPERATING DATA
The following unaudited pro forma condensed consolidated financial and operating
data of PETsMART, Inc. and subsidiaries (the "Company") for the periods ended
and as of the dates indicated are based on the historical financial statements
of the Company included elsewhere in this quarterly report on Form 10-Q or in
the Company's Annual Report on Form 10-K for the fiscal year ended January 31,
1999, adjusted to give effect to the following: (i) the sale of the United
Kingdom subsidiary (the "Transaction") for approximately $49.0 million in cash
less bank indebtedness of approximately $7 million, resulting in a loss of
approximately $26.0 million; and (ii) the payment of approximately $3.0 million
in fees and expenses related to the Transaction.
The Unaudited Pro Forma Condensed Consolidated Statement of Operations for the
year ended January 31, 1999 and the Unaudited Pro Forma Condensed Consolidated
Statement of Operations for the thirty-nine weeks ended October 31, 1999 and
November 1, 1998, give effect to the Transaction as if the Transaction had
occurred as of February 1, 1998. The pro forma adjustments are based upon
available information and certain assumptions that the Company believes are
reasonable. The Unaudited Pro Forma Condensed Consolidated Statements of
Operations do not purport to represent what the Company's results of operations
would actually have been had the Transaction in fact occurred as of such dates
or to project the Company's results of operations for any future period. The
unaudited pro forma condensed consolidated financial and operating data should
be read in conjunction with the historical consolidated financial statements of
the Company and the notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in the Company's Annual
Report on Form 10-K for the fiscal year ended January 31, 1999.
The Transaction was structured as a stock sale, whereby the Company sold 100% of
the stock of the United Kingdom subsidiary. Based on the terms of the
Transaction, the Company has estimated the net proceeds (cash less bank debt)
and recognized a loss for the difference in the net proceeds and the net book
value of the United Kingdom subsidiary in the thirty-nine week period ended
October 31, 1999. The actual net proceeds may differ from the pro forma amounts
included herein.
21
<PAGE> 22
ITEM 5. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL AND OPERATING DATA
(CONTINUED)
UNAUDITED PRO FORMA CONDENSED STATEMENT OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED FISCAL YEAR ENDED
OCTOBER 31, 1999 JANUARY 31, 1999
--------------------------------------- -----------------------------------------
PRO FORMA PRO FORMA
ADJUST- ADJUST-
HISTORICAL MENTS(a) PRO FORMA HISTORICAL MENTS(a) PRO FORMA
---------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net sales $1,540,311 $ 1,540,311 $ 2,109,322 $ 205,468 $ 1,903,854
Cost of sales 1,138,551 1,138,551 1,581,202 165,858 1,415,344
---------- ----------- ----------- ----------- -----------
Gross profit 401,760 401,760 528,120 39,610 488,510
Store operating expenses 306,731 306,731 399,897 40,654 359,243
Store preopening expenses 4,800 4,800 8,814 1,659 7,155
General and administrative expenses 42,630 42,630 60,345 5,588 54,757
Loss on disposal of subsidiary (43,607) (43,607) 0 0 0 0
---------- ----------- ----------- ----------- ----------- -----------
Operating income (loss) 3,992 47,599 59,064 (8,291) 67,355
Interest income 2,524 2,524 3,092 40 3,052
Interest expense (17,363) (17,363) (23,050) (1,678) (21,372)
---------- ----------- ----------- ----------- ----------- -----------
Income (loss) before equity in loss of
PETsMART.com, income tax expense
(benefit) and cumulative effect of a
change in accounting principle (10,847) (43,607) 32,760 39,106 (9,929) 49,035
Equity in loss of PETsMART.com (11,282) 0 (11,282) 0 0 0
---------- ----------- ----------- ----------- ----------- -----------
Income (loss) before income tax expense
(benefit) and cumulative effect of a
change in accounting principle (22,129) (43,607) 21,478 39,106 (9,929) 49,035
Income tax expense (benefit) 4,976 (4,382) 9,358 15,837 (5,722) 21,559
---------- ----------- ----------- ----------- ----------- -----------
Income (loss) before cumulative effect
of a change in accounting principle $ (27,105) $ (39,225) $ 12,120 $ 23,269 $ (4,207) $ 27,476
========== =========== =========== =========== =========== ===========
Earnings per common share - basic:
Weighted average shares - basic 115,701 116,281
Income before cumulative effect of a
change in accounting principle $ 0.10 $ 0.24
Earnings per common share - diluted:
Weighted average shares - basic 115,701 116,281
Effect of dilutive securities - Options 400 804
----------- ------------
Weighted average shares - diluted 116,101 117,085
Income before cumulative effect of a
change in accounting principle $ 0.10 $ 0.24
</TABLE>
<TABLE>
<CAPTION>
THIRTY-NINE WEEKS ENDED
NOVEMBER 1, 1998
------------------------------------------------
PRO FORMA
ADJUST-
HISTORICAL MENTS(a) PRO FORMA
----------- ----------- -----------
<S> <C> <C> <C>
Net sales $ 1,527,601 $ 149,362 $ 1,378,239
Cost of sales 1,158,247 121,257 1,036,990
----------- ----------- -----------
Gross profit 369,354 28,105 341,249
Store operating expenses 292,035 30,676 261,359
Store preopening expenses 8,396 1,606 6,790
General and administrative expenses 47,694 4,226 43,468
Loss on disposal of subsidiary 0 0 0
----------- ----------- -----------
Operating income (loss) 21,229 (8,403) 29,632
Interest income 2,388 40 2,348
Interest expense (17,139) (1,258) (15,881)
Income (loss) before equity in loss of
PETsMART.com, income tax expense
(benefit) and cumulative effect of a
change in accounting principle 6,478 (9,621) 16,099
Equity in loss of PETsMART.com 0 0 0
----------- ----------- -----------
Income (loss) before income tax expense
(benefit) and cumulative effect of a
change in accounting principle 6,478 (9,621) 16,099
Income tax expense (benefit) 2,672 (5,545) 8,217
----------- ----------- -----------
Income (loss) before cumulative effect
of a change in accounting principle $ 3,806 $ (4,076) $ 7,882
=========== =========== ===========
Earnings per common share - basic:
Weighted average shares - basic 116,115
Income before cumulative effect of a
change in accounting principle $ 0.07
Earnings per common share - diluted:
Weighted average shares - basic 116,115
Effect of dilutive securities - Options 752
-----------
Weighted average shares - diluted 116,867
Income before cumulative effect of a
change in accounting principle $ 0.07
</TABLE>
(a) Pro forma adjustments represent the actual results of the United Kingdom
subsidiary for the periods presented.
22
<PAGE> 23
Item 5. Unaudited Pro Forma Condensed Consolidated Financial and Operating
Data (continued)
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
(In thousands)
<TABLE>
<CAPTION>
October 31, 1999
----------------------------------------
Pro Forma
Historical Adjustments(a) Pro Forma
---------- -------------- ---------
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents ..................................... $ 38,624 $(33,581)(b) $ 72,205
Merchandise inventories ....................................... 419,462 23,221 396,241
Other current assets .......................................... 84,283 8,575 75,708
-------- -------- --------
Total current assets ..................................... 542,369 (1,785) 544,154
Property and equipment, net ................................... 275,898 16,076 259,822
Other assets .................................................. 123,329 18,113 105,216
-------- -------- --------
Total assets ............................................. $941,569 $ 32,404 $909,192
======== ======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Accounts payable .............................................. $208,608 $13,616 $194,992
Other current liabilities ..................................... 131,546 11,550 (c) 119,996
-------- -------- --------
Total current liabilities ................................ 339,614 25,166 314,448
6 3/4% Subordinated Convertible Notes ......................... 200,000 -- 200,000
Other long-term liabilities ................................... 87,982 7,238 80,744
-------- -------- --------
Total liabilities ........................................ 627,569 32,404 595,192
-------- -------- --------
Stockholders' equity .......................................... 314,000 -- 314,000
-------- -------- --------
Total liabilities and stockholders' equity ............... $941,596 $ 32,404 $909,193
======== ======== ========
</TABLE>
(a) Pro forma adjustments represent the actual results of the United Kingdom
subsidiary for the periods presented
(b) Reflects sale proceeds of $42.0 million, net of $0.3 million of existing
cash and $8.3 million of cash invested subsequent to October 31, 1999.
(c) Reflects actual current liabilities of $16.7 million less transaction
related fees of $3.0 million and operating activities of $2.1 million.
23
<PAGE> 24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 Financial Data Schedule (EDGAR only)
(b) Reports on Form 8-K
During the thirteen weeks ended October 31, 1999 the Company filed no
reports on Form 8-K.
24
<PAGE> 25
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 20, 1999.
PETSMART, INC.
(Registrant)
/s/ Neil T. Watanabe
---------------------------
Neil T. Watanabe
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
25
<PAGE> 26
Exhibit Index
Exhibit 27 Financial Data Schedule
<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-30-2000
<PERIOD-START> FEB-01-1999
<PERIOD-END> OCT-31-1999
<EXCHANGE-RATE> 1
<CASH> 38,624
<SECURITIES> 0
<RECEIVABLES> 51,554
<ALLOWANCES> 0
<INVENTORY> 419,462
<CURRENT-ASSETS> 542,369
<PP&E> 451,121
<DEPRECIATION> 175,223
<TOTAL-ASSETS> 941,596
<CURRENT-LIABILITIES> 339,614
<BONDS> 269,957
0
0
<COMMON> 12
<OTHER-SE> 313,988
<TOTAL-LIABILITY-AND-EQUITY> 941,596
<SALES> 1,693,397
<TOTAL-REVENUES> 1,693,397
<CGS> 1,266,277
<TOTAL-COSTS> 1,266,277
<OTHER-EXPENSES> 422,271
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 17,363
<INCOME-PRETAX> (22,129)
<INCOME-TAX> 4,976
<INCOME-CONTINUING> (27,105)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 528
<NET-INCOME> (27,633)
<EPS-BASIC> (0.24)
<EPS-DILUTED> (0.24)
</TABLE>
