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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED FEBRUARY 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
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PETSMART, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3024325
State or other jurisdiction of incorporation or (I.R.S. Employer Identification
organization No.)
19601 NORTH 27TH AVENUE 85027
(Address of principal executive offices (Zip Code)
Registrant's telephone number, including area code: (602) 580-6100
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.0001 PAR VALUE
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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 report(s), and (2) has been subject to such
filing requirements for the past 90 days. /X/ Yes / / No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
Based on the closing sale price of $10.75 on March 27, 1998, the aggregate
market value of the voting stock held by non-affiliates of the registrant was
$1,222,589,362.
On March 27, 1998 there were outstanding 115,646,012 shares of the
Registrant's Common Stock.
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DOCUMENTS INCORPORATED BY REFERENCE
(TO THE EXTENT INDICATED HEREIN)
Registrant's Proxy Statement (specified portions) with respect to the Annual
Meeting of Stockholders to be held June 25, 1998.
TABLE OF CONTENTS
ITEM PAGE
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PART I
1. Business............................................................................................ 3
2. Properties.......................................................................................... 16
3. Legal Proceedings................................................................................... 17
4. Submission of Matters to a Vote of Security Holders................................................. 18
PART II
5. Market for the Registrant's Common Stock and Related Shareholder Matters............................ 19
6. Selected Financial Data............................................................................. 19
7. Management's Discussion and Analysis of Financial Condition and Results of Operations............... 20
7A. Quantitative and Qualitative Disclosures About Market Risks......................................... 28
8. Financial Statements and Supplementary Data......................................................... 28
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................ 29
PART III
10. Directors and Executive Officers of the Registrant.................................................. 29
11. Executive Compensation.............................................................................. 29
12. Security Ownership of Certain Beneficial Owners and Management...................................... 29
13. Certain Relationships and Related Transactions...................................................... 29
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................................... 29
2
PART I
ITEM 1. BUSINESS
The following Business section contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth under "Risk Factors" and
elsewhere in this Form 10-K.
GENERAL
PETsMART, Inc. and its subsidiaries ("PETsMART" or "the Company") is the
largest operator of superstores specializing in pet food, supplies and services
in North America and the United Kingdom. At February 1, 1998, the Company
operated 468 superstores, consisting of 372 superstores in the United States, 84
superstores in the United Kingdom, and 12 superstores in Canada. PETsMART offers
a complete assortment of pet products at prices typically below those offered by
supermarkets, mass merchandisers, and traditional pet food and supply retailers,
as well as a wide range of pet services. PETsMART's superstores utilize a hybrid
retail-warehouse format that reinforces the image of warehouse shopping at
discount prices, enhances merchandise presentation, and provides a fun shopping
experience for customers and their pets.
THE PET FOOD AND PET SUPPLY INDUSTRY
The pet food, supplies and services business, fueled by growth in pet
populations and the trend toward better pet care, generated U.S. sales, of
approximately $31 billion in 1996. According to recent estimates, approximately
58 million U.S. households, or over half of all U.S. households, owned at least
one pet and over half of pet-owning households owned more than one pet. There
were an estimated 57 million dogs, 70 million cats and 11 million horses in the
United States in 1996. Demand for pets is primarily influenced by family
formation; most pets are owned by families with children between ages five and
nineteen.
Pet food, primarily dog and cat food, represents the largest volume category
of pet-related products, with 1996 U.S. sales estimated at approximately $9
billion. The Company estimates that supermarket pet food brands, such as Purina,
Alpo, Friskies and Kal Kan accounted for approximately 75% of U.S. pet food
sales in 1996. In recent years, supermarkets' share of total pet food sales has
steadily decreased as a result of increased competition from superstores,
warehouse clubs, mass merchandisers and specialty pet stores as well as the
growing proportion of pet food sales accounted for by premium foods. Premium pet
foods brands such as Science Diet and IAMS, which offer higher levels of
nutrition than non-premium brands, accounted for approximately 25% of total pet
food sales in 1996. These premium pet foods currently are not sold through
supermarkets, warehouse clubs and mass merchandisers due to manufacturers'
restrictions but are sold primarily through superstores such as PETsMART,
specialty pet stores, veterinarians and farm and feed stores.
U.S. sales of pet supplies, consisting of items such as dog and cat toys,
collars and leashes, cages and habitats, books, vitamins and supplements,
shampoos, flea and tick control products, and aquatic supplies, were
approximately $3.3 billion in 1996. Pet supplies are sold by many types of
retailers, including supermarkets, discount stores and other mass merchandisers,
specialty pet stores, direct mail houses and veterinarians. The channels of
distribution for pet supplies are highly fragmented, with superstores and
discount stores estimated to account for over 50% of U.S. sales volume.
The Company estimates that U.S. sales of equine food, tack, riding apparel
and related supplies and equipment were approximately $8 billion in 1996.
U.S. sales of pet services were estimated at approximately $11 billion in
1996. Major pet-related services include veterinary care, grooming, and
obedience training. The Company considers the pet
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services industry also to be highly fragmented and significantly under-served;
many pet owners do not regularly use pet services due to inconvenience, a lack
of awareness or the cost of the services provided.
MERCHANDISE
Merchandise, which represented approximately 93.5% of PETsMART's North
American retail revenues in fiscal 1997, generally falls into three main
categories:
- PET FOOD, TREATS AND LITTER. PETsMART emphasizes premium dog and cat
foods, which currently are not available in supermarkets, warehouse clubs
or mass merchandisers, as well as quality national brands traditionally
found in supermarkets and pet stores. PETsMART also offers a wide-
selection of its own corporate brand food products including
"Authority-Registered Trademark-" premium dog and cat food and treats,
"Sophista Cat-Registered Trademark-" cat food and "Grreat
Choice-Registered Trademark-" dog food. The sale of pet food, treats and
litter comprised approximately 47.3% of PETsMART's North American retail
revenues in fiscal 1997.
- PET SUPPLIES. PETsMART's broad assortment of pet supplies includes
collars, leashes, health and beauty aids, shampoos, medication, toys,
animal carriers, dog houses, cat furniture and equestrian supplies. The
Company also offers a complete line of supplies for fish, birds and small
animals, including aquariums, filters, bird cages and small animal
supplies. Corporate brand pet supplies include "Top
Paw-Registered Trademark-", "Top Fin-Registered Trademark-" and "Top
Wing-Registered Trademark-". PETsMART also has an equine department in
certain superstores serving trade areas which have high rates of horse
ownership. The sale of pet supplies comprised approximately 42.1% of
PETsMART's North American retail revenues in fiscal 1997.
- LIVESTOCK AND OTHER GOODS. PETsMART superstores feature fresh water
tropical fish and, in certain superstores, domestically bred birds,
reptiles and small animals. In addition, PETsMART actively supports the
activities of local humane organizations through its in-store Luv-A-Pet
pet adoption centers. Livestock and other non-pet supply goods comprised
approximately 4.1% of the Company's North American retail revenues in
fiscal 1997.
PET SERVICES
Unlike its principal competitors, PETsMART offers a wide range of services
for the pet owner. Services comprised approximately 6.5% of the Company's North
American retail revenues in fiscal 1997. Approximately one-half of PETsMART's
North American superstores include veterinary clinics. In most superstores,
PETsMART also offers on-site grooming and obedience classes.
Veterinary clinics operated in PETsMART stores generally offer routine
examinations and vaccinations, dental care, pharmacy and most surgical
procedures. The availability of comprehensive veterinary care further
differentiates PETsMART and reflects the Company's overall commitment to animal
care. The Company's prototype 2,000 square foot in-store clinic provides
state-of-the-art operating and examining rooms as well as on-site X-ray machines
and blood diagnostic equipment. These clinics offer customers more sophisticated
services than traditional veterinary competitors typically provide. In addition,
many PETsMART stores without these in-store clinics offer routine vaccinations
and wellness services. At February 1, 1998, veterinary clinics were operating
within 213 PETsMART stores in North America. Of these, 102 were operated
directly by PETsMART and 98 were leased to and operated by Medical Management
International, Inc., a third party operator of veterinary clinics. An additional
13 clinics were leased to and operated by independent veterinarians.
THE PETSMART STRATEGY: BACK-TO-BASICS
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
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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 of the
Company and implemented a series of "Back to Basics" initiatives intended to
refocus the Company and to improve financial performance. The "Back to Basics"
initiatives consist of:
- PROVIDING CUSTOMERS WITH VALUE THROUGH A FIRM COMMITMENT TO EVERYDAY LOW
PRICING. PETsMART endeavors to be the low-price leader in each of the
markets it serves for each product that it offers. The Company reinforces
customers' expectations of savings by offering a "double-the-difference"
price guarantee on all of its products. The Company regularly checks
prices at competitors' stores to ensure that PETsMART's prices are
competitive within each market.
- MAINTAINING A BROAD PRODUCT ASSORTMENT. PETsMART's strategy is to offer
the most complete assortment of pet-related products and services in the
marketplace. PETsMART U.S. prototype superstores typically carry
approximately 12,000 pet related items.
- ENSURING A HIGH IN-STOCK POSITION ON KEY ITEMS WHILE IMPROVING INVENTORY
TURNS. The Company's inventory management systems are designed to
maintain inventory levels that provide optimum in-stock positions. The
Company is focused on ensuring that factors which led to widespread
out-of-stock conditions in the first half of fiscal 1997 are not repeated
in the future. Also, in August 1997, the Company decided to discontinue
the Discovery Center department within all of its stores, to eliminate or
reduce certain other merchandise categories and to expand other offerings.
The elimination of the Discovery Center in particular will allow the
central "drive" aisle of PETsMART stores to be remerchandised to enhance
store productivity. In addition, the elimination of the Discovery Center
and other slower-moving merchandise is expected over time to improve
inventory turnover rates.
- REEMPHASIZING EMPLOYEE TRAINING TO ENSURE A HIGH LEVEL OF CUSTOMER
SERVICE. The Company has renewed its emphasis on training and personnel
development. PETsMART views the quality of its customers' interaction with
its associates as critical to its continued success in building and
enhancing customer confidence and loyalty. PETsMART strives to provide
customers with personalized service and a friendly shopping atmosphere. To
enhance the stores' fun environment, customers are encouraged to bring
their pets into PETsMART superstores while they shop.
- REINSTATING PROVEN MARKETING AND ADVERTISING PROGRAMS TO REBUILD SALES
MOMENTUM. In the first half of fiscal 1997, the Company experimented with
alternative marketing programs. Due to disappointing results, the Company
has returned to its historically more successful strategy of using
circular, radio and television advertising that focuses on specific buying
opportunities to encourage customers to shop at PETsMART.
- CLOSING OR RELOCATING CERTAIN UNDERPERFORMING SUPERSTORES. The Company
has decided to accelerate the closing of approximately 33 underperforming
or redundant superstores which had been slated for closing over the next
two years, 31 of which were acquired superstores. Twenty-four of the 33
superstores are being replaced by superstores to be opened in the same
trade area. At February 1, 1998, 12 of these 33 superstores had been
closed, and four replacement superstores had been opened.
The lost sales and earnings momentum experienced in the first half of 1997
continued to negatively affect results of operations and comparable store sales
throughout fiscal 1997. Specifically, comparable store sales increases for the
North American stores approximated 4% for the second half of fiscal 1997, well
below the Company's historical and anticipated levels, and gross margins
remained below historical norms due to the mix of merchandise sales, increased
occupancy and warehouse and distribution costs, higher personnel costs in
service areas of the business, and the effects of the Company's return to the
every-day-low pricing policy. Store operating expenses also increased during the
second half of fiscal 1997 due to the increased emphasis on customer service
which required increased payroll expenditures, and
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general and administrative expenses also increased as a result of the activities
related to the Company's management information systems project. The Company
does not anticipate these costs to decrease significantly, if at all, during
fiscal 1998.
The Company believes that during the second half of fiscal 1997, the
operational matters which precipitated the reduced inventory levels,
out-of-stock conditions and lost sales momentum were addressed and that
significant progress is being made to prevent a recurrence of these issues.
Specifically, the Company's comparable transaction counts continue to increase;
inventory levels and in-stock positions are believed to be more balanced; the
Company's cash and working capital positions are adequate to fund future growth
and projects for the next fiscal year; and the Company believes that the
increased emphasis on customer service is having positive results in store
morale and customer responsiveness. There can be no assurance that these recent
trends and favorable developments will continue or that the Company will not
experience other operational issues which have a material adverse impact upon
results of operations during fiscal 1998. Additionally, the Company's planned
schedule of new store openings in fiscal 1998 is heavily weighted to the first
half of the fiscal year and therefore, cash requirements, along with the
associated preopening expenses and inventory needs, will be significant and may
negatively impact results of operations during such period.
PETSMART SUPERSTORES
At February 1, 1998, PETsMART operated 468 superstores, consisting of 372
superstores in the United States, 84 superstores in the United Kingdom and 12
superstores in Canada. PETsMART's superstores are generally located in sites
co-anchored by strong consumables-oriented retailers and other destination
superstores, typically in or near major regional shopping centers.
The Company's expansion strategy is to increase its market share in existing
markets and to penetrate new markets with a goal of establishing a leading
position in each market it serves and to achieve operating efficiencies and
economies in advertising, distribution and management. By the end of fiscal
1998, PETsMART currently expects to operate 444 superstores in North America and
104 superstores in the United Kingdom. PETsMART believes there is a potential
for an aggregate of 900 to 1,000 PETsMART superstores in North America and up to
250 PETsMART superstores in the United Kingdom. See "Risk Factors--Expansion
Plans."
PETSMART DIRECT
PETsMART Direct, the Company's catalog operation, is the leading direct
marketing retailer of pet related and equine products in North America. PETsMART
Direct sells pet supplies through three catalogs: R.C. Steele, Pedigrees and
Groomer Direct. PETsMART Direct also offers discount brand name tack, riding
apparel and equine supplies through four additional catalogs: State Line Tack
Western, State Line Tack English, Wiese Equine Supply and National Bridle Shop.
In fiscal 1997, PETsMART Direct circulated more than 37 million catalogs.
PETsMART Direct's marketing and customer database management is designed to
attract new customers and to generate additional sales from existing catalog or
retail customers. PETsMART Direct's proprietary customer database currently
contains the names of approximately 1.2 million customers who have made a
purchase from PETsMART Direct catalogs within the past 24 months. In fiscal
1997, PETsMART Direct's average transaction was approximately $90.
DISTRIBUTION
PETsMART is committed to pursuing distribution strategies which the Company
believes minimize delivered cost on the merchandise it sells. The Company buys
from approximately 700 vendors worldwide, the two largest of which account for
approximately 21% of total purchases. The Company employs a hybrid distribution
system including, as appropriate, full truckload shipments to individual
superstores, the splitting of full truckloads among several closely located
superstores, consolidation centers to service
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regional clusters of superstores and central distribution centers. The Company
operates a 300,000 square foot distribution center in Columbus, Ohio, and a
430,000 square foot distribution center in Phoenix, Arizona. The Company's
230,000 square foot distribution center in Ennis, Texas is in the process of
being consolidated into the PETsMART Phoenix facility. These centers primarily
handle small, light and easy to handle products. The Company also currently
operates 13 regional consolidation centers in the United States and operates a
110,000 square foot distribution center in Gloucester, England. In addition,
PETsMART Direct operates a 200,000 square foot catalog fulfillment and equine
distribution center in Brockport, New York.
INFORMATION SYSTEMS
The Company is committed to making ongoing investments in its information
systems to increase operating efficiency, provide superior customer service and
support its anticipated growth. The Company has made, and continues to make,
significant investments in information systems to support point of sale
applications, inventory replenishment, merchandising, inventory control,
warehousing and distribution, financial controls and reporting. PETsMART has
completed the conceptual design of an integrated, worldwide information system
which will feature a common set of applications. The Company estimates that its
costs in connection with the development 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 can be financed through lease
transactions, although there can be no assurance that adequate financing will be
available to the Company on acceptable terms. When complete, it is anticipated
that the system will provide the Company with a significant competitive
advantage in better serving its customers and improving its business operations.
There can be no assurance that the actual costs for the new system will not
exceed current estimates or extend beyond fiscal year 2000. 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. See "Risk Factors--New Information
System" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
COMPETITION
Based on total sales, the Company is the largest retailer of pet food,
supplies and services in North America and the United Kingdom. The pet food and
pet supply retail business is highly competitive and can be categorized into
three different segments: (i) supermarkets, warehouse clubs and other mass
merchandisers, (ii) specialty pet supply chains and pet supply superstores and
(iii) independent pet stores. The Company believes that the principal
competitive factors influencing the Company's business are product selection and
quality, convenience of store locations, customer service and price. In this
regard, the major premium pet food brands offered by the Company, such as
Science Diet and IAMS, are not currently available to grocery stores, warehouse
clubs or other mass merchandisers due to manufacturers' restrictions. PETsMART
believes that it competes effectively within its various markets; however, some
of the Company's competitors are larger in terms of overall sales volume and
have access to greater capital and management resources than the Company. See
"Risk Factors--Reliance on Vendors and Product Lines" and "--Competition."
GOVERNMENT REGULATION
The Company is subject to laws governing its relationship with employees,
including minimum wage requirements, overtime, working conditions and
citizenship requirements. In certain locations, PETsMART leases space to
independent veterinary operators. Statutes and regulations in certain states,
Canadian provinces or abroad affecting the ownership of veterinary practices or
the operation of
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veterinary clinics within retail stores or the operation of superstores may
impact the Company's ability to operate veterinary clinics within certain of its
facilities.
The laws of many states prohibit veterinarians from splitting fees with
non-veterinarians and prohibit business corporations from providing, or holding
themselves out as providers of, veterinary medical care. These laws vary from
state to state and are enforced by the courts and by regulatory authorities with
broad discretion. While the Company seeks to structure its operations to comply
with the corporate practice of veterinary medicine laws of each state in which
it operates, there can be no assurance that, given varying and uncertain
interpretations of such laws, the Company would be found to be in compliance
with restrictions on the corporate practice of veterinary medicine in all
states. A determination that the Company is in violation of applicable
restrictions on the practice of veterinary medicine in any state in which it
operates could require the Company to restructure its operations to comply with
the requirements of such states, or render it unable to operate veterinary
clinics in those states. See "Risk Factors-- Government Regulation."
INSURANCE
The Company maintains standard product and casualty insurance on all of its
superstores, as well as product liability insurance covering the sale of live
animals and veterinary malpractice insurance covering its veterinary clinics.
TRADEMARKS
The Company owns several service marks and trademarks registered with the
United States Patent and Trademark Office ("USPTO"), including
"PETsMART-Registered Trademark-," "Santa Claws-Registered Trademark-," "Grreat
Choice-Registered Trademark-," "Sophista-Cat-Registered Trademark-,"
"Authority-Registered Trademark-," "Top Paw-Registered Trademark-," "Top
Wing-Registered Trademark-," "Top Fin-Registered Trademark-," "Where Pets Are
Family-Registered Trademark-" and the PETsMART Logos. PETsMART also has several
applications pending with the USPTO for additional trademarks and anticipates
filing additional applications in the future. The Company believes its
trademarks and logos have become important components in its merchandising and
marketing strategy. The Company believes it has all the licenses necessary to
conduct its business.
EMPLOYEES
As of February 1, 1998, the Company employed approximately 18,800 associates
worldwide, approximately 8,300 of whom were employed full time. PETsMART's
associates receive wages and benefits competitive with those of the local retail
community. The Company is not subject to any collective bargaining agreements
and has not experienced any work stoppages. The Company considers its
relationship with its associates to be good.
RISK FACTORS
The risk factors discussed below include some, but not necessarily all, of
the matters which present risks and uncertainties which could have a material
adverse affect on the Company's ability to operate its businesses successfully
or in a manner consistent with historical operating results. The Company's
actual results could differ materially from those projected results due to some
or all of the factors discussed below.
SUPERSTORE EXPANSION PLANS, MATURATION OF EXISTING SUPERSTORES AND
DEPENDENCE ON PERFORMANCE OF SUPERSTORE. PETsMART currently operates
superstores in many of the major market areas of North America and the
United Kingdom. In North America, the Company's current plans for fiscal
1998 include opening an aggregate of 50 superstores in existing markets and
25 superstores in new markets, of which 17 are considered to be single store
markets. Additionally, the Company anticipates opening up to 20 superstores
in the United Kingdom in fiscal 1998. It has been the Company's experience
that superstores opened in existing markets may result in some
cannibalization of the sales of other
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PETsMART superstores already in operation in those markets. In addition, as
a result of the Company's rapid expansion in recent years, many of its
superstores are still relatively immature. Approximately one-third of the
Company's North America superstores have been opened since the beginning of
fiscal 1996. As superstores reach maturity, the rate of comparable store
sales increases tends to decline. The Company believes these factors, and
the negative effects of the inventory management difficulties which resulted
in out-of-stock conditions and lost sales, as well as an ineffective
advertising program during the first six months of fiscal 1997 (see
"Management's Discussion and Analysis--Recent Developments"), have
contributed to the decline in the rate of comparable store sales increases
which it has reported in recent years. PETsMART's North American comparable
store sales increases were 19.1% in fiscal 1994, 12.5% in fiscal 1995, 11.9%
in fiscal 1996 and 4.6% for fiscal 1997. As a result of new store openings
in existing markets and because mature superstores will represent an
increasing proportion of the Company's store base over time, it is likely
the Company's comparable store sales increases will continue to be lower
than historical levels. There can be no assurance new or existing
superstores will perform in accordance with historical patterns or current
management expectations, or that any cannibalization of sales will not be
greater than historical experience or current management expectations.
Operating margins are also expected to be impacted by new superstore
openings because of the recognition of preopening expenses and the lower
sales volumes characteristic of immature stores. Compared to results
achieved in other regions, the Company has experienced lower comparable
store sales increases and levels of store contribution in certain North
American geographic regions that it has recently entered. In addition,
certain operating costs, particularly those related to occupancy, are
expected to be higher than historical levels in some of these newly-entered
geographic regions and tight labor markets in certain areas are expected to
increase store personnel expenses more rapidly than historical trends. As a
result of the expected slower overall rate of comparable store sales
increase and the impact of these rising costs, the Company expects its total
store contribution and operating margins to continue to be lower than
historical levels in future periods. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Overview."
OPERATIONAL RESTRUCTURING AND INITIATIVES. During 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 the departure from the
Company's historically more effective advertising programs. As a result, the
Company has moved to implement a series of "Back to Basics" initiatives
intended to refocus the Company and improve its financial performance.
Additionally, the Company 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. See "Management's Discussion
and Analysis--Developments During Fiscal 1997." There can be no assurance
that the Company's recent initiatives will be successful or that financial
performance can be improved as a result of these efforts. Should these
efforts prove unsuccessful, the Company may conclude that further
restructuring and other actions are necessary in order to attempt to improve
the Company's operating and financial performance. As such, additional
restructuring and other costs may be incurred in future periods which would
adversely affect financial performance.
NEW INFORMATION SYSTEM. The Company's existing information systems are not
fully integrated on a worldwide basis. PETsMART has completed the conceptual
design of an integrated, worldwide information system which will feature a
common set of applications, and is implementing the system in North America.
The Company is currently negotiating with various vendors with respect to
the hardware and software needs associated with this system. It is
anticipated the development and implementation of the new system will
require significant capital expenditures, operating expense and management
effort to complete. There can be no assurance that the new system will 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, or to do so on a timely basis, could
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materially adversely affect the Company's future operating results or its
ability to expand. Costs of the new system will be expenses as incurred or
capitalized and expensed in future periods. The new system will require
significant financing, a portion of which will be provided by the November
1997 Note offering. The Company estimates that its costs in connection with
the development and implementation of the new system in North America,
before giving consideration to any lease financing that may be available,
will be up to $20 million annually through fiscal 2000. The Company believes
that certain hardware and software components of the new system may be
leased, although there can be no assurance that the actual costs for the new
system will not exceed current estimates or extend beyond fiscal year 2000.
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.
INTERNATIONAL OPERATIONS. The Company entered the European market by
acquiring Pet City in December 1996 and operated 84 superstores in the
United Kingdom at February 1, 1998. The Company also recently entered the
Canadian market, where it operated 12 superstores at February 1, 1998.
Operating these businesses requires significant management and financial
resources. In particular, international operations require coordination of
geographically separate management organizations, the integration of
personnel with disparate cultural and business backgrounds and an
understanding of the relevant differences in the legal and regulatory
environments. The Company had not previously operated stores outside of the
United States and there can be no assurance that PETsMART will be able to do
so successfully. As the Company's international operations expand,
PETsMART's results will be increasingly affected by the risks of such
activities, including fluctuations in currency exchange rates, changes in
international staffing and employment issues, tariff and other trade
barriers, the burden of complying with foreign laws, including tax laws, and
political and economic instability and developments. Presently, the United
Kingdom store expansion program is, and is anticipated to continue to be,
financed in large part by North American operations and financing sources,
including a portion of the proceeds of the 1997 Note offering. There can be
no assurance that the North American operations will continue to be able to
provide funding for the opening of superstores in the United Kingdom or that
adequate alternative sources of capital could be obtained on acceptable
terms. The Credit Facility contains covenants restricting the amounts
invested in certain foreign subsidiaries, including Pet City.
LITIGATION. On January 6, 1998, the Company was served with a complaint
entitled Miller v. Parker, et al. (Case No. CV 98-0020 PHX RCS) in the
Federal District Court for the District of Arizona, Phoenix Division by a
putative class of investors in PETsMART, Inc. securities. The lawsuit
alleges, among other things, that the Company and its officers and directors
issued materially false financial statements about the Company's flea and
tick product inventory, financial condition and results of operations.
Several additional complaints by putative class representatives alleging
substantially the same allegations have been filed in the District of
Arizona. A motion is currently pending to consolidate all such actions in
the District Court. Of such additional complaints, on March 5, 1998, the
Company was served with an amended complaint entitled Kowal v. Parker, et
al. (Case No. CV98-0133 PHX ROS) alleging an expanded class period. The
Company believes that this case will be consolidated with the other pending
securities class action lawsuits. The Company believes the allegations by
the putative class representatives are without merit and the Company intends
to defend itself vigorously.
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
10
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 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. The Company has begun its
evaluation of this complaint, and intends to respond on a timely basis.
GOVERNMENT REGULATION. The Company is subject to laws governing its
operation of veterinary clinics in its retail stores. Statutes and
regulations in certain states, Canadian provinces or abroad affecting the
ownership of veterinary practices or the operation of veterinary clinics
within retail stores or the operation of superstores may impact the
Company's ability to operate veterinary clinics within certain of its
facilities.
The laws of many states prohibit veterinarians from splitting fees with
non-veterinarians and prohibit business corporations from providing, or
holding themselves out as providers of, veterinary medical care. These laws
vary from state to state and are enforced by the courts and by regulatory
authorities with broad discretion. While the Company seeks to structure its
operations to comply with the corporate practice of veterinary medicine laws
of each state in which it operates, there can be no assurance that, given
varying and uncertain interpretations of such laws, the Company would be
found to be in compliance with restrictions on the corporate practice of
veterinary medicine in all states. A determination that the Company is in
violation of applicable restrictions on the practice of veterinary medicine
in any state in which it operates could require the Company to restructure
its operations to comply with the requirements of such states.
EXPANSION PLANS. PETsMART has expanded since its inception in 1986 to 372
superstores in the United States, 84 superstores in the United Kingdom and
12 superstores in Canada at February 1, 1998. In North America, the Company
currently anticipates opening an additional 75 superstores in fiscal 1998
and 55 superstores in fiscal 1999. The Company also currently anticipates
opening up to 20 new superstores annually in the United Kingdom. The
Company's ability to open additional superstores is dependent on adequate
sources of capital for leasehold improvements, fixtures and inventory,
preopening expenses, the training and retention of skilled managers and
personnel and other factors, some of which may be beyond the Company's
control. Presently, the Company's store expansion plans are expected to be
financed by cash flow from operations, lease financing, a portion of the
proceeds from the November 1997 Note offering and borrowing capacity under
the Credit Facility. To the extent the Company is unable to obtain adequate
financing for new store growth on acceptable terms, the Company's ability to
open new superstores will be negatively impacted. As a result, there can be
no assurance that the Company will be able to achieve its current plans for
the opening of new superstores. Any failure by PETsMART to expand its
distribution capabilities or other internal systems or procedures as
required could also adversely affect its ability to support its planned new
store growth.
While the Company has no present plans with respect to future acquisitions
or disposition of assets, the Company may make additional acquisitions in
the future. Future acquisitions by the Company, if any, could result in
potentially dilutive issuances of securities, the incurrence of additional
debt or contingent liabilities, and amortization expenses related to
goodwill and other intangible assets, which could materially adversely
affect the Company's profitability. The Company's operating results also
could be adversely affected if it is unable to successfully integrate any
future acquisition into its operations.
PETsMART routinely evaluates its strategic alternatives with respect to each
of its superstores, the operations of PETsMART Direct and the Company's
other operating assets and investments. In connection with such evaluation,
the Company may elect to close superstores or to sell or otherwise dispose
of selected assets or investments. There can be no assurance that any such
future sale or
11
disposition would be achieved on terms favorable to the Company.
Additionally, the Company has announced its intention to close 33 U.S.
superstores, including 31 of the smaller former Petstuff, Pet Food Giant and
PETZAZZ superstores, and to replace 24 of them with 26,000 square foot
prototype superstores. At February 1, 1998, 12 of these superstores had been
closed and 4 replacement superstores had been opened.
RELIANCE ON VENDORS AND PRODUCT LINES. PETsMART does not have any long-term
supply contracts with any of its premium food or other product vendors.
Sales of premium pet food for dogs and cats, such as Science Diet and IAMS,
make up a significant portion of PETsMART's revenues. Currently, the major
vendors of premium pet foods do not permit these products to be sold in
supermarkets, warehouse clubs or through other mass merchandisers. The
Company could be materially adversely affected were any of these vendors to
make their products available in supermarkets or through mass merchandisers,
or if the grocery brands currently available to such retailers were to gain
market share at the expense of the premium brands sold only through
specialty pet food and supply outlets.
PETsMART's principal vendors currently provide it with certain incentives,
such as trade discounts, cooperative advertising and market development
funds. A reduction or discontinuance of these incentives could have a
material adverse effect on the Company.
The Company purchases significant amounts of pet supplies from a number of
vendors with limited supply capabilities. There can be no assurance that
PETsMART's current pet supply vendors will be able to accommodate the
Company's anticipated growth. PETsMART is continually seeking to expand its
base of pet supply vendors and to identify new pet supply products.
Additionally, the Company purchases significant amounts of pet supplies from
vendors outside of the United States. There can be no assurance the
Company's overseas vendors will be able to satisfy PETsMART's requirements,
including timeliness of delivery, acceptable product quality, packaging and
labeling requirements, and other requirements of the Company. An inability
of PETsMART's existing vendors to provide products in a timely or
cost-effective manner could have a material adverse effect on the Company.
While the Company believes its vendor relationships are satisfactory, any
vendor could discontinue selling to the Company at any time.
COMPETITION. The pet food and supply retailing industry is highly
competitive. PETsMART competes with supermarkets, warehouse clubs and mass
merchandisers, many of which are larger and have significantly greater
resources than PETsMART. PETsMART also competes with a number of pet supply
warehouse or specialty stores, smaller pet store chains and independent pet
stores. The industry has become increasingly competitive due to the entrance
of other specialty retailers into the pet food and supply market, some of
which have developed store formats similar to PETsMART's. There can be no
assurance the Company will not face greater competition from these or other
retailers in the future. In particular, if any of the Company's major
competitors seek to gain or retain market share by reducing prices, the
Company may reduce its prices in order to remain competitive, which could
have a material adverse effect of the Company.
QUARTERLY AND SEASONAL FLUCTUATIONS. The timing of new superstore openings
may cause the Company's quarterly results of operations to fluctuate. In
addition, the Company's business is subject to some seasonal fluctuation.
PETsMART typically realizes a higher portion of its net sales and operating
profit 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 are expected to continue to be
negatively impacted by the introduction of alternative pharmaceutical
treatments, as well as by variations in weather conditions. In addition,
because PETsMART superstores typically draw customers from a large trade
area, sales may be impacted by adverse weather or travel conditions.
ANTI-TAKEOVER MEASURES. The PETsMART Restated Certificate of Incorporation,
as amended (the "Restated Certificate") and the PETsMART Bylaws include
provisions that may delay, defer or
12
prevent a change in management or control that holders of Notes or
stockholders might consider to not be in their best interests. These
provisions include (i) a classified Board of Directors consisting of three
classes, (ii) the ability of the Board of Directors to issue without
stockholder approval up to 10,000,000 shares of preferred stock in one or
more series with such rights, obligations, and preferences as the Board of
Directors may determine, (iii) no right of stockholders to call special
meetings of stockholders, (iv) no right to stockholders to act by written
consent and (v) certain advance notice procedures for nominating candidates
for election to the Board of Directors. In addition, the Restated
Certificate requires a 66 2/3% vote of stockholders to (i) alter or amend
the PETsMART By-laws, (ii) remove a director without cause, or (iii) alter,
amend or repeal certain provisions of the Restated Certificate. The Restated
Certificate does not permit cumulative voting. In August 1997, the Company's
Board of Directors adopted a Share Purchase Rights Plan, commonly referred
to as a "poison pill." The Company is subject to the anti-takeover
provisions of Section 203 of the Delaware General Corporation Law, which
prohibits the Company from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. The application of
Section 203 could have the effect of delaying or preventing a change of
control of the Company.
POSSIBLE VOLATILITY OF STOCK PRICE; ABSENCE OF DIVIDENDS. Since the initial
public offering of the Company's Common Stock has been subject to
significant fluctuation. The market price of the Common Stock may continue
to be subject to significant fluctuations in response to operating results
and other factors. During fiscal 1997, the price of the Company's Common
Stock ranged from high of $23.00 in the first quarter of fiscal 1997 to a
low of $6.00 in the fourth quarter of fiscal 1997. In addition, the stock
market in recent years has experienced price and volume fluctuations that
often have been unrelated or disproportionate to the operating performance
of companies. These fluctuations, as well as general economic and market
conditions, may adversely affect the market price of the Common Stock.
PETsMART has never paid any cash dividends on its Common Stock. The Company
currently intends to retain earnings for use in its business and therefore
does not anticipate paying cash dividends in the foreseeable future. In
addition, under the terms of its credit facility, the Company is prohibited
from paying any cash dividends without prior bank approval.
13
MANAGEMENT
EXECUTIVE OFFICERS
Effective March 1, 1998, Philip L. Francis joined PETsMART as President and
Chief Executive Officer. Mr. Francis, a director of the Company since 1989, was
previously President and Chief Executive Officer of Shaw's Supermarkets, Inc., a
subsidiary of J. Sainsbury plc, a United Kingdom retailer. Samuel J. Parker, who
resigned as the Company's Chief Executive Officer effective March 1, 1998, will
remain as Chairman of the Board of Directors. In November 1997, following the
resignation of the Company's Chief Financial Officer, the Company's Executive
Vice President, C. Donald Dorsey, resumed his former role as Chief Financial
Officer. In March 1998, Neil T. Watanabe joined the Company as Executive Vice
President and Chief Financial Officer. Mr. Watanabe, a certified public
accountant, was previously Chief Financial Officer of MacFrugal's Bargain
Close-Out, a publicly-held retailer. Mr. Dorsey will remain with the Company as
Executive Vice President responsible for corporate development matters.
The executive officers of the Company and their ages and positions at March
27, 1998, are as follows:
NAME AGE POSITION
- ---------------------------------------------- --- ------------------------------------------------------------
Samuel J. Parker.............................. 55 Chairman of the Board
Philip L. Francis............................. 51 President and Chief Executive Officer
Donna R. Ecton................................ 50 Chief Operating Officer and Director
Neil T. Watanabe.............................. 43 Executive Vice President, Chief Financial Officer
C. Donald Dorsey.............................. 56 Executive Vice President
C. Giles Clarke............................... 44 Executive Vice President, Europe
Ronald E. Brown............................... 51 Senior Vice President, Store Operations
J. Patrick Johnston........................... 54 Senior Vice President, Human Resources
H. Jake Mendelsohn............................ 40 Senior Vice President, Chief Information Officer
Marcia R. Meyer............................... 48 President, PETsMART International Supply Company
James D. Nelson............................... 44 Senior Vice President, Logistics and Distribution
Samuel J. Parker joined the Company in 1989 as President and Chief Executive
Officer. Mr. Parker served as President and Chief Executive Officer until 1993,
when he was elected Chairman. Effective with the annual meeting of stockholders
in 1995, Mr. Parker resigned as Chief Executive Officer but remained as Chairman
of the Board. In June 1997, following the resignation of the Chief Executive
Officer, Mr. Parker again served as Chief Executive Officer of the Company until
March 1998.
Philip L. Francis has been a director of the Company since 1989 and
President and Chief Executive Officer since March 1998. Prior to joining the
Company, Mr. Francis was President of, and since 1993, Chief Executive Officer
of Shaw's Supermarkets Inc., a subsidiary of J. Sainsbury plc, a supermarket
operator. From 1991 to 1993, Mr. Francis served as Chief Operating Officer of
Shaw's.
Donna R. Ecton has been a director of the Company since 1994 and joined the
Company as Chief Operating Officer in 1996. From 1995 until 1996, Ms. Ecton was
Chairman, President and Chief Executive Officer of Business Mail Express, Inc.,
a business services company. From 1991 to 1994, she served as President and
Chief Executive Officer of Van Houten North America, Inc. and Andes Candies
Inc., manufacturers of confectionery products. Ms. Ecton also serves as a
director of the Barnes Group, Inc., Vencor, Inc., and H&R Block, Inc.
Neil T. Watanabe joined the Company in March 1998 as Executive Vice
President and Chief Financial Officer. From 1996 to January 1998, Mr. Watanabe
was Senior Vice President and Chief Financial Officer of Mac Frugal's Bargain
Close-Out, a discount retailer. From 1995 to 1996, he was Vice President
Finance/
14
Controller and Corporate Administration for Kay-Bee Toys, a mall-based specialty
toy retailer. Prior to joining Kay-Bee Toys, Mr. Watanabe was Chief Financial
and Operating Officer of Motherhood Maternity, Inc. from 1994 to 1995, and Vice
President and Corporate Controller of Filene's Basement, Incorporated from 1988
to 1994. A certified public accountant, Mr. Watanabe holds a Bachelors Degree
from the University of California at Los Angeles.
C. Donald Dorsey joined the Company in 1989 as Senior Vice President and
Chief Financial Officer. He was elected Executive Vice President in 1994 and
remained Chief Financial Officer until February 1997. In November 1997,
following the resignation of the Company's Chief Financial Officer, Mr. Dorsey
resumed the position of Chief Financial Officer on an interim basis until March
1998.
C. Giles Clarke was named Executive Vice President, Europe in 1996 following
the Company's merger with Pet City, of which he had been Deputy Chairman and
Chief Executive Officer since June 1993. Mr. Clarke co-founded Pet City in 1989
and served as its President until 1993.
Ronald E. Brown joined the Company in 1995, as Senior Vice President of
Store Operations,. From 1986 through 1994, Mr. Brown held several senior
management positions with Kash-N-Karry, a Florida-based supermarket operation,
including Vice President of General Merchandise, Vice President of Warehousing
and Distribution, Senior Vice President of Perishables and Senior Vice President
of Store Services.
J. Patrick Johnston joined the Company in 1997 as Senior Vice President of
Human Resources. From 1985 to 1997, Mr. Johnston was Vice President of Human
Resources for American Drug Stores, a division of American Stores Company.
H. Jake Mendelsohn joined PETsMART in 1996, as Senior Vice President, Chief
Information Officer. Mr. Mendelsohn, who has been associated with PETsMART in a
consulting capacity since 1989, was a principal of the Windsor Park Group from
1987 to 1996.
Marcia R. Meyer joined the Company in 1990 as Vice President and General
Merchandise Manager. In 1997, she was promoted President of PETsMART
International Supply Company, a unit of PETsMART. From 1985 to 1989, Ms. Meyer
held various executive positions with Broadway Southwest, a division of Carter
Hawley Hale Stores, Inc., most recently as Senior Vice President and General
Merchandise Manager.
James D. Nelson joined the Company in October 1997 as Senior Vice President,
Logistics and Distribution. Prior to joining PETsMART, from 1996 to 1997, Mr.
Nelson was Vice President of Logistics Administration at K-Mart Corporation.
From 1995 to 1996, Mr. Nelson was Senior Manager at Ernst & Young LLP. From 1994
to 1995, he was Director of Logistics (North and Latin America) at Compaq
Computer Corporation, and from 1990 to 1994, he was Vice President of Retail
Distribution for Sears Logistics Services, a wholly-owned subsidiary of Sears
Roebuck & Co.
15
ITEM 2. PROPERTIES
The following table summarizes the locations of the superstores by country
and state at February 1, 1998:
NUMBER OF
SUPERSTORES
---------------
UNITED STATES:
Arizona.......................................................................... 15
Arkansas......................................................................... 2
California....................................................................... 51
Colorado......................................................................... 14
Florida.......................................................................... 27
Georgia.......................................................................... 16
Idaho............................................................................ 1
Illinois......................................................................... 26
Indiana.......................................................................... 8
Iowa............................................................................. 1
Kansas........................................................................... 3
Kentucky......................................................................... 1
Maryland......................................................................... 15
Massachusetts.................................................................... 3
Michigan......................................................................... 13
Minnesota........................................................................ 10
Mississippi...................................................................... 1
Missouri......................................................................... 9
Nebraska......................................................................... 2
Nevada........................................................................... 6
New Hampshire.................................................................... 1
New Jersey....................................................................... 12
New Mexico....................................................................... 2
New York......................................................................... 8
North Carolina................................................................... 6
Ohio............................................................................. 23
Oklahoma......................................................................... 5
Oregon........................................................................... 5
Pennsylvania..................................................................... 10
Rhode Island..................................................................... 1
South Carolina................................................................... 2
Tennessee........................................................................ 6
Texas............................................................................ 34
Utah............................................................................. 5
Virginia......................................................................... 14
Washington....................................................................... 11
---
Total United States PETsMART superstores......................................... 369
State Line Tack (Delaware, New Hampshire and Texas).............................. 3
---
Total United States superstores.................................................. 372
Canada........................................................................... 12
---
Total North America superstores.................................................. 384
UNITED KINGDOM SUPERSTORES
England.......................................................................... 69
Scotland......................................................................... 9
Wales............................................................................ 3
Northern Ireland................................................................. 3
---
Total United Kingdom superstores................................................. 84
---
TOTAL WORLDWIDE SUPERSTORES...................................................... 468
16
PETsMART leases substantially all of its superstores, retail distribution
centers and corporate offices under noncancellable operating leases. The terms
of the superstore leases, other than leases under its Structured Lease
Facilities, as described below, generally range from 10 to 20 years and
typically allow the Company to renew for three to five additional five year
terms. Superstore leases, excluding renewal options, expire at various dates
through 2015. Certain leases require payment of property taxes, utilities,
common area maintenance and insurance and, if annual sales at certain
superstores exceed specified amounts, provide for additional rents. To date, no
additional rents have been paid by the Company pursuant to such leases.
The Company has entered into lease agreements for certain of its superstores
as part of structured lease financing facilities (the "Structured Lease
Facilities"). The Structured Lease Facilities provide a special purpose entity
(not affiliated with the Company) with the necessary financing to complete the
acquisition and construction of new PETsMART superstores. Once construction has
been completed, another special purpose entity (also not affiliated with the
Company) leases the completed superstores to the Company for a five-year term.
The Company's corporate offices cover approximately 165,000 square feet. The
lease for this space expires in 2012. PETsMART's distribution center in
Columbus, Ohio covers 300,000 square feet. The lease on this distribution center
expires in 2008. The Company operates 13 regional consolidation centers in
public warehouse facilities. In addition, the Company has opened a new 430,000
square foot small good distribution center in Phoenix, Arizona, the lease on
which expires in April 2002. PETsMART also operates a 110,000 square foot
break-bulk center outside of Gloucester, England, the lease on which expires in
2001.
PETsMART Direct operates a catalog fulfillment and equine distribution
center in Brockport, New York, which covers approximately 200,000 square feet.
The Company has a purchase option on approximately seven acres of
industrial-zoned land adjacent to this facility.
ITEM 3. LEGAL PROCEEDINGS
On January 6, 1998, the Company was served with a complaint entitled Miller
v. Parker, et al. (Case No. CV 98-0020 PHX RCS) in the Federal District Court
for the District of Arizona, Phoenix Division by a putative class of investors
in PETsMART, Inc. securities. The lawsuit alleges, among other things, that the
Company and its officers and directors issued materially false financial
statements about the Company's flea and tick product inventory, financial
condition and results of operations. Several additional complaints by putative
class representatives alleging substantially the same allegations have been
filed in the District of Arizona. A motion is currently pending to consolidate
all such actions in the District Court. Of such additional complaints, on March
5, 1998, the Company was served with an amended complaint entitled Kowal v.
Parker, et al. (Case No. CV98-0133 PHX ROS) alleging an expanded class period.
The Company believes that this case will be consolidated with the other pending
securities class action lawsuits. The Company believes the allegations by the
putative class representatives are without merit and the Company intends to
defend itself vigorously.
In addition, a former Pet City affiliate has retained counsel in the United
States and made allegations claiming that the Company misled the shareholders of
Pet City at the time of the acquisition of Pet City concerning PETsMART's
business, finances and prospects. On September 30, 1997, shortly after the
receipt of the allegations by PETsMART, Richard Northcott, the former Chairman
of Pet City, resigned as a director of the Company. No litigation has been filed
with respect to this matter, and the Company believes that the allegations are
without merit. Nevertheless, there can be no assurance that one or more former
Pet City affiliates will not initiate litigation seeking monetary damages or an
equitable remedy.
On March 28, 1998, a lawsuit was filed in federal court in the middle
district of Florida entitled Carucci et al. v. PETsMART, Inc. (Case No.
98-CV-340). This class-action complaint alleges unspecified damages based on
various alleged violations of the Fair Labor Standards Act, including alleged
failures to
17
pay overtime premiums. The Company has begun its evaluation of this complaint,
and intends to respond on a timely basis.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the fourth quarter of the fiscal year ended February 1, 1998.
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY The Company's common stock
is traded on the Nasdaq Stock Market under the symbol "PETM." Public trading of
the common stock commenced on July 23, 1993. Prior to that, there was no public
market for the common stock. The following table sets forth for the periods
indicated the high and low price per share of the common stock on the Nasdaq
Stock Market, as adjusted for the 2-for-1 stock split effected as a stock
dividend on July 19, 1996 to stockholders of record on July 8, 1996. These
prices represent quotations among dealers without adjustments for retail
mark-ups, mark-downs or commissions, and may not represent actual transactions.
FISCAL YEAR ENDED
FEBRUARY 2, 1997 HIGH LOW
--------- ---------
First Quarter ended April 28, 1996.......................... $ 22.50 $ 14.88
Second Quarter ended July 28, 1996.......................... 24.00 18.56
Third Quarter ended October 27, 1996........................ 29.88 22.38
Fourth Quarter ended February 2, 1997....................... 27.00 20.38
FISCAL YEAR ENDED
FEBRUARY 1, 1998 HIGH LOW
--------- ---------
First Quarter ended May 4, 1997............................. $ 23.00 $ 11.00
Second Quarter ended August 3, 1997......................... 12.75 9.81
Third Quarter ended November 2, 1997........................ 12.25 6.44
Fourth Quarter ended February 1, 1998....................... 8.00 6.00
The Company has never paid cash dividends on its common stock. The Company
presently intends to retain earnings for use in the operation and expansion of
its business and therefore does not anticipate paying any cash dividends in the
foreseeable future. In addition, the Company's revolving credit agreement
restricts the payment of dividends.
On March 27, 1998, there were 5,891 holders of record of the Company's
common stock.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is attached as Appendix A.
19
ITEM 7. 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 THIS 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 February 1,
1998, the Company operated 468 superstores, consisting of 372 superstores in the
United States, 84 superstores in the United Kingdom, and 12 superstores in
Canada. PETsMART's store base has grown rapidly since the Company's inception in
1986 through the opening of new stores and through the acquisitions of PETZAZZ
in March 1994, Petstuff in June 1995, Pet Food Giant in September 1995, and Pet
City in December 1996. The Company also acquired two leading catalog retailers,
Sporting Dog in May 1995 and State Line Tack in January 1996. All of these
transactions were accounted for as poolings of interest. Earnings per share are
presented in conformity with Statement of Financial Accounting Standards No.
128, "Earnings per Share."
The Company expects that future increases in net sales and net income, if
any, will be dependent on the opening of additional superstores and the improved
performance of new and existing superstores. In view of the increasing maturity
of its superstore base, as well as the planned opening of additional superstores
in existing markets and single-store markets, the Company anticipates that its
comparable store sales increases may be lower in future periods. As a result of
its expansion plans, the Company anticipates the timing of new superstore
openings, and related preopening expenses, and the amount of revenue contributed
by new and existing superstores may cause the Company's quarterly results of
operations to fluctuate. The Company has achieved less favorable operating
results in certain North American geographic regions it recently entered than it
has achieved historically in other regions. In addition, because new superstores
have higher payroll, advertising and other store level expenses as a percentage
of sales than mature superstores, the impact of new superstore openings will
also contribute to lower store operating margins until they become established.
The Company charges preopening costs associated with each new superstore to
earnings when the superstore is opened. Therefore, the Company expects that the
opening of large numbers of new superstores in a given quarter will adversely
impact its quarterly results of operations for that period. See "Risk
Factors--Performance of Superstores" and "--Quarterly and Seasonal
Fluctuations."
DEVELOPMENTS DURING FISCAL 1997
For the first half of fiscal 1997, the Company reported disappointing
operating results due to a combination of reduced inventory levels, which led to
out-of-stock conditions in certain key categories, and lost sales momentum as a
result of a departure from the Company's historically more effective advertising
programs. In June 1997, Samuel J. Parker, the Company's Chairman, resumed his
former role as Chief Executive Officer and began the implementation of a series
of "Back to Basics" initiatives intended to refocus the Company and to improve
financial performance. See "Business--The PETsMART Strategy: Back to Basics." 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,
20
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, reserves for litigation and other matters. Of
these expenses, the $9.4 million that was reflected as a component of cost of
goods sold included the writedown of the Discovery Center inventory from cost to
net realizable value in connection with the discontinuance of that department,
as well as the writedown of certain non-Discovery Center inventory from cost to
net realizable value as a result of the decision to exit other product
categories. As a consequence of its "Back to Basics" initiatives and to better
focus its merchandise selections on pet-related products, the Company determined
that its "Discovery Center" merchandise, consisting primarily of educational and
human-oriented items, should be discontinued. Given the square footage and store
location devoted to this area, combined with the lower turnover and sell-through
gross margin, management believed the store area would be better utilized with
different merchandise. The $3.3 million of other expenses reflected as a
component of store operating expenses and the $3.4 million of one-time expenses
reflected as general and administrative expenses consist primarily of a change
in estimated self-insurance costs due to adverse loss developments in the
Company's worker's compensation experience, expenses related to the preliminary
stages of a consulting project for the new management information system,
certain costs of several litigation matters, as well as expenses related to
other miscellaneous matters.
Of the $44.9 million in restructuring charges recorded in the second quarter
of fiscal 1997, approximately $30.0 million was related to the costs of closing
or relocating 33 stores, of which 31 were former PETZAZZ, Petstuff or Pet Food
Giant stores, approximately $8.5 million was related to the costs of
discontinuing the Discovery Center department in all superstores and the
write-down or write-off of related fixtures and approximately $4.1 million was
related to the Company's previous acquisitions. The remaining charges of $2.3
million included approximately $1.0 million of anticipated costs associated with
the Company's decision to complete the consolidation of the Ennis, Texas
distribution center into the Company's new Phoenix, Arizona facility and
approximately $1.3 million representing the write-off of the Company's
investments in certain other entities accounted for under the cost method, which
were impaired as a result of the Company's decision to exit certain departments
within the PETsMART superstores.
As a result of the acquisition of Pet City, the Company recorded charges for
merger and business integration costs of $13.6 million during fiscal 1997,
primarily related to reformatting, refixturing, and remerchandising the acquired
stores to the PETsMART superstore format and other costs of integration. The
majority of these expenses related to an advertising program to promote the new
store image and format. The Company also recorded charges of approximately $3.0
million for merger and business integration costs during second quarter 1997 as
a result of additional real estate costs incurred in connection with certain of
its previous acquisitions.
The activity within the accrued merger and restructuring costs liability
account is summarized below (in thousands):
BALANCE AT PAYMENTS/ BALANCE AT
FEB. 2, ADDITIONAL ASSET FEB. 1,
1997 EXPENSES WRITE-OFFS 1998
----------- ----------- -------------- -----------
Professional fees.......................................... $ 938 $ 990 $ (1,928) $ --
Accrued severance.......................................... 1,287 1,083 (2,370) --
Lease termination & real estate costs...................... 8,329 42,988 (17,927) 33,390
Accrued business integration costs......................... 7,950 13,724 (21,327) 347
Store conversion costs..................................... 3,080 14,729 (17,809) --
----------- ----------- -------------- -----------
$ 21,584 $ 73,514 $ (61,361) $ 33,737
----------- ----------- -------------- -----------
----------- ----------- -------------- -----------
21
In November 1997, $200,000,000 of 6 3/4% Subordinated Convertible Notes (the
"Notes") were issued by the Company and sold to "qualified institutional buyers"
(as defined in Rule 144A of the Securities Act) in transactions exempt from
registration under the Securities Act, and in sales outside the United States
within the meaning of Regulation S under the Securities Act. The net proceeds to
PETsMART from the sale of the Notes were approximately $193,250,000.
The lost sales and earnings momentum experienced in the first half of 1997
continued to negatively affect results of operations and comparable store sales
throughout fiscal 1997. Specifically, comparable store sales increases for the
North American stores approximated 4% for the second half of fiscal 1997, well
below the Company's historical and anticipated levels, and gross margins
remained below historical norms due to the mix of merchandise sales, increased
occupancy and warehouse and distribution costs, higher personnel costs in
service areas of the business, and the effects of the Company's return to the
every-day-low pricing policy. Store operating expenses also increased during the
second half of fiscal 1997 due to the increased emphasis on customer service
which required increased payroll expenditures, and general and administrative
expenses also increased as a result of the activities related to the Company's
management information systems project. The Company does not anticipate these
costs to decrease significantly, if at all, during fiscal 1998.
The Company believes that during the second half of fiscal 1997, the
operational matters which precipitated the reduced inventory levels,
out-of-stock conditions and lost sales momentum were addressed and that
significant progress is being made to prevent a recurrence of these issues.
Specifically, the Company's comparable transaction counts continue to increase;
inventory levels and in-stock positions are believed to be more balanced; the
Company's cash and working capital positions are adequate to fund future growth
and projects for the next fiscal year; and the Company believes that the
increased emphasis on customer service is having positive results in store
morale and customer responsiveness. There can be no assurance that these recent
trends and favorable developments will continue or that the Company will not
experience other operational issues which have a material adverse impact upon
results of operations during fiscal 1998. Additionally, the Company's planned
schedule of new store openings in fiscal 1998 is heavily weighted to the first
half of the fiscal year and therefore, cash requirements, along with the
associated preopening expenses and inventory needs, will be significant and may
negatively impact results of operations during such period.
22
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
statements of operations:
FISCAL YEAR ENDED
-------------------------------------
FEB. 1, FEB. 2, JAN. 28,
1998(A) 1997 1996
----------- ----------- -----------
STATEMENT OF OPERATIONS DATA:
Net sales............................................................................. 100.0% 100.0% 100.0%
Cost of sales......................................................................... 75.3 71.6 73.6
----- ----- -----
Gross profit.......................................................................... 24.7 28.4 26.4
Store operating expenses.............................................................. 19.3 19.3 19.6
Store preopening expenses............................................................. 0.5 0.7 0.5
General and administrative expenses................................................... 2.8 2.8 3.1
Merger and business integration costs................................................. 3.2 2.8 3.9
----- ----- -----
Operating income (loss)............................................................... (1.1) 2.8 (0.7)
Interest income....................................................................... 0.0 0.1 0.2
Interest expense...................................................................... 0.8 0.6 0.8
----- ----- -----
Income (loss) before income tax expense (benefit) and cumulative effect of a change in
accounting principle................................................................ (1.9) 2.3 (1.3)
Income tax expense (benefit).......................................................... (1.0) 0.9 (0.8)
----- ----- -----
Income (loss) before cumulative effect of a change in accounting principle............ (0.9) 1.4 (0.5)
Cumulative effect of a change in accounting principle................................. (0.1) -- --
----- ----- -----
Net income (loss)..................................................................... (1.0)% 1.4% (0.5 )%
----- ----- -----
----- ----- -----
- ------------------------
(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.
FISCAL 1997 COMPARED TO FISCAL 1996
The following discussion of results of operations for fiscal 1997 and fiscal
1996 excludes the results of the effects of the restructuring, merger and
business integration costs discussed above in "Developments During Fiscal 1997."
Net sales increased 19.3% to approximately $1.8 billion for fiscal 1997 from
$1.5 billion for fiscal 1996. Excluding the fifty-third week in fiscal 1996, net
sales increased approximately 21.0% over fiscal 1996. Comparable North American
store sales increased 4.6% for the year, and comparable United Kingdom store
sales increased 5.0%. During 1997, the Company opened 76 new superstores and
closed 12 relocated stores in North America and opened 29 stores and closed 1
relocated store in the United Kingdom. The Company had 468 superstores in
operation at February 1, 1998 compared to 376 superstores open at February 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 24.7% for 1997 as compared to 28.4% for 1996. The decrease is primarily
a result of higher occupancy costs in newer locations, increased United Kingdom
warehouse and distribution costs, the effects of higher personnel costs in
veterinarian and grooming operations, and lower than anticipated vendor monies
resulting from decreased purchasing activities.
Store operating expenses, which includes payroll and benefits, advertising
and other store level expenses, remained constant at 19.3% of net sales as
compared to last year. Certain store expenses were
23
increased to improve service levels in the North American stores, which were
offset by certain reductions in catalog operating expenses.
Store preopening expenses as a percentage of net sales decreased to 0.5% for
the year compared to 0.7% for 1996, primarily as a result of the higher
preopening costs associated with the five super-regional format stores opened in
San Diego and the eight Canadian stores opened in 1996. The Company opened 76
North American stores and 29 United Kingdom stores during 1997, as compared to
82 stores last year. Average preopening costs for 1997 approximated $88,000 per
store.
General and administrative expenses remained steady as a percentage of sales
at 2.8% for 1997 and for 1996. Increases during 1997 in legal, relocation and
other executive expenses, and the effects of a required change in accounting for
the computer system upgrade project, were offset by continued corporate expense
management.
The Company's operating income decreased to $37.7 million for fiscal 1997
from $83.4 million for 1996. Operating income as a percentage of sales decreased
to 2.1% for 1997 from 5.6% for 1996, primarily as a result of the decrease in
gross profit described above.
Interest income decreased to $0.2 million for 1997 from $1.1 million for
1996 principally due to the decrease in average cash balances in 1997 compared
to 1996. Interest expense increased to $13.9 million for 1997 from $9.5 million
for 1996 principally due to higher average borrowings during the fiscal 1997,
and the interest cost resulting from the issuance in November 1997 of the Notes.
The Company's income tax provision for both 1997 and 1996 reflects the
effects of the nondeductibility of certain of the costs associated with the
merger and restructuring charges recorded in both years. After excluding the
effects of these items, the Company's effective income tax rate from operations
was 38.5% and 38% for 1997 and 1996, respectively.
Due to the issuance of Emerging Issues Task Force Consensus 97-13 in fourth
quarter 1997, which requires the expensing of certain business process
reengineering activities, the Company recorded a cumulative effect of a change
in accounting principle of $2.6 million, net of taxes (approximately $0.02 per
share). Additionally, general and administrative expenses were increased by
approximately $1.3 million as a result of this required accounting change.
Excluding the effects of the merger and restructuring charges and other
charges, and the related tax benefits, net income for 1997 decreased to $15.5
million (or $0.13 per share--diluted), compared to $46.5 million (or $0.39 per
share--diluted) for fiscal 1996. Including the effects of the restructuring and
other charges recorded in both years, the Company reported a net loss before
cumulative effect of a change in accounting principle of $31.8 million (or $0.28
per share--diluted) for fiscal 1997 compared to net income of $20.6 million (or
$0.17 per share--diluted) for 1996.
FISCAL 1996 COMPARED TO FISCAL 1995
Net sales increased 28.5% to approximately $1.5 billion for fiscal 1996 from
approximately $1.2 billion for fiscal 1995. Excluding the fifty-third week in
fiscal 1996, net sales increased 26.4% over fiscal 1995. Excluding the
fifty-third week in fiscal 1996, comparable North American store sales increased
11.9% as compared to an increase of 12.5% for fiscal 1995, excluding the
Petstuff and Pet Food Giant stores, some of which were closed for retrofitting
during the year. Comparable United Kingdom store sales increased 9.2% for fiscal
1996. During fiscal 1996, the Company opened 82 new superstores, including 21 in
the United Kingdom, and relocated three superstores. Net sales from the 82
superstores opened in fiscal 1996 contributed $88.6 million or 26.6% of the
total increase in net sales. Of the remainder of the total net sales increase,
$167.3 million or 50.3% was contributed by superstores opened in fiscal 1995.
The Company had 376 superstores in operation at the end of fiscal 1996 as
compared to 297 superstores open at the end of fiscal 1995.
24
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 28.4% for fiscal 1996 as compared to 26.4% for fiscal 1995. The
increase in margin was principally due to a change in sales mix in retail
stores, improved margins in catalog operations, and the continued maturation of
the Company's store base.
Store operating expenses, which includes payroll and benefits, advertising
and other store level expenses, were 19.3% of net sales for fiscal 1996 versus
19.6% for fiscal 1995.
Store preopening expenses as a percentage of net sales increased to 0.7% for
fiscal 1996 compared to 0.5% for fiscal 1995. The average preopening expenses
for the 64 North American PETsMART superstores opened in fiscal 1996 increased
to $133,000 from $74,000 for the 42 PETsMART superstores opened during fiscal
1995. The increase in preopening expenses on a per unit basis reflected the
additional training and store setup costs incurred with the Company's initial
entry into Canada, which occurred in fourth quarter fiscal 1996, as well as the
impact of the Company's five 40,000 square foot hybrid pet/equine megastores
opened in Southern California.
General and administrative expenses were 2.8% of net sales for fiscal 1996
versus 3.1% for fiscal 1995, due primarily to the elimination of the duplicate
overhead costs related to the acquisitions in fiscal 1995 of Petstuff and Pet
Food Giant.
Charges for merger and business integration costs of $28.4 million related
to the State Line Tack and Pet City acquisitions were recorded in fiscal 1996.
These charges included legal, investment banking, and accounting fees ($8.8
million), costs associated with reformatting, refixturing and remerchandising
the acquired Pet City superstores to the format consistent with that of a
PETsMART prototype superstore ($11.0 million), a provision for the closure of a
redundant warehouse and other inadequate facilities ($5.5 million) and other
costs of consolidation ($3.1 million).
Also during fiscal 1996, the Company recorded charges for merger and
business integration costs of $12.3 million to reflect additional lease
termination costs anticipated to be incurred in connection with the settlement
of lease obligations for the 17 former Petstuff stores closed by the Company
immediately following the 1995 merger with Petstuff, along with the settlement
of obligations with respect to seven lease commitments for future Petstuff
locations that were either duplicate or inadequate facilities and therefore
abandoned.
The Company generated operating income of $42.6 million for fiscal 1996
compared to an operating loss of $8.7 million in fiscal 1995. However, excluding
the charges for merger and business integration costs recorded in both fiscal
1996 and fiscal 1995, operating income increased $44.9 million to $83.4 million
from $38.5 million for fiscal 1995. Excluding the charges for merger and related
business integration costs, operating income as a percentage of sales increased
to 5.6% for fiscal 1996 from 3.3% for fiscal 1995.
Interest income decreased to $1.1 million for fiscal 1996 from $2.7 million
for fiscal 1995, principally due to the decrease in average cash balances in
fiscal 1996 compared to fiscal 1995. Interest expense increased to $9.5 million
for fiscal 1996 from $8.9 million for fiscal 1995 principally due to higher
average borrowings outstanding during the period.
Income tax expense was $13.7 million for fiscal 1996 compared to a benefit
of $9.4 million for fiscal 1995. The Company's effective income tax rate for
fiscal 1996 was 38% compared to 35% for fiscal 1995, excluding the effect of
permanent differences within the merger and business integration charges
recorded in fiscal 1996 and fiscal 1995 and the effects of net operating loss
carryforwards recognized in both years. This increase was primarily due to an
increased federal rate due to the absence of targeted job tax credits, lower
tax-advantaged investments, and a higher effective state income tax rate.
As a result of the foregoing, the Company reported net income of $20.6
million (or $0.17 per share-- diluted) for fiscal 1996 compared to a net loss,
before accretion of the Pet Food Giant and State Line Tack preferred stock, of
$5.4 million (or $0.05 per share--diluted) for fiscal 1995. Excluding the
charges for
25
merger and business integration costs and related tax benefits as well as the
recognition of net operating loss carryforwards recorded in both years, net
income for fiscal 1996 increased $26.2 million to $46.5 million (or $0.39 per
share--diluted) from $21.0 million (or $0.19 per share--diluted) for fiscal
1995. The Company's North American operations, excluding charges for merger and
business integration costs and their related income tax effects, reported net
income of $0.44 per share--diluted for fiscal 1996 as compared to net income of
$0.22 per share--diluted for fiscal 1995.
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 securities,
lease financing and borrowings under its credit facility. Additional sources of
financing include vendor terms on inventory purchases.
At February 1, 1998, total assets were $839.7 million, of which $515.7
million were current assets. Cash and cash equivalents were $125.0 million.
Cash used in operations was $2.4 million for fiscal 1997 compared to cash
used in operations of $46.3 million for the prior year. Approximately $24.5
million of the net cash used in operations during fiscal 1997 related to the
timing of inventory purchases on account and payment of those accounts.
Merchandise accounts payable leveraging (the percentage of merchandise inventory
financed by vendor credit terms, e.g., accounts payable divided by merchandise
inventory), decreased to 36.1% at February 1, 1998, compared to 46.2% at
February 2, 1997 primarily as a result of the Company taking advantage of cash
discounts and the timing of purchasing activities. Inventory balances were
approximately $317.5 million at February 1, 1998, and $300.9 million at February
2, 1997. Average North American store inventory, which excludes the inventory of
PETsMART Direct, decreased 14% to $707,000 per store at February 1, 1998, from
approximately $820,000 at February 2, 1997, due to management's efforts to
improve inventory turns. As part of the Company's efforts to reduce the carrying
value of North American superstore inventories, certain actions were taken which
caused a severe and sudden decrease in inventory purchasing activities during
the first quarter of fiscal 1997. As a consequence, store deliveries of certain
key merchandise were temporarily interrupted and resulted in out-of-stock
conditions in several key merchandise categories and locations. As a result,
certain merchandise was not available for customer purchase during the later
half of the first quarter and the first half of the second fiscal quarter of
1997. Inventory balances, in the aggregate, increased slightly over the second
half of fiscal 1997 and are anticipated to increase moderately during fiscal
1998. This inventory increase is anticipated to occur as a consequence of the
inventory purchasing requirements resulting from the Company's current plan to
open approximately 75 new North American superstores in fiscal 1998.
Cash used in operations was offset by $22.6 million resulting from the
recording in second quarter 1997 of the non-cash portion of the accrued merger
and restructuring costs. Future cash uses for restructuring costs will be
partially offset by cash inflows from the liquidation of inventory and the
related tax benefits associated with the discontinuation of certain departments
within all superstores and the closing of certain superstores.
The Company estimates an approximate $12.0 million to $13.0 million
aggregate positive net cash flow from the restructuring activities over the next
two years.
The Company has used cash in investing activities since inception to
purchase leaseholds, fixtures and equipment and computer software in support of
its administrative functions. The Company has lease arrangements with leasing
companies that the Company uses to finance certain store and warehouse fixtures
and equipment, point-of-sale equipment and management information systems. The
Company has also used cash to purchase properties for sale and leaseback. Net
cash used in investing activities was $61.2 million for the year ended February
1, 1998.
26
Net cash flow from financing activities, primarily proceeds from the Notes
offering, borrowings and repayments under the Company's Credit Facility, net
cash from bank overdrafts, and proceeds from the exercise of employee stock
options, was $150.4 million for the year ended February 1, 1998.
The Company's primary long-term capital requirement 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 $600,000. This
amount will include an average of approximately $50,000 for leasehold
improvements (an average of approximately $200,000 if the superstore site is a
rehabilitated unit), approximately $100,000 for preopening costs, and
approximately $450,000 for inventory, net of accounts payable. Approximately
$400,000 is required for store fixtures and equipment, which is typically
fully-funded through lease financing.
PETsMART is in the initial phases 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 in North America, before giving
consideration to any lease financing that may be available, will be up to $20
million annually through fiscal 2000. The Company believes that certain hardware
and software components of the new system may be financed through lease
transactions, although there can be no assurance that the actual costs for the
new system will not exceed current estimates. There can be no assurance that the
new system can be developed, tested and implemented on a timely basis, or at
all, or that it will deliver the anticipated operational benefits in a reliable
manner. Failure to complete the new system, or 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. The Company is currently assessing the extent of the
Year 2000 impact on its suppliers and other vendors. 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. See "Risk Factors--New Information
System."
Capital expenditures, net of construction allowances, were approximately
$59.0 million during 1997 and the Company expects such expenditures will be
approximately $65.0 million during fiscal 1998. Such expenditures were and will
be 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 in North America and the remodel and maintenance of the
Company's existing superstores. See "Business-- PETsMART Superstores."
Management believes that its existing cash and cash equivalents, together
with cash flow from operations, borrowing capacity under the 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. See "Risk
Factors."
SEASONALITY AND INFLATION
The Company's business is subject to some seasonal fluctuation and it
typically realizes a higher portion of its net sales and operating profits
during the fourth fiscal quarter. In addition, sales of certain of
27
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 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments
of an Enterprise and Related Information," which will be effective for fiscal
years beginning after December 15, 1997. SFAS 131 redefines how operating
segments are determined and requires expanded quantitative and qualitative
disclosures relating to an entity's operating segments. The Company will comply
with this pronouncement beginning in fiscal 1998.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive
Income," which will be effective for the Company's fiscal year ending January
31, 1999. Under SFAS 130, companies are required to report comprehensive income
as a measure of overall performance. Comprehensive income includes all changes
in equity during a period except those resulting from investments by owners and
distributions to owners. The Company will be required to report net income
(loss) and foreign currency translation adjustments as the components of
comprehensive income. The Company will comply with this pronouncement beginning
with the first quarter of fiscal 1998.
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
currently evaluating the impact of this SOP on its financial statements.
ITEM 7A. 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 into borrowings at a fixed rate of approximately 6.6%. The Company
does not expect changes in fair value of these arrangements to have a
significant effect on the Company's operations, cash flow or financial position.
See Notes 5 and 6 of Notes to Consolidated Financial Statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is attached as Appendix F.
28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item with respect to Directors is
incorporated by reference from the information under the caption "Election of
Directors" contained in the Company's definitive proxy statement in connection
with the solicitation of proxies for the Company's 1997 Annual Meeting of
Stockholders to be held on June 25, 1998 (the "Proxy Statement").
The required information concerning Executive Officers of the Company is
contained in Item 1, Part 1 of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
information under the caption "Executive Compensation" contained in the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" contained in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
information under the caption "Certain Relationships and Related Transactions"
contained in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report on Form
10-K.
1. FINANCIAL STATEMENTS: The financial statements of PETsMART are
included as Appendix F of this report. See Index to Financial
Statements on page F-1.
2. FINANCIAL STATEMENT SCHEDULES: Financial statement schedules required
under the related instructions are not applicable for the period
ended February 1, 1998, and have therefore been omitted or the
information is presented in the consolidated financial statements or
related notes.
3. EXHIBITS: The exhibits which are filed with this Report or which are
incorporated herein by reference are set forth in the Exhibit Index
on page E-1.
(b) Reports on Form 8-K.
During the fourth quarter of fiscal 1997, the Company filed the following
report on Form 8-K:
1. Report on Form 8-K dated October 27, 1997, and filed on November 13,
1997, announcing the sale through a private placement by the Company
of $175 million aggregate principal amount of its 6 3/4% Subordinated
Convertible Notes to qualified institutional investors and details of
the sales of the securities under Regulation S.
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 March 31, 1998.
PETSMART, INC.
By: /s/ PHILIP L. FRANCIS
-----------------------------------------
Philip L. Francis
PRESIDENT, CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ SAMUEL J. PARKER
- ------------------------------ Chairman of the Board of March 31, 1998
Samuel J. Parker Directors
/s/ PHILIP L. FRANCIS
- ------------------------------ President, Chief Executive March 31, 1998
Philip L. Francis Officer and Director
Executive Vice President,
/s/ NEIL T. WATANABE Chief Financial Officer
- ------------------------------ (Principal Financial March 31, 1998
Neil T. Watanabe Officer)
/s/ KENNETH A. CONWAY Vice President, Controller
- ------------------------------ (Principal Accounting March 31, 1998
Kenneth A. Conway Officer)
/s/ DONNA R. ECTON
- ------------------------------ Chief Operating Officer March 31, 1998
Donna R. Ecton and Director
/s/ RICHARD M. KOVACEVICH
- ------------------------------ Director March 31, 1998
Richard M. Kovacevich
/s/ LAWRENCE S. PHILLIPS
- ------------------------------ Director March 31, 1998
Lawrence S. Phillips
/s/ WALTER J. SALMON
- ------------------------------ Director March 31, 1998
Walter J. Salmon
/s/ THOMAS G. STEMBERG
- ------------------------------ Director March 31, 1998
Thomas G. Stemberg
31
APPENDIX A
PETSMART SELECTED HISTORICAL FINANCIAL DATA (1)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND OPERATING DATA)
FISCAL YEAR ENDED
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FEB. 1, FEB. 2, JAN. 28, JAN. 29, JAN. 30,
1998 1997(2) 1996 1995 1994
------------ ------------ ------------ ------------ ------------
HISTORICAL STATEMENT OF OPERATIONS DATA:
Net sales................................... $ 1,790,599 $ 1,501,017 $ 1,168,056 $ 924,199 $ 544,762
Gross profit................................ 434,186 426,351 308,237 245,779 149