PETCO HEALTH AND WELLNESS COMPANY, INC.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and the accompanying notes included elsewhere in this Annual Report
on Form 10-K. The discussion and analysis below contain certain forward-looking
statements about our business and operations that are subject to the risks,
uncertainties, and other factors described in the section entitled "Risk
Factors," included in Part I, Item 1A, and elsewhere in this Annual Report on
Form 10-K. These risks, uncertainties, and other factors could cause our actual
results to differ materially from those expressed in, or implied by, the
forward-looking statements. Please read the section entitled "Cautionary Note
Regarding Forward-Looking Statements."
Overview
We are a beloved brand in the U.S. pet care industry with more than 55 years of
service to pets and the people who love and care for them. Since our founding in
1965, we have been developing new standards in pet care, delivering
comprehensive wellness solutions through our products and services, and creating
communities that deepen the pet-parent bond. Over the last three years, we have
transformed the business from a successful traditional retailer to a disruptive,
fully integrated, digital-focused provider of pet health and wellness offerings.
We revamped our leadership team and invested over $375 million to build out
leading capabilities across e-commerce and digital, owned brands, data
analytics, and a full suite of on-site services including veterinary care.
Our go-to-market strategy is powered by a multi-channel platform that integrates
our strong digital presence with our nationwide physical network. Our
data-driven digital footprint, consisting of an entirely
redesigned e-commerce site and personalized mobile app, delivers an exceptional
customer experience and serves as a hub for pet parents to manage their pets'
health, wellness, and merchandise needs, while enabling them to shop wherever,
whenever, and however they want. By strategically leveraging our extensive
physical network consisting of approximately 1,454 pet care centers located
within three miles of 53 % of our customers, we are able to offer our
comprehensive product and service offering in a localized manner with a
meaningful last-mile advantage over our competition. Through our connected
platform, we serve our customers in a differentiated manner by offering the
convenience of ship-from-store, BOPUS, curbside pick-up and same day delivery.
Multi-channel customers, who spend between 3x to 7x more with us compared to
single-channel customers, increased by double-digits in fiscal 2020.
Through our multi-channel platform, we provide a comprehensive offering of
differentiated products and services that fulfill all the needs of pet parents
and their pets. Our product offering leverages our owned brand portfolio and
partnerships with premium third-party brands to deliver high quality food that
avoids artificial ingredients, complemented by a wide variety of premium pet
care supplies. We augment this product offering with a broad suite of
professional services, including grooming as well as in-store and online
training. Our service offering is further enhanced by a rapidly expanding,
affordable veterinary service platform, which includes full-service veterinary
hospitals, Vetco clinics, and tele-veterinarian services. In addition, we are
increasingly linking our offerings with subscription programs such as membership
and pet health insurance that create deeper engagement with our customers, and
with our Pals Rewards loyalty program members specifically, which members
accounted for approximately 80% of transactions in fiscal 2020. At the end of
fiscal 2020, we launched our Vital Care membership program, the industry's first
broad-scale, comprehensive membership program covering items including
vaccinations, grooming, services and merchandise discounts. In addition to
providing differentiated products and services, our over 23,000 knowledgeable,
passionate partners provide important high-quality advice to our customers in
our pet care centers.
How We Assess the Performance of Our BusinessIn assessing our performance, we consider a variety of performance and financial measures including the following:
Comparable Sales
Comparable sales is an important measure throughout the retail industry and
includes both retail and digital sales of products and services. A new location
or digital site is included in comparable sales beginning on the first day of
the fiscal month following 12 full fiscal months of operation and is
subsequently compared to like time periods from the previous year. Relocated pet
care centers become comparable pet care centers on the first day of
41
--------------------------------------------------------------------------------
operation if the original pet care center was open longer than 12 full fiscal
months. If, during the period presented, a pet care center was closed, sales
from that pet care center are included up to the first day of the month of
closing. Additionally, our comparable sales exclude the impact of the wind-down
and migration of our Drs. Foster & Smith digital site to Petco.com in fiscal
2018 and fiscal 2019. There may be variations in the way in which some of our
competitors and other retailers calculate comparable sales. As a result, data in
this filing regarding our comparable sales may not be comparable to similar data
made available by other retailers.
Comparable sales allow us to evaluate how our overall ecosystem is performing by
measuring the change in period-over-period net sales from locations and digital
sites that have been open for the applicable period. We intend to improve
comparable sales by continuing initiatives aimed to increase customer retention,
frequency of visits, and basket size. General macroeconomic and retail business
trends are a key driver of changes in comparable sales.
Non-GAAP Financial Measures
Management and the Board of Directors review certain non-GAAP financial
measures, along with GAAP measures (as defined herein), to evaluate our
operating performance, generate future operating plans and make strategic
decisions regarding the allocation of capital. Our key non-GAAP financial
measures are Adjusted EBITDA, Adjusted Net income, Adjusted EPS, Free Cash Flow
and Net Debt. Further explanation on our non-GAAP measures, along with
reconciliations to their most comparable GAAP measures, is presented below under
"Reconciliation of Non-GAAP Financial Measures to GAAP Measures."
Factors Affecting Our BusinessWe believe that our performance and future success depend on a number of factors that present significant opportunities for us but also pose risks and challenges, including those discussed below and in the section titled "Risk Factors" included in Part I, Item 1A of this Annual Report on Form 10-K.
Pet Industry Trends
In 2020, theU.S. pet care industry served more than 72 million households with pets and represented a total addressable market of$97 billion , growing by over 3 million pets driven by heightened adoption activity through the COVID-19 pandemic. Due to its non-discretionary nature, the market has demonstrated a long-term track record of consistent growth and resilience throughout economic cycles. From 2020 to 2024, the industry is expected to grow at a 7% CAGR, driven by steady, predictable growth in the underlying pet population coupled with strong tailwinds associated with pet humanization and COVID-19.
Customer Pet Purchase Trends
Our multi-channel integrated ecosystem is designed to support our customers regardless of how customers choose to shop for their pet care needs. As we saw the major purchase trend shift and growth into areas like e-commerce, services, and veterinary care, we actively invested to build capabilities and offerings to effectively capitalize on the opportunity. Our business will be impacted by our ability to continue to understand and react to changing customer purchase trends.
Customer Acquisition, Retention, and Spend
Our business is impacted by our ability to successfully attract new customers to any one of our channels, build their loyalty to engender return visits, and expand their spend with Petco across multiple purchase channels (e.g., pet care centers, e-commerce, and services) and categories (e.g., pet food, supplies, and companion animal). This is the primary focus of all our customer engagement efforts from digital, to performance marketing campaigns, to new product introductions, and to Petco partner cross-selling activities in pet care centers. The ability to convert more of our customers to loyal, multi-channel shoppers will affect business performance.
Innovation and Transformation
Our operating results over the last two years reflect significant investments
made to support innovation and business transformation strategies. These
investments include: digital and e-commerce integration and expansion; data
analytical capabilities; veterinary services; marketing and advertising; and our
owned brands. We also have developed advanced sales reporting that provides our
pet care center General Managers and field leadership teams with data to track
performance across multiple dimensions, identify opportunities, and execute
strategies to drive incremental sales.
42--------------------------------------------------------------------------------
Specifically, some of these investments have included:
• Approximately
fiscal 2019 in our new and existing pet care center locations, including
the build-out of over 85 veterinary hospitals.
• Approximately
fiscal 2019 related to digital and information technology, specifically
the development of integration capabilities with our pet care center
locations, our Petco App, and the development and deployment of data
analytical and reporting capabilities.
• A $70.7 million increase in advertising in fiscal 2020 compared to
fiscal 2019 to further adapt our advertising footprint to support the
acceleration of our e-commerce and digital sales growth.
While these investments provided a key foundation and drive increased sales,
ongoing performance of the business will depend on our ability to leverage our
existing distribution network and pet care center locations for product delivery
and fulfillment, including BOPUS, curbside pick-up, and same day delivery, and
build upon and enhance these efforts.
Gross Margin and Expense Management
Our operating results are impacted by our ability to convert revenue growth into higher gross margin and operating margin. The sales mix related to consumables, supplies, and services, with services typically having lower margins, as well as customer shopping preferences, impacts our gross margin results. We focus gross margin and expense management on achieving a balance between ensuring adequate resource spend to grow sales with attention to driving increased profitability. The business has successfully implemented cost optimization initiatives in the past and will continue to find opportunities to enhance profit margins and operate more efficiently in the future.
Talent and Culture
We see our Petco partners as the core to building a purpose-driven performance
culture. Our business results rely on our ability to continually: add talented
partners, specifically in our scaling business areas like e-commerce, veterinary
care, and grooming and training services; provide the best tools, partner
training, and competitive compensation to deliver higher sales and better
customer experiences; and engender a positive, collaborative, and respectful
working environment. Our partners represent the strength of our brand every day
and are key to ongoing growth.
Impact of the COVID-19 Pandemic on Our Business
The COVID-19 pandemic has impacted every aspect of the economy in fiscal 2020.
As an essential retailer, all of our pet care centers have remained open, as we
are the grocery store, pharmacy, and doctor's office for many of our nation's
pets. Market data indicates that with more of the working population staying
home, there has been an increase in pet ownership and the percentage of
disposable income spent on home-related goods and services, including pet care.
Overall, this macroeconomic trend has favorably impacted our business results to
date, but the possible sustained spread or resurgence of the pandemic, and any
government response thereto, increases the uncertainty regarding future economic
conditions that could impact our business in the future.
We quickly adapted our business and operations since the start of the pandemic
to ensure, first and foremost, the health and safety of our partners, the
animals in our care, and the customers we serve. These adaptations include:
providing additional paid-time off and five cycles of appreciation bonuses to
our frontline partners; establishing a $2 million employee support fund to
assist our partners and their families impacted by the pandemic; investing in
sanitation, plexiglass barriers, signage, and personal protective equipment; and
adopting strict safety protocols that limit direct human interactions and
promote social distancing.
We were well-positioned to meet the increasing and evolving needs of pets and
their parents at the onset of the pandemic. Initially, we experienced
significant increases in customer pet food purchases, but as the months
progressed, our sales growth shifted to our supplies category, due to an
increase in pet ownership and shifts in disposable income spending toward pets.
In services, we temporarily suspended our training services and vaccination
clinic operations, and we reduced our grooming capacity while stay-at-home
orders were in place. Although we had experienced increasing customer demand for
services before the pandemic, sales attributable to such services declined
significantly from March through May 2020 as a result of the suspension.
43
--------------------------------------------------------------------------------
We have experienced a significant acceleration of our e-commerce business,
particularly as it relates to the integrated offering with our pet care centers.
Our ship-from-store capability enabled us to maintain regular shipping
timelines, and we capitalized on our BOPUS capability and rolled out curbside
pick-up in a matter of weeks, enabling us to get products to customers faster
and at a higher margin than online retailers that incur costs to ship products
to their customers. Additionally, in the fourth quarter of fiscal 2020, we
implemented same day delivery. We have incurred additional expenses to support
this business growth.
To preserve liquidity during the pandemic, we temporarily suspended capital
expenditures, but as our financial results surpassed earlier expectations, we
returned to our initial capital plan in the second half of fiscal 2020. In
efforts to control expenses, we negotiated discounts and concessions with
landlords and vendors and temporarily furloughed or implemented temporary pay
cuts for non-frontline partners.
Significant Components of Results of OperationsOur net sales comprise gross sales of products and services, net of sales tax and certain discounts and promotions offered to our customers, including those offered under our customer loyalty programs. Net sales are driven by comparable sales, new pet center locations, and expanded offerings.
Cost of Sales and Gross Profit
Gross profit is equal to our net sales minus our cost of sales. Gross profit rate measures gross profit as a percentage of net sales.
Our cost of sales includes the following types of expenses:
• direct costs (net of vendor rebates, allowances, and discounts for
products sold) including inbound freight charges;
• shipping and handling costs associated with sales to customers;
• freight costs associated with moving merchandise inventories;
• inventory shrinkage costs and write-downs;
• payroll costs of pet groomers, trainers, veterinarians, and other direct
costs of services; and
• costs associated with operating our distribution centers including
payroll, occupancy costs and depreciation.
Our digital gross profit rate tends to be lower than the gross profit rate from sales in our pet care centers due to incremental costs associated with shipping and other expenses of delivery to customers. In addition, our gross profit rate tends to be lower for services than for products.
Selling, General, and Administrative Expense
The following types of expenses are included in our selling, general, and administrative costs ("SG&A"):
• payroll and benefit costs of pet care center employees and corporate
employees;
• occupancy and operating costs of pet care centers and corporate facilities;
• depreciation and amortization related to pet care centers and corporate
assets;
• credit card fees;
• store pre-opening and remodeling costs;
• advertising costs; and
• other administrative costs.
44
--------------------------------------------------------------------------------
SG&A includes both fixed and variable costs and therefore is not directly correlated with net sales. We expect that our SG&A expenses will increase in future periods due to additional expenses we expect to incur as a result of being a public company, including stock-based compensation.
In connection with the fiscal 2015 acquisition by our Sponsors, we recorded goodwill of approximately$3.0 billion and an indefinite-lived trade name asset of$1.1 billion . We evaluate these assets for impairment annually and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Please read the discussion of these assets under "Critical Accounting Policies and Estimates."
Interest Expense
Our interest expense is primarily associated with the senior secured credit facilities, the Floating Rate Senior Notes, the 3.00% Senior Notes (as defined herein), and interest rate caps. InJanuary 2021 , the Floating Rate Senior Notes and the 3.00% Senior Notes were exchanged, canceled, and/or redeemed in connection with the initial public offering, and our interest rate caps were settled in accordance with their contractual terms. Additionally, onMarch 4, 2021 , we borrowed$1,700.0 million under a new first lien term loan facility, repaid all outstanding principal and interest on the existing term loan facility, and replaced our existing revolving credit facility with a new revolving credit facility. Please read discussion under "-Liquidity and Capital Resources-Sources of Liquidity" for further information.
Income Tax Benefit
Income taxes consist of an estimate of federal and state income taxes based on enacted federal and state tax rates, as adjusted for allowable credits, deductions, and the valuation allowance against deferred tax assets, as applicable.
(Income) Loss from Equity Method Investees
Our equity method investments prior to fiscal 2019 consisted primarily of our 50% owned veterinary joint venture and our 50% ownedMexico joint venture. Beginning in fiscal 2019, the veterinary joint venture is now included in our consolidated results. Please read "Net Loss Attributable to Noncontrolling Interest" below for more information regarding our noncontrolling interests.
Net Loss Attributable to Noncontrolling Interest
The noncontrolling interest represents 50% of the net loss of our veterinary
joint venture, which is a variable interest entity for which we were deemed to
be the primary beneficiary beginning in fiscal 2019 due to revisions made in the
joint operating agreement. Prior to fiscal 2019, the veterinary joint venture
was accounted for as an equity method investment.
Executive SummaryOur business transformation initiatives, accelerated by an increase in pet ownership and a shift in customer discretionary spend on pets, have driven strong top- and bottom-line growth in our business. Comparing fiscal 2020 and fiscal 2019, we achieved the following results:
• increase in net sales from
period-over-period growth of 11.0%;
• comparable sales growth of 11.4%;
• increase in operating income from $110.6 million to $194.4 million ,
representing period-over-period growth of 75.8%;
• a decrease in net loss attributable to Class A and B-1 common
stockholders from $95.9 million to $26.5 million , representing a
period-over-period improvement of 72.4%;
• an increase in Adjusted EBITDA from $424.5 million to $484.3 million ,
representing period-over-period growth of 14.1%; and
45
--------------------------------------------------------------------------------
• Net cash provided by operating activities increased from $110.3 million
in fiscal 2019 to $268.6 million in fiscal 2020.
For a description of our non-GAAP measures and reconciliations to their most
comparable GAAP measures, please read the section below titled "Reconciliation
of Non-GAAP Financial Measures to GAAP Measures."
Results of Operations
The following tables summarize our results of operations and the percent of net
sales of line items included in our consolidated statements of operations
(dollars in thousands):
Fiscal years ended
January 30, February 1, February 2,
2021 2020 2019
(52 weeks) (52 weeks) (52 weeks)
Net sales $ 4,920,202 $ 4,434,514 $ 4,392,173
Cost of sales 2,813,464 2,527,995 2,487,334
Gross profit 2,106,738 1,906,519 1,904,839
Selling, general and administrative expenses 1,912,314 1,776,919 1,746,387
Goodwill and indefinite-lived intangible
impairment - 19,000 373,172
Operating income (loss) 194,424 110,600 (214,720 )
Interest income (653 ) (335 ) (420 )
Interest expense 219,083 253,018 243,744
Loss on extinguishment of debt 17,549 - 460
Loss before income taxes and (income) loss
from
equity method investees (41,555 ) (142,083 ) (458,504 )
Income tax benefit (3,337 ) (35,658 ) (45,840 )
(Income) loss from equity method investees (6,482 ) (2,441 ) 1,124
Net loss (31,736 ) (103,984 ) (413,788 )
Net loss attributable to noncontrolling
interest (5,253 ) (8,111 ) -
Net loss attributable to Class A and B-1
common
stockholders $ (26,483 ) $ (95,873 ) $ (413,788 )
Fiscal years ended
January 30, February 1, February 2,
2021 2020 2019
(52 weeks) (52 weeks) (52 weeks)
Net sales 100.0 % 100.0 % 100.0 %
Cost of sales 57.2 57.0 56.6
Gross profit 42.8 43.0 43.4
Selling, general and administrative expenses 38.9 40.1 39.8
Goodwill and indefinite-lived intangible
impairment - 0.4 8.5
Operating income (loss) 3.9 2.5 (4.9 )
Interest income 0.0 0.0 0.0
Interest expense 4.4 5.7 5.5
Loss on extinguishment of debt 0.3 - 0.0
Loss before income taxes and (income) loss
from
equity method investees (0.8 ) (3.2 ) (10.4 )
Income tax benefit (0.1 ) (0.8 ) (1.0 )
(Income) loss from equity method investees (0.1 ) (0.1 ) 0.0
Net loss (0.6 ) (2.3 ) (9.4 )
Net loss attributable to noncontrolling
interest (0.1 ) (0.1 ) -
Net loss attributable to Class A and B-1
common
stockholders (0.5 )% (2.2 )% (9.4 )%
46
--------------------------------------------------------------------------------
Fiscal years ended
January 30, February 1, February 2,
2021 2020 2019
(52 weeks) (52 weeks) (52 weeks)
Operational Data:
Comparable sales increase (decrease) 11.4 % 3.9 % (1.1 )%
Total pet care centers at end of period 1,454 1,478 1,490
Total pet care centers with veterinarian
practices at
end of period 125 81 39
Adjusted EBITDA (in thousands) $ 484,348 $ 424,547 $ 437,836
Fiscal 2020 (52 weeks) Compared with Fiscal 2019 (52 weeks)
Net sales increased$485.7 million , or 11.0%, to$4.92 billion in fiscal 2020 compared to net sales of$4.43 billion in fiscal 2019, driven by a 11.4% increase in our comparable sales. With our investments in our business over the past two years, we were, and continue to be, well-positioned to meet the increasing and evolving needs of pets and their parents. Our sales growth period-over-period was a result of these investments, coupled with an increase in pet ownership and a shift in consumer spending toward the pet category as a result of the COVID-19 pandemic. Our e-commerce and digital sales increased 103% from fiscal 2019 to fiscal 2020 driven by a change in consumer shopping preferences. With an integrated offering that includes BOPUS, curbside pick-up, ship-from-store, and same day delivery, we were able to quickly get products to customers in a safe manner regardless of their delivery or pick-up preference. Supplies and companion animal sales increased 20.1% from fiscal 2019 to fiscal 2020 due to increases in pet ownership and shifts in disposable income toward pets. Dog and cat food sales increased 3.4% and services and other sales increased 6.1% from fiscal 2019 to fiscal 2020, respectively. The increase in services was primarily due to growth in the hospital business due to the addition of 44 new hospitals period-over-period partially offset by the temporary suspension of our training, grooming and vaccination clinic services while stay-at-home orders were in place.
Cost of Goods Sold and Gross Profit
Gross profit increased$200.2 million , or 10.5%, to$2.11 billion in fiscal 2020 compared to gross profit of$1.91 billion for fiscal 2019. As a percentage of sales, our gross profit rate decreased slightly at 42.8% for fiscal 2020 compared to 43.0% for fiscal 2019. The increase in gross profit was due to the overall increase in net sales. The slight decrease in gross profit rate was primarily due to a shift in sales to e-commerce, which typically carries lower margins than pet care center sales. E-commerce sales margins benefitted by the growth in BOPUS, curbside delivery, and ship-from-store, which typically carry higher margins as they reduce or eliminate shipping costs associated with online sales. Approximately 83% of Petco.com orders were fulfilled by our pet care centers during fiscal 2020. Also contributing to the decrease in gross profit rate period-over-period were$9.6 million of COVID-19 related expenses and a lower year-over-year actuarial true-up benefit of$7.3 million . COVID-19 related expenses in fiscal 2020 included approximately$7.9 million of appreciation bonuses for our frontline services partners, including groomers, trainers and veterinarians, and distribution center partners and approximately$1.7 million of increased sanitation costs at our distribution centers and for purchases of personal protective equipment.
Selling, General and Administrative Expenses
SG&A expenses increased$135.4 million , or 7.6%, to$1.91 billion for fiscal 2020 compared to$1.78 billion for fiscal 2019. As a percentage of net sales, SG&A expenses decreased from 40.1% in fiscal 2019 to 38.9% in fiscal 2020 reflecting operating leverage from net sales growth. The increase in expense period-over-period was driven by a$70.7 million increase in advertising expenses to support the acceleration of our e-commerce and digital sales growth;$18.4 million of COVID-19 related appreciation bonuses for our frontline pet care center partners;$11.7 million of COVID-19 related expenses for sanitation, safety-related costs, personal protective equipment and the establishment of our employee assistance fund; and$8.7 million of professional fees expensed in connection with the initial public offering. Depreciation expense increased$10.6 million due to increased capital spend to support e-commerce and digital initiatives. 47
--------------------------------------------------------------------------------
Our annual impairment test in fiscal 2020 and fiscal 2019 indicated that the fair value of our single reporting unit exceeded the carrying value, and therefore no goodwill impairment charge was recorded.
The annual impairment analysis of our indefinite-lived trade name in fiscal 2020 indicated that the fair value of the asset exceeded the carrying value, and therefore no trade name impairment charge was recorded in fiscal 2020. In fiscal 2019, an impairment charge of$19.0 million was recorded driven by a combination of market conditions, increased competition from online competitors, and financial performance.
Interest Expense
Interest expense decreased$33.9 million , or 13.4%, to$219.1 million in fiscal 2020 compared with$253.0 million in fiscal 2019. The decrease was primarily driven by lower interest rates between the periods. In addition, interest expense decreased by approximately$3.5 million due to the redemption/cancellation of the Floating Rate Senior Notes and the 3.00% Senior Notes and repayment of a portion of the Amended Term Loan Facility in connection with the initial public offering. InMarch 2020 , we borrowed$250.0 million on the revolving credit facility as a precautionary measure given the uncertainty of the macroeconomic environment at the start of the COVID-19 pandemic. We subsequently repaid the amount in full in the second quarter of fiscal 2020 and had no borrowings outstanding on the revolving credit facility as ofJanuary 30, 2021 . Income Tax Benefit Our effective tax rate was 11.2% for fiscal 2020, resulting in income tax benefit of$3.3 million , compared to an effective tax rate of 27.3% and income tax benefit of$35.7 million for fiscal 2019. The decrease in effective tax rate in fiscal 2020 as compared to fiscal 2019 is driven by various factors, including the change in earnings as compared to fiscal 2019, a remeasurement of deferred tax assets related to$67.4 million of net operating losses available under the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") that were carried back to fiscal years before theU.S. Tax Cuts and Jobs Act was enacted, which resulted in a benefit of$8.8 million . These decreases were partially offset by an increase in equity-based compensation resulting from the initial public offering as discussed in Note 13 of the consolidated financial statements, an increase in unrecognized tax benefits as discussed in Note 14 of the consolidated financial statements, limitations of deductibility for certain public company executive compensation in accordance with Section 162(m) of the Internal Revenue Code of 1986 as amended (the "Code"), and changes to state taxes from changes in tax laws, tax rates, and apportionment of income.
Net Loss Attributable to Class A and B-1 Common Stockholders
Net loss attributable to Class A and B-1 common stockholders decreased$69.4 million to$26.5 million for fiscal 2020 compared with a net loss attributable to Class A and B-1 common stockholders of$95.9 million for fiscal 2019. The improvement period-over-period was primarily driven by higher gross margin of$200.2 million and lower interest expense of$33.9 million , offset by higher SG&A costs of$135.4 million and a lower income tax benefit of$32.3 million . Prior Year Discussion of Results and Comparisons
For information on fiscal 2018 results and similar comparisons, please read
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" of our final prospectus filed with the
Reconciliation of Non-GAAP Financial Measures to GAAP Measures
The following information provides definitions and reconciliations of certain
non-GAAP financial measures to the most directly comparable financial measures
calculated and presented in accordance with GAAP. Such non-GAAP financial
measures are not in accordance with GAAP and should not be considered superior
to, as a substitute for or alternative to, and should be considered in
conjunction with, the most comparable GAAP measures. The non-GAAP financial
measures presented may differ from similarly-titled measures used by other
companies.
48--------------------------------------------------------------------------------
Adjusted EBITDA
We present Adjusted EBITDA, a non-GAAP financial measure, because we believe it enhances an investor's understanding of our financial and operational performance by excluding certain material non-cash items, unusual or non-recurring items that we do not expect to continue in the future, and certain other adjustments we believe are or are not reflective of our ongoing operations and performance. Adjusted EBITDA enables operating performance to be reviewed across reporting periods on a consistent basis. We use Adjusted EBITDA as one of the principal measures to evaluate and monitor our operating financial performance and to compare our performance to others in our industry. We also use Adjusted EBITDA in connection with establishing discretionary annual incentive compensation targets, to make budgeting decisions, to make strategic decisions regarding the allocation of capital, and to report our quarterly results as defined in our debt agreements, although under such agreements the measure is calculated differently and is used for different purposes.
We define Adjusted EBITDA as net (loss) income attributable to members excluding:
• interest expense, net and losses on debt extinguishment; • income tax (benefit) expense; • depreciation, amortization, asset impairments, and write-offs; • (income) loss from equity method investees; • goodwill and indefinite-lived intangible impairment; • equity-based compensation; • pre-opening and closing expenses; • non-cash occupancy-related costs; • severance expenses; and • other non-recurring costs. We believe it is useful to exclude these items that are non-cash or non-routine in nature, as they are not components of our business operations and may not directly correlate to the underlying performance of our business. In addition, we add back 50% of EBITDA related to our 50% owned veterinary joint venture for years prior to fiscal 2019 (in fiscal 2019, we began consolidating this joint venture in our financial results) and our 50% ownedMexico joint venture for all periods. We believe it is useful to include our portion of the results of these joint ventures, as it reflects the performance of key components of our business, including veterinary services and international operations, and presents more comparable EBITDA-based financial information rather than (income) loss on a standalone basis. Our portion of the results of these joint ventures has limitations as an analytical tool, including that amounts shown on the individual line items do not necessarily represent our legal claim to the assets and liabilities, or the revenues and expenses presented. In addition, other companies may calculate such proportionate results differently, which reduces their comparability. Further, we define Adjusted EBITDA Margin as Adjusted EBITDA divided by net sales. Adjusted EBITDA is not a substitute for net (loss) income, the most comparable GAAP measure, and is subject to a number of limitations as a financial measure, so it should be used in conjunction with GAAP financial measures and not in isolation. There can be no assurances that we will not modify the presentation of Adjusted EBITDA in the future. In addition, other companies in our industry may define Adjusted EBITDA differently, limiting its usefulness as a comparative measure. 49
--------------------------------------------------------------------------------
The table below reflects the calculation of Adjusted EBITDA and Adjusted EBITDA Margin, after taking into account net sales for the periods presented:
Fiscal years ended
January 30, February 1, February 2,
2021 2020 2019
(dollars in thousands) (52 weeks) (52 weeks) (52 weeks)
Reconciliation of Net Loss Attributable to
Class A and B-1
Common Stockholders to Adjusted EBITDA
Net loss attributable to Class A and B-1
common stockholders $ (26,483 ) $ (95,873 ) $ (413,788 )
Interest expense, net 218,430 252,683 243,324
Income tax benefit (3,337 ) (35,658 ) (45,840 )
Depreciation and amortization 174,836 173,544 186,997
(Income) loss from equity method investees (6,482 ) (2,441 ) 1,124
Loss on debt extinguishment 17,549 - 460
Goodwill & indefinite-lived intangible
impairment - 19,000 373,172
Asset impairments and write offs 15,606 11,871 17,677
Equity-based compensation 12,915 9,489 8,452
Veterinary Joint Venture EBITDA (1) - - (4,135 )
Mexico Joint Venture EBITDA (2) 19,074 14,227 7,614
Store pre-opening expenses 9,228 10,325 6,551
Store closing expenses 7,782 4,068 16,484
Severance 5,283 10,164 6,699
Non-cash occupancy-related costs (3) 19,240 32,763 4,339
Non-recurring costs (4) 20,707 20,385 28,706
Adjusted EBITDA $ 484,348 $ 424,547 $ 437,836
Net sales $ 4,920,202 $ 4,434,514 $ 4,392,173
Net margin (5) (0.5 )% (2.2 )% (9.4 )%
Adjusted EBITDA Margin (5) 9.8 % 9.6 % 10.0 %
(1) Veterinary Joint Venture EBITDA represents 50% of the entity's operating
results for years prior to fiscal 2019, when the joint venture was accounted
for as an equity method investment. Beginning in fiscal 2019, this joint
venture is now included in our consolidated results with the 50% portion we
do not own being adjusted as a noncontrolling interest. We believe it is
useful to include our portion of the results of this joint venture prior to
fiscal 2019, as it best reflects the actual performance of our overall
business and improves comparability of our financial information. The
Veterinary Joint Venture EBITDA is aligned with the portion of such entity's
net loss that is included in (income) loss from equity method investees in
the financial statements because such entity does not have similar items to
those excluded in our calculation of Adjusted EBITDA.
(2) Mexico Joint Venture EBITDA represents 50% of the entity's operating results
for all years, as adjusted to reflect the results on a basis comparable to
our Adjusted EBITDA. In the financial statements, this joint venture is
accounted for as an equity method investment and reported net of
depreciation and income taxes. Because such a presentation would not reflect
the adjustments made in our calculation of Adjusted EBITDA, we include our
50% interest in our Mexico Joint Venture on an Adjusted EBITDA basis to
ensure consistency. The table below presents a reconciliation of
Joint Venture net income to Mexico Joint Venture EBITDA:
Fiscal years ended
January 30, February 1, February 2,
2021 2020 2019
(dollars in thousands) (52 weeks) (52 weeks) (52 weeks)
Net income $ 14,225 $ 8,662 $ 6,902
Depreciation 12,248 11,298 4,532
Income tax expense 6,229 4,107 3,673
Foreign currency gain (loss) 705 (406 ) 164
Interest expense (income), net 4,740 4,793 (43 )
EBITDA $ 38,147 $ 28,454 $ 15,228
50% of EBITDA $ 19,074 $ 14,227 $ 7,614 (3) Non-cash occupancy-related costs include the difference between cash and
straight-line rent for all periods. Beginning in fiscal 2019, in connection
with our adoption of the lease accounting standard, favorable lease rights
of
reclassified from intangible assets and other long-term liabilities,
respectively, to right-of-use lease assets and the related amortization is
now included in non-cash occupancy costs. In addition to the
reclassification, the amortization period of these lease right assets has
decreased to align with the terms of the underlying right-of-use lease
assets, thus resulting in an acceleration of expense compared to prior
years. The overall adoption of the lease accounting standard did not have an
impact on our Adjusted EBITDA, as this increase in addback was completely
offset in other impacted lines such as lower depreciation and amortization,
asset impairments and write-offs, and store closing expenses.
50
--------------------------------------------------------------------------------
(4) Non-recurring costs include: unrealized fair market value adjustments
on non-operating investments; class action settlements and related legal
fees; one-time consulting and other costs associated with our strategic
transformation initiatives; discontinuation and liquidation costs; and costs
related to the initial public offering. While we have incurred significant
costs associated with the COVID-19 pandemic during fiscal 2020, we have not
classified any of these costs as non-recurring due to the uncertainty
surrounding the pandemic's length and long-term impact on the macroeconomic
operating environment.
(5) We define net margin as net loss attributable to Class A and B-1 common
stockholders divided by net sales and Adjusted EBITDA margin as Adjusted
EBITDA divided by net sales.
Adjusted Net Income and Adjusted EPS
Adjusted Net Income and Adjusted EPS are considered non-GAAP financial measures because they exclude certain amounts included in net loss attributable to Class A and B-1 common stockholders and diluted loss per Class A and B-1 common share, the most directly comparable financial measures calculated in accordance with GAAP. Management believes that Adjusted Net Income and Adjusted EPS are meaningful measures to share with investors because they best allow comparison of the performance with that of the comparable period. In addition, Adjusted Net Income and Adjusted EPS afford investors a view of what management considers the Company's earnings performance to be and the ability to make a more informed assessment of such earnings performance with that of the prior year.
The table below reflects the calculation of Adjusted Net Income and Adjusted EPS for the periods presented:
Fiscal years ended
January 30, 2021 February 1, 2020 February 2, 2019
(52 weeks) (52 weeks) (52 weeks)
(dollars in thousands, except
per share amounts) Amount Per share Amount Per share Amount Per share
Reconciliation of Diluted Loss
per Share to
Adjusted EPS
Net loss attributable to Class A
and B-1
common stockholders $ (26,483 ) $ (0.13 ) $ (95,873 ) $ (0.46 ) $ (413,788 ) $ (1.98 )
Income tax benefit (3,337 ) (0.02 ) (35,658 ) (0.17 ) (45,840 ) (0.22 )
Loss on debt extinguishment 17,549 0.08 - - 460 -
Goodwill & indefinite-lived
intangible impairment - - 19,000 0.09 373,172 1.79
Asset impairments and write offs 15,606 0.07 11,871 0.06 17,677 0.08
Equity-based compensation 12,915 0.06 9,489 0.04 8,452 0.04
Store pre-opening expenses 9,228 0.05 10,325 0.05 6,551 0.03
Store closing expenses 7,782 0.04 4,068 0.02 16,484 0.08
Severance 5,283 0.03 10,164 0.05 6,699 0.03
Non-cash occupancy-related costs 19,240 0.09 32,763 0.16 4,339 0.02
Non-recurring costs 20,707 0.10 20,385 0.10 28,706 0.14
Adjusted pre-tax income (loss) /
adjusted
pre-tax diluted earnings
(loss) per share $ 78,490 $ 0.37 $ (13,466 ) $ (0.06 ) $ 2,912 $ 0.01
Income tax expense (benefit) at
26% normalized
tax rate 20,407 0.09 (3,501 ) (0.01 ) 757 -
Adjusted Net Income (Loss) /
Adjusted EPS$ 58,083 $ 0.28 $ (9,965 ) $ (0.05 ) $ 2,155 $ 0.01 Free Cash Flow Free Cash Flow is a non-GAAP financial measure that is calculated as net cash provided by operations less cash paid for fixed assets. Management believes that Free Cash Flow, which measures our ability to generate additional cash from our business operations, is an important financial measure for use in evaluating the company's financial performance. Although other companies report their free cash flow, numerous methods exist for calculating a company's free cash flow. As a result, the method used by the Company's management to calculate our Free Cash Flow may differ from the methods used by other companies to calculate their free cash flow. 51
--------------------------------------------------------------------------------
The table below reflects the calculation of Free Cash Flow for the periods
presented:
Fiscal years ended
January 30, February 1, February 2,
2021 2020 2019
(dollars in thousands) (52 weeks) (52 weeks) (52 weeks)
Net cash provided by operating activities $ 268,615 $ 110,337 $ 203,202
Cash paid for fixed assets (159,560 ) (156,906 ) (148,063 )
Free Cash Flow $ 109,055 $ (46,569 ) $ 55,139
Net Debt
Net Debt is a non-GAAP financial measure that is calculated as the sum of
current and non-current debt, less cash and cash equivalents. Management
considers this adjustment useful because it reduces the volatility of total debt
caused by fluctuations between cash paid against the company's revolving credit
facility and cash held on hand in cash and cash equivalents.
Although other companies report their net debt, numerous methods exist for
calculating a company's net debt. As a result, the method used by the Company's
management to calculate our Net Debt may differ from the methods used by other
companies to calculate their net debt.
The table below reflects the calculation of net debt for the periods presented:
January 30, February 1,
(dollars in thousands) 2021 2020
Total debt:
Senior secured credit facilities, net, including
current portion $ 1,646,281 $ 2,387,552
Senior notes, net -
866,145
Finance leases, including current portion 13,639
16,434
Total debt$ 1,659,920 $
3,270,131
Less: cash and cash equivalents (111,402 ) (148,785 ) Net Debt$ 1,548,518 $ 3,121,346 Adjusted EBITDA$ 484,348 $ 424,547 Net Debt / Adjusted EBITDA ratio 3.2x 7.4x Liquidity and Capital Resources Overview Our primary sources of liquidity are funds generated by operating activities and available capacity for borrowings on our revolving credit facility. Our ability to fund our operations, to make planned capital investments, to make scheduled debt payments and to repay or refinance indebtedness depends on our future operating performance and cash flows, which are subject to prevailing economic conditions and financial, business, and other factors, some of which are beyond our control. Our liquidity as ofJanuary 30, 2021 was$499.0 million inclusive of cash and cash equivalents of$111.4 million and$387.6 million of availability on the revolving credit facility. We believe that our current resources, together with anticipated cash flows from operations and borrowing capacity under the revolving credit facility will be sufficient to finance our operations, meet our current cash requirements, and fund anticipated capital investments for the next 12 months. We may, however, seek additional financing to fund future growth or refinance our existing indebtedness through the debt capital markets, but we cannot be assured that such financing will be available on favorable terms, or at all. We are a party to contractual obligations involving commitments to make payments to third parties. These obligations impact our short-term and long-term liquidity and capital resource needs. Certain contractual obligations are reflected on the consolidated balance sheet as ofJanuary 30, 2021 , while others are considered future obligations. Our contractual obligations primarily consist of operating leases and long-term debt and related interest payments. We do also enter certain short-term lease commitments, letters of credit and purchase obligations in the normal course of business. For more information regarding our primary obligations, refer to Note 6 and Note 8 to the historical consolidated financial statements included elsewhere in this Annual Report on Form 10-K for amounts outstanding as ofJanuary 30, 2021 related to debt and operating leases, respectively. Also refer to further discussion on our debt refinancing transaction in sources of liquidity below. 52
--------------------------------------------------------------------------------
Cash Flows
The following table summarizes our consolidated cash flows:
Fiscal years ended
January 30, February 1, February 2,
(dollars in thousands) 2021 2020 2019
(52 weeks) (52 weeks) (52 weeks)
Total cash provided by (used in):
Operating activities $ 268,615 $ 110,337 $ 203,202
Investing activities (157,185 ) (139,041 ) (142,682 )
Financing activities (146,608 ) (3,071 ) (32,099 )
Net (decrease) increase in cash, cash equivalents
and restricted cash $ (35,178 ) $ (31,775 ) $ 28,421
Operating Activities
Our primary source of operating cash is sales of products and services to
customers, which are substantially all on a cash basis and therefore provide us
with a significant source of liquidity. Our primary uses of cash in operating
activities include purchases of inventory; freight and warehousing costs;
employee-related expenditures; occupancy-related costs for our pet care centers,
distribution centers and corporate support centers; credit card fees; interest
under our debt agreements; and marketing expenses. Net cash provided by
operating activities is impacted by our net loss adjusted for certain non-cash
items, including: depreciation, amortization, impairments and write-offs;
amortization of debt discounts and issuance costs; deferred income taxes;
equity-based compensation; impairments of goodwill and intangible assets; and
the effect of changes in operating assets and liabilities.
Net cash provided by operating activities was $268.6 million in fiscal 2020
compared with net cash provided by operating activities of $110.3 million in
fiscal 2019. The increase was driven by stronger operating performance
period-over-period resulting from our strategic investments, an increase in pet
ownership and increased consumer spending in the pet category. In addition, a
decrease in cash payments for interest and lower payroll taxes due to the CARES
Act contributed to the increase. This was partially offset by the timing of
receipts and payments on inventory, increases in advertising spend and
non-recurring expenses related to COVID-19 and the initial public offering.
Net cash provided by operating activities was $110.3 million in fiscal 2019
compared with $203.2 million in fiscal 2018. This decrease was primarily driven
by the timing of cash collections on trade accounts receivable, increases in
cash paid for advertising to support initiatives and digital growth, and an
increase net cash used in operating activities to expand our vet footprint.
Increases in cash paid for interest and income taxes also contributed to the
overall decrease.
Investing Activities
Cash used in investing activities consists primarily of capital expenditures,
which in fiscal 2020, fiscal 2019 and fiscal 2018 primarily supported our
transformation initiatives. Net cash used in investing activities was $157.2
million , $139.0 million , and $142.7 million for fiscal 2020, 2019, and 2018
respectively. Offsetting our cash used for capital expenditures in fiscal 2019
was proceeds from the sale-leaseback of our San Antonio corporate support
center, for which we received net proceeds of $18.5 million . The sale-leaseback
enabled us to enhance our liquidity and fund investments to support our
strategic growth and transformation initiatives.
The majority of our capital expenditures are discretionary in nature and made to
expand our business. In fiscal 2021, we expect to spend approximately
53--------------------------------------------------------------------------------
Capital expenditures by category during the periods set forth below are as
follows:
Fiscal years ended
January 30, February 1, February 2,
(dollars in thousands) 2021 2020 2019New and existing pet care center
locations $ 80,776 $ 100,394 Digital and Information technology 68,232 51,358 55,465 Supply chain and other 10,552 5,154 7,927 Total capital expenditures$ 159,560 $ 156,906 $ 148,063 Financing Activities Financing activities in fiscal 2020, 2019 and 2018 primarily consisted of borrowings and paydowns on the revolving credit facility to support the working capital needs of the business. Principal payments on the Amended Term Loan Facility were$25.3 million per year in fiscal 2019 and 2018. In fiscal 2020, financing activities included net proceeds from our initial public offering and the subsequent use of proceeds for debt repayments. In fiscal 2020, the Company paid$745.9 million in principal payments on the Amended Term Loan Facility. Net cash used in financing activities was$146.6 million for fiscal 2020, compared with$3.1 million used in financing activities in fiscal 2019 and$32.1 million used in financing activities in fiscal 2018. At the start of the COVID-19 pandemic inMarch 2020 , we took a precautionary draw on the Amended Revolving Credit Facility of$250.0 million . As operations stabilized and financial results improved, the balance was repaid in full in the second quarter of fiscal 2020 and no amounts were outstanding as ofJanuary 30, 2021 . Net cash used in financing activities was fiscal 2020 primarily consisted of repayments of debt in connection with the initial public offering that occurred onJanuary 19, 2021 . Upon the closing of the initial public offering, the Company repaid$727.0 million of the Amended Term Loan Facility,$300.0 million in principal on the Floating Rate Senior Notes and$4.0 million on the 3.00% Senior Notes. These payments were made from net proceeds of$936 million from the initial public offering. The Company paid an additional$18.9 million of term loan principal payments in fiscal 2020. For more information regarding these activities, refer to Note 8 and Note 9 to the historical consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Net cash used in financing activities in fiscal 2019 primarily consisted of term loan principal payments of$25.3 million and net borrowings on the Amended Revolving Credit Facility of$29.0 million to support the working capital needs of the business. The outstanding balance on the Amended Revolving Credit Facility was$29.0 million as ofFebruary 1, 2020 .
Net cash used in financing activities was
Sources of Liquidity
Senior Secured Credit Facilities
AtJanuary 30, 2021 , the Company had$1,678.1 million outstanding on the Amended Term Loan Facility and no balance on the Amended Revolving Credit Facility, providing for senior secured financing of up to$500.0 million expiring on the earlier of 91 days prior to the maturity of the Amended Term Loan Facility (October 27, 2022 or five years from the most recent amendment), subject to a borrowing base. In connection with the closing of our initial public offering in onJanuary 19, 2021 , a$17.5 million loss on extinguishment of debt was recorded in fiscal 2020 related to partial extinguishment of the Amended Term Loan Facility and cancellation of the existing Floating Rate Senior Notes. For more information regarding this indebtedness, refer to Note 8 to the historical consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 54
-------------------------------------------------------------------------------- OnMarch 4, 2021 , subsequent to fiscal 2020, the Company completed a refinancing transaction and, in combination with the application of the proceeds from the Company's initial public offering and other recapitalization transactions in connection therewith, reduced total debt by 49 percent over the prior year. The Company entered into the First Lien Term Loan and the ABL Revolving Credit Facility, which matures onMarch 4, 2026 and has availability of up to$500.0 million , subject to a borrowing base. Net Debt reduction and Adjusted EBITDA improvement as a result of the transaction led to a decrease of 4.2x of the Company Net Debt to Adjusted EBITDA ratio of 3.2x. Interest under the First Lien Term Loan is at the Company's option, either a base rate or Adjusted LIBOR, subject to a 0.75% floor, payable upon maturity of the LIBOR contract, in either case plus the applicable rate. The base rate is the greater of the bank prime rate, federal funds effective rate plus 0.5% or Adjusted LIBOR plus 1.0%. The applicable rate is 2.25% per annum for a base rate loan or 3.25% per annum for an Adjusted LIBOR loan. Principal payments are$4.25 million quarterly and commence onJune 30, 2021 . The terms under the ABL Revolving Credit Facility are substantially similar to those of the Amended Revolving Credit Facility.
Derivative Instruments
InMarch 2016 , the Company entered into a series of five interest rate cap agreements with four counterparties totaling$1,950.0 million to limit the maximum interest rate on a portion of the variable-rate debt and limit exposure to interest rate variability when three-month LIBOR exceeds 2.25%. The interest rate caps are accounted for as cash flow hedges, and changes in the fair value of the interest rate caps are reported as a component of accumulated other comprehensive income. The interest rate caps were settled in accordance with their contractual terms onJanuary 29, 2021 . For more information regarding derivative instruments, refer to Note 10 to the historical consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Segment
We operate under one reportable segment and support and serve pets and their parents through our integrated ecosystem of pet care centers, services, and e-commerce.
SeasonalityOur financial performance is not significantly impacted by seasonality, as the majority of our sales are generated by pet parents caring for their pets year-round.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements in conformity with
accounting principles generally accepted in the United States , or "GAAP,"
requires us to make assumptions and estimates about future results, and apply
judgments that affect the reported amounts of assets, liabilities, net sales,
expenses and related disclosures. We base our estimates and judgments on
historical experience, current trends and other factors that we believe to be
relevant at the time our consolidated financial statements are prepared. On an
ongoing basis, we review the accounting policies, assumptions, estimates and
judgments to ensure that our financial statements are presented fairly and in
accordance with GAAP. However, because future events and their effects cannot be
determined with certainty, actual results could differ from our assumptions and
estimates, and such differences could be material.
We state our significant accounting policies in the notes to our annual
consolidated financial statements, which are included in this Annual Report on
Form 10-K. We believe that the following accounting policies and estimates
described below have the greatest potential impact on our financial statements,
and therefore we consider these to be critical to aid in fully understanding and
evaluating our reported financial results.
Inventory Reserves
We value our inventory at the lower of the cost or net realizable value through
the establishment of inventory valuation and shrink reserves. Cost is determined
by the average cost method and includes inbound freight charges. Our valuation
reserves represent the excess of the carrying value or average cost, over the
amount we expect to realize from the ultimate sale of the inventory. Valuation
reserves establish a new cost basis, and subsequent changes in facts or
circumstances do not result in an increase in the newly established cost basis.
Our valuation reserves are subject to uncertainties, as the calculation requires
us to make assumptions regarding inventory aging, forecasted consumer demand and
trends and the promotional environment.
55
--------------------------------------------------------------------------------
Our inventory shrink reserve represents estimated physical inventory losses that
have occurred since the last physical inventory date. Periodic inventory
observations are performed on a regular basis at pet care center locations, and
cycle counts are performed for inventory at distribution centers to ensure
inventory is properly stated in our consolidated financial statements. During
the period between counts at pet care center locations, we accrue for estimated
shrink losses based on historical shrinkage results, taking into consideration
any current trends in the business.
We have not made any material changes in our methodology used to establish our
inventory valuation and shrink reserves during the past three fiscal years, and
we have not had material adjustments between our estimated shrinkage percentages
and actual results. A 10% difference in our actual valuation reserve at January
30, 2021 would have an insignificant effect on pre-tax loss in fiscal 2020.
Additionally, we do not believe there is a reasonable likelihood that there will
be a material change in future estimates or assumptions we use to calculate our
shrink reserve. However, if estimates of losses are inaccurate, we may be
exposed to losses or gains that could be material. A 10% difference in our
actual shrink reserve at January 30, 2021 would have affected pre-tax loss by
$3.8 million in fiscal 2020.
Vendor Allowances
We receive various forms of consideration from our merchandise vendors (vendor
allowances). We receive vendor allowances, primarily in the form of cooperative
advertising reimbursements, rebate incentives, prompt purchase discounts, and
vendor compliance charges pursuant to agreements with certain vendors.
Substantially all vendor allowances are initially deferred as a reduction of the
cost of inventory purchased and recorded as a reduction to cost of sales in the
consolidated statements of operations as the inventory is sold. Vendor rebates
and allowances that are identified as specific, incremental, and identifiable
costs incurred by the Company in selling the vendors' products are classified as
a reduction of selling, general and administrative expenses in the consolidated
statements of operations as the costs are incurred, as the related costs are
also classified as selling, general and administrative expenses.
We establish a deferral for vendor income that is earned but not yet received
and record the deferral as a reduction to merchandise inventory. The majority of
the year-end vendor income deferrals are collected within the following fiscal
quarter, and we do not believe there is reasonable likelihood that the
assumptions used in our estimate will change significantly. Historically,
adjustments to our vendor income deferral have not been material. A 10%
difference in our vendor income deferred at January 30, 2021 would have affected
pre-tax loss by $2.3 million in fiscal 2020.
We have not made any material changes in the accounting methodology we use to assess valuation allowances during the past three fiscal years.
Long-lived Assets
Long-lived assets, other than goodwill and intangible assets, which are separately discussed below, are tested for recoverability whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. A long-lived asset is not recoverable if its carrying amount exceeds the sum of the undiscounted cash flows expected to result from its use and eventual disposition. If a long-lived asset is not recoverable, an impairment loss is recognized for the amount by which the carrying amount of the long-lived asset (or group of assets) exceeds its fair value, with fair value determined based on the income approach. Factors we consider important and which could trigger an impairment review include: (i) significant underperformance of a pet care center relative to expected historical or projected future operating results; (ii) significant changes in the manner of our use of assets or strategy for our overall business; (iii) significant negative industry or economic trends; or (iv) planned pet care center closings.
We have not made any material changes in the accounting methodology we use to assess impairment losses during the past three fiscal years.
56--------------------------------------------------------------------------------
We evaluate goodwill annually in our fourth quarter or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We have identified one reporting unit and selected our fourth fiscal quarter to perform our annual goodwill impairment testing.Goodwill impairment guidance provides entities the option to perform a qualitative assessment to determine whether further impairment testing is necessary. The qualitative assessment requires significant judgments about economic conditions, including the entity's operating environment, its industry and other market conditions, entity-specific events related to financial performance or loss of key personnel, and other events that could impact the reporting unit. If management concludes, based on assessment of relevant events, facts, and circumstances, that it is more likely than not that a reporting unit's fair value is greater than its carrying value, no further impairment testing is required. If management's assessment of qualitative factors indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then a quantitative assessment is performed. We also have the option to bypass the qualitative assessment described above and proceed directly to the quantitative assessment, where we compare the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit exceeds the carrying value of our net assets assigned to that unit, goodwill is not considered impaired and we are not required to perform further testing. If the carrying value of net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we would record an impairment loss equal to the difference. In cases where a quantitative test is performed, the fair value of our reporting unit is estimated using the assistance of a third-party valuation firm and quantitative impairment tests are calculated using a discounted cash flow analysis and a public company analysis. Significant assumptions inherent in these valuation methodologies are employed and include, but are not limited to, prospective financial information, growth rates, discount rates, and comparable multiples from publicly traded companies in similar industries.
We have not made any material changes in the accounting methodology we use to assess goodwill impairment losses during the past three fiscal years.
Indefinite-lived trade name
We consider the Petco trade name to be an indefinite-lived intangible asset, as we currently anticipate that this trade name will contribute cash flows to us indefinitely. We perform our annual impairment test during the fourth quarter of each year or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Management has the option to first perform a quantitative assessment of its trade name asset to determine whether it is necessary to perform a quantitative impairment test. We also have the option to bypass the qualitative assessment described above and proceed directly to quantitative assessment. In cases where a quantitative test is performed, the fair value of our trade name is estimated using the assistance of a third-party valuation firm using the relief from royalty valuation method, a variation of the discounted cash flow approach. Significant assumptions inherent in the valuation methodology are employed and include, but are not limited to, prospective financial information, royalty rates and discount rates. An impairment charge is recorded for the amount by which the carrying amount of the trade name exceeds its fair value.
We have not made any material changes in the accounting methodology we use to assess indefinite-lived trade name impairment during the past three fiscal years.
Self-insurance Reserves
We maintain accruals for our self-insurance of workers' compensation,
employee-related healthcare benefits and general and auto liabilities. Insurance
coverage is in place above per occurrence retention limits to limit our exposure
to large claims. These insurance policies have stated maximum coverage limits,
after which we bear the risk of loss. When estimating our self-insurance
reserves, we consider a number of factors, including historical experience,
trends related to claims and payments, and information provided by our insurance
brokers and actuaries. Periodically, we review our assumptions and valuations
provided by our actuaries to determine the adequacy of our self-insurance
reserves.
57
--------------------------------------------------------------------------------
We are required to make assumptions and to apply judgments to estimate the
ultimate cost to settle reported claims and claims incurred but not reported at
the balance sheet date. There were no significant changes to the self-insurance
reserves during the past three years other than routine current period activity.
A 10% change in our self-insurance reserves at January 30, 2021 would have
affected pre-tax loss by $8.4 million in fiscal 2020.
Recent Accounting Pronouncements
Refer to Note 1 in the historical consolidated financial statements included
elsewhere in this Annual Report on Form 10-K for information regarding recently
issued accounting pronouncements.
© Edgar Online, source
