Petco Health & Wellness Company, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 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 Quarterly Report on Form 10-Q (this “Form 10-Q”), as well as the corresponding Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended January 30, 2021 (the “2020 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 sections entitled “Risk Factors” in Part I, Item 1A in the 2020 Form 10-K and Part II, Item 1A in our Quarterly Report on Form 10-Q for the period ended May 1, 2021 (the “Q1 Form 10-Q”) and in this Form 10-Q. 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” in the 2020 Form 10-K . All amounts herein are unaudited. Overview Petco Health and Wellness Company, Inc. (“Petco”, the “Company”, “we”, “our” and “us”) is a category-defining health and wellness company focused on improving the lives of pets, pet parents, and our own partners. Since our founding in 1965, we have been striving to set new standards in pet care, delivering comprehensive wellness solutions through our products and services, and creating communities that deepen the pet-pet parent bond. Over the last three years, our world-class leadership team and our dedicated and passionate partners have transformed the business from a successful yet traditional retailer to a disruptive, fully integrated, digital-focused provider of premium nutrition, products, services and veterinary care. We operate more than 1,500 Petco locations across the U.S., Mexico, and Puerto Rico, including a growing network of more than 150 in-store veterinary hospitals, and offer a complete online resource for pet health and wellness at petco.com and on the Petco app. Our go-to-market strategy is powered by a multi-channel platform that integrates our digital presence with a nationwide physical network. Our e-commerce site and personalized mobile app serve as hubs for pet parents to manage their pets’ health, wellness, and merchandise needs, while enabling them to shop wherever, whenever, and however they want. By leveraging an extensive physical network, we are able to offer a comprehensive product and service offering in a localized manner with a meaningful last-mile delivery advantage over the competition. We strive to be a truly unique company, one that is saving and improving millions of pet lives and tangibly improving the lives of pet parents and the partners who work for us, while at the same time executing our differentiated strategy with excellence. In tandem with Petco Love (formerly the Petco Foundation), an independent nonprofit organization, we work with and support thousands of local animal welfare groups across the country and, through in-store adoption events, we have helped find homes for more than 6.5 million animals. Impact of the COVID-19 Pandemic on Our Business The COVID-19 pandemic has impacted every aspect of the economy. 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 continued to favorably impact our business results to date with millions of additional new pets that need to be fed, groomed and vaccinated for years to come, but the possible sustained spread or resurgence of the pandemic, and any government response thereto, increases the uncertainty regarding potential economic conditions that could impact our business in the future. We cannot predict the duration or severity of COVID-19 or its ultimate impact on the broader economy or our operations and liquidity. Please refer to the risk factors described in the sections entitled “Risk Factors” in Part I, Item 1A in the 2020 Form 10-K and Part II, Item 1A in the Q1 Form 10-Q and this Form 10-Q. How We Assess the Performance of Our Business In assessing our performance, we consider a variety of performance and financial measures, including the following: 15 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 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. 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 also a key driver of changes in comparable sales. Non-GAAP Financial Measures Management and our board of directors review, in addition to GAAP (as defined herein) measures, certain non-GAAP financial measures, including Adjusted EBITDA, Free Cash Flow and Net Debt, to evaluate our operating performance, generate future operating plans, and make strategic decisions regarding the allocation of capital. Further explanations of our non-GAAP measures, along with reconciliations to their most comparable GAAP measures, are presented below under “Reconciliation of Non-GAAP Financial Measures to GAAP Measures.” Executive Summary Our business transformation initiatives, accelerated by an increase in pet ownership and a shift in customer discretionary spend toward the pet category, have driven strong top and bottom-line growth in our business. Comparing the thirteen weeks ended July 31, 2021 with the thirteen weeks ended August 1, 2020, we achieved the following results: • an increase in net sales from $1.21 billion to $1.43 billion, representing period-over-period growth of 18.7%; • comparable sales growth of 19.7%; • an increase in operating income from $65.0 million to $73.5 million, representing period-over-period growth of 12.9%; • an increase in net income attributable to Class A and B-1 common stockholders from $7.4 million to $75.1 million, representing a period-over-period improvement of 909.4%; • an increase in Adjusted EBITDA from $130.8 million to $155.1 million, representing period-over-period growth of 18.5%; and • net cash flows provided by operating activities improved from $92.4 million during the twenty-six weeks ended August 1, 2020 to $202.4 million during the twenty-six weeks ended July 31, 2021. 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.” 16 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): Thirteen weeks ended Twenty-six weeks ended July 31, 2021 August 1, 2020 July 31, 2021 August 1, 2020 Net sales $ 1,434,534 $ 1,208,971 $ 2,849,528 $ 2,322,492 Cost of sales 835,124 679,218 1,653,133 1,326,457 Gross profit 599,410 529,753 1,196,395 996,035 Selling, general and administrative expenses 525,942 464,706 1,075,178 914,623 Operating income 73,468 65,047 121,217 81,412 Interest income (13 ) (99 ) (34 ) (283 ) Interest expense 19,206 54,493 39,735 115,301 Loss on extinguishment and modification of debt — — 20,838 — Other non-operating income (45,162 ) — (45,162 ) — Income (loss) before income taxes and income from equity method investees 99,437 10,653 105,840 (33,606 ) Income tax expense (benefit) 27,011 4,958 29,690 (5,597 ) Income from equity method investees (2,429 ) (745 ) (4,854 ) (1,077 ) Net income (loss) 74,855 6,440 81,004 (26,932 ) Net loss attributable to noncontrolling interest (256 ) (1,001 ) (1,667 ) (3,205 ) Net income (loss) attributable to Class A and B-1 common stockholders $ 75,111 $ 7,441 $ 82,671 $ (23,727 ) Thirteen weeks ended Twenty-six weeks ended July 31, 2021 August 1, 2020 July 31, 2021 August 1, 2020 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 58.2 56.2 58.0 57.1 Gross profit 41.8 43.8 42.0 42.9 Selling, general and administrative expenses 36.7 38.4 37.7 39.4 Operating income 5.1 5.4 4.3 3.5 Interest income (0.0 ) (0.0 ) (0.0 ) (0.0 ) Interest expense 1.3 4.5 1.4 4.9 Loss on extinguishment and modification of debt — — 0.7 — Other non-operating income (3.1 ) — (1.5 ) — Income (loss) before income taxes and income from equity method investees 6.9 0.9 3.7 (1.4 ) Income tax expense (benefit) 1.9 0.5 1.1 (0.2 ) Income from equity method investees (0.2 ) (0.1 ) (0.2 ) (0.0 ) Net income (loss) 5.2 0.5 2.8 (1.2 ) Net loss attributable to noncontrolling interest (0.0 ) (0.1 ) (0.1 ) (0.2 ) Net income (loss) attributable to Class A and B-1 common stockholders 5.2 % 0.6 % 2.9 % (1.0 )% Thirteen weeks ended Twenty-six weeks ended July 31, 2021 August 1, 2020 July 31, 2021 August 1, 2020 Operational Data: Comparable sales 19.7 % 10.7 % 23.9 % 6.4 % Total pet care centers at end of period 1,451 1,474 1,451 1,474 Total pet care centers with veterinarian practices at end of period 155 93 155 93 Adjusted EBITDA (in thousands) $ 155,073 $ 130,812 $ 280,819 $ 217,648 17 Thirteen and Twenty-six Weeks Ended July 31, 2021 Compared with Thirteen and Twenty-six Weeks Ended August 1, 2020 Net Sales and Comparable Sales Thirteen weeks ended Twenty-six weeks ended July 31, 2021 August 1, 2020 $ Change % Change July 31, 2021 August 1, 2020 $ Change % Change Consumables $ 611,946 $ 492,274 $ 119,672 24.3 % $ 1,207,078 $ 1,018,026 $ 189,052 18.6 % Supplies and companion animals 663,572 612,630 50,942 8.3 % 1,321,744 1,106,364 215,380 19.5 % Services and other 159,016 104,067 54,949 52.8 % 320,706 198,102 122,604 61.9 % Net sales $ 1,434,534 $ 1,208,971 $ 225,563 18.7 % $ 2,849,528 $ 2,322,492 $ 527,036 22.7 % Net sales increased $225.6 million, or 18.7%, to $1.43 billion in the thirteen weeks ended July 31, 2021 compared to net sales of $1.21 billion in the thirteen weeks ended August 1, 2020, driven by a 19.7% increase in our comparable sales. Net sales increased $527.0 million, or 22.7%, to $2.85 billion in the twenty-six weeks ended July 31, 2021 compared to net sales of $2.32 billion in the twenty-six weeks ended August 1, 2020, driven by a 23.9% increase in our comparable sales. Our sales growth period-over-period was driven by our strong execution and differentiated model across digital and in our pet care centers, coupled with an increase in new pet ownership and a resulting increase in sales to meet the needs of these pet parents. For the thirteen and twenty-six weeks ended July 31, 2021, pet care center merchandise delivered growth of 16.9% and 20.9%, respectively, with strong growth in all major categories including consumables, supplies and companion animals. Our e-commerce and digital sales increased 14.3% and 17.9% during the thirteen and twenty-six weeks ended July 31, 2021 respectively, lapping strong sales growth in the same period last year at the start of the COVID-19 pandemic. This digital sales growth excludes the impact associated with the closure of our Live Aquaria business during the thirteen and twenty-six weeks ended August 1, 2020 . The increase in services and other was due in part to growth in our veterinary hospital business with the addition of 62 new hospitals period-over-period coupled with headwinds experienced during the thirteen and twenty-six weeks ended August 1, 2020 with the temporary suspension of our training, grooming and vaccination clinic services while stay-at-home orders were still in place. The increase in consumables between the periods is driven by the increase in new pets and our strategic investments in customer acquisition and retention. Also affecting the comparison in our sales mix for the thirteen and twenty-six weeks ended July 31, 2021 was the prior year impact of the COVID-19 pandemic. After experiencing an increase in consumables sales due to pantry loading during the first quarter of fiscal year 2020, we saw our sales mix shift heavily to supplies and companion animals during the thirteen weeks ended August 1, 2020 due to increases in new pets and shifts in disposable income towards pets, and initial stimulus payments which provided additional disposable income to pet parents. Gross Profit Gross profit increased $69.7 million, or 13.1%, to $599.4 million in the thirteen weeks ended July 31, 2021 compared to gross profit of $529.8 million for the thirteen weeks ended August 1, 2020. As a percentage of sales, our gross profit rate was 41.8% for the thirteen weeks ended July 31, 2021 compared with 43.8% for the thirteen weeks ended August 1, 2020. Gross profit increased $200.4 million, or 20.1%, to $1,196.4 million in the twenty-six weeks ended July 31, 2021 compared to gross profit of $996.0 million for the twenty-six weeks ended August 1, 2020. As a percentage of sales, our gross profit rate was 42.0% for the twenty-six weeks ended July 31, 2021 compared with gross profit 42.9% for the twenty-six weeks ended August 1, 2020. The decrease in gross profit rate between the periods was primarily due to the unique macroeconomic conditions that impacted our sales mix during the early months of the COVID-19 pandemic, as described above. In particular, the influx of new pets in fiscal 2020 drove a higher supplies sales mix, which typically carry higher gross margin rates compared to other categories of sales. During the thirteen and twenty-six weeks ended July 31, 2021, this sales mix has shifted from supplies to higher consumables, though we expect overall customer sales patterns to moderate over time. Sales channel impacts driven by strength in our digital, services and vet business, and moderate increases in distribution costs also contributed to the decrease in gross profit rate during the thirteen and twenty-six weeks ended July 31, 2021 as compared to the prior year. 18 Selling, General and Administrative (“SG&A”) Expenses SG&A expenses increased $61.2 million, or 13.2%, to $525.9 million for the thirteen weeks ended July 31, 2021 compared to $464.7 million for the thirteen weeks ended August 1, 2020. As a percentage of net sales, SG&A expenses was 36.7% for the thirteen weeks ended July 31, 2021 compared with 38.4% for the thirteen weeks ended August 1, 2020, reflecting operating leverage from net sales growth. The increase in expenses period over period was partially due to a $34.0 million increase in G&A expenses. A portion of this increase was due to a legal settlement accrual for a class action matter as well as increase in stock-based compensation expense driven by our initial public offering. The remainder of the increase in SG&A was predominately due to higher incentive compensation for corporate and field partners along with increased variable costs associated with our higher sales growth. In addition, SG&A expenses were lower for the thirteen weeks ended August 1, 2020 due to precautionary cost containment measures put in place throughout the early stages of the COVID-19 pandemic. SG&A expenses increased $160.6 million, or 17.6%, to $1,075.2 million for the twenty-six weeks ended July 31, 2021 compared to $914.6 million for the twenty-six weeks ended August 1, 2020. As a percentage of net sales, SG&A expenses was 37.7% for the twenty-six weeks ended July 31, 2021 compared with 39.4% for the twenty-six weeks ended August 1, 2020, reflecting operating leverage from net sales growth. The increase in expenses period-over-period was driven by a $45.5 million increase in advertising expenses to support the acceleration of our sales growth. The remainder of the increase was predominately due to the drivers discussed in the paragraph above. Interest Expense Interest expense decreased $35.3 million, or 64.8%, to $19.2 million in the thirteen weeks ended July 31, 2021 compared with $54.5 million in the thirteen weeks ended August 1, 2020. Interest expense decreased $75.6 million, or 65.5%, to $39.7 million in the twenty-six weeks ended July 31, 2021 compared with $115.3 million in the twenty-six weeks ended August 1, 2020. The decrease was primarily driven by the redemption/cancellation of the Floating Rate Senior Notes and the 3.00% Senior Notes and repayment of a portion of our then-outstanding Amended Term Loan Facility (each as defined in Note 4 , “ Senior Notes ,” and Note 3, “ Senior Secured Credit Facilities, ” to the Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q ) in connection with our initial public offering. In March 2020, we borrowed $250.0 million on our then-outstanding senior secured asset-based revolving credit facility (the “Amended 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 Amended Revolving Credit Facility as of January 30, 2021. Loss on Extinguishment and Modification of Debt Loss on extinguishment and modification of debt was $20.8 million for the twenty-six weeks ended July 31, 2021. This loss was recognized in conjunction with the March 4, 2021 debt refinancing transaction described above. There was no loss on debt extinguishment and modification for the thirteen weeks ended July 31, 2021 or the thirteen and twenty-six weeks ended August 1, 2020. For more information regarding these activities, refer to Note 3 , “ Senior Secured Credit Facilities ,” to the Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q. Other Non-Operating Income Other non-operating income was $45.2 million for the thirteen and twenty-six weeks ended July 31, 2021. This income relates to a non-cash gain from the remeasurement of the fair value of our investment in A Place for Rover, Inc. (“Rover”). There was no other non-operating income recognized during the thirteen or twenty-six weeks ended August 1, 2020. For more information regarding this activity, refer to Note 6 , “Fair Value Measurements,” to the Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q. Income Tax Expense (Benefit) Our effective tax rates were 26.4% and 26.4%, resulting in income tax expense of $27.0 million and $29.7 million for the thirteen and twenty-six weeks ended July 31, 2021, respectively, compared to effective tax rates of 39.4% and 19.2%, resulting in income tax expense (benefit) of $5.0 million and $(5.6) million for the thirteen and twenty-six weeks ended August 1, 2020, respectively. The increase in effective tax rate for the twenty-six weeks 19 ended July 31, 2021 is primarily driven by an increase in earnings along with an increase in stock-based compensation expense. 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. 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. Adjusted EBITDA is not a substitute for net income (loss), 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. Refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Reconciliation of Non-GAAP Financial Measures to GAAP Measures” included in the 2020 Form 10-K for more information regarding how we define Adjusted EBITDA. 20 The table below reflects the calculation of Adjusted EBITDA and Adjusted EBITDA Margin, after taking into account net sales for the periods presented : Thirteen weeks ended Twenty-six weeks ended July 31, 2021 August 1, 2020 July 31, 2021 August 1, 2020 Reconciliation of Net Income (Loss) Attributable to Class A and B-1 Common Stockholders to Adjusted EBITDA Net income (loss) attributable to Class A and B-1 common stockholders $ 75,111 $ 7,441 $ 82,671 $ (23,727 ) Interest expense, net 19,193 54,394 39,701 115,018 Income tax expense (benefit) 27,011 4,958 29,690 (5,597 ) Depreciation and amortization 41,238 42,471 82,845 86,038 Income from equity method investees (2,429 ) (745 ) (4,854 ) (1,077 ) Loss on debt extinguishment and modification — — 20,838 — Asset impairments and write offs 1,743 2,852 2,690 6,261 Equity-based compensation 11,506 2,312 23,110 4,617 Other non-operating income (45,162 ) — (45,162 ) — Mexico joint venture EBITDA (1) 5,856 3,483 11,862 7,502 Store pre-opening expenses 3,488 1,477 7,517 3,385 Store closing expenses 962 2,609 2,065 3,636 Non-cash occupancy-related costs (2) 2,885 5,969 4,024 13,169 Non-recurring costs (3) 13,671 3,591 23,822 8,423 Adjusted EBITDA $ 155,073 $ 130,812 $ 280,819 $ 217,648 Net sales $ 1,434,534 $ 1,208,971 $ 2,849,528 $ 2,322,492 Net margin (4) 5.2 % 0.6 % 2.9 % (1.0 )% Adjusted EBITDA Margin (4) 10.8 % 10.8 % 9.9 % 9.4 % ( 1 ) Mexico joint venture EBITDA represents 50% of the entity’s operating results for the periods presented, 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 Mexico joint venture net income to Mexico joint venture EBITDA: Thirteen weeks ended Twenty-six weeks ended (dollars in thousands) July 31, 2021 August 1, 2020 July 31, 2021 August 1, 2020 Net income $ 4,864 $ 2,384 $ 9,713 $ 3,112 Depreciation 3,401 2,702 6,801 5,856 Income tax expense 2,631 1,129 5,411 2,423 Foreign currency (gain) loss (342 ) (295 ) (487 ) 1,262 Interest expense, net 1,158 1,046 2,286 2,350 EBITDA $ 11,712 $ 6,966 $ 23,724 $ 15,003 50% of EBITDA $ 5,856 $ 3,483 $ 11,862 $ 7,502 ( 2 ) Non-cash occupancy-related costs include the difference between cash and straight-line rent for all periods. ( 3 ) Non-recurring costs include: severance; legal reserves and related fees; one-time consulting and other costs associated with the Company’s strategic transformation initiatives; discontinuation and liquidation costs; and costs related to our initial public offering and refinancing. While we 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. ( 4 ) We define net margin as net income (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. 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 21 additional cash from our business operations, is an important financial measure for use in evaluating the C ompany’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 to calculate our Free Cash Flow may differ from the methods used by other companies to calculate their free cash flow. The table below reflects the calculation of Free Cash Flow for the periods presented: Twenty-six weeks ended July 31, 2021 August 1, 2020 (dollars in thousands) Net cash provided by operating activities $ 202,404 $ 92,389 Cash paid for fixed assets (99,883 ) (50,043 ) Free Cash Flow $ 102,521 $ 42,346 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 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: (dollars in thousands) July 31, 2021 August 1, 2020 Total debt: Senior secured credit facilities, net, including current portion $ 1,663,463 $ 2,381,419 Senior notes, net — 867,778 Finance leases, including current portion 15,104 14,347 Total debt $ 1,678,567 $ 3,263,544 Less: cash and cash equivalents (203,404 ) (168,892 ) Net Debt $ 1,475,163 $ 3,094,652 Adjusted EBITDA $ 547,519 $ 449,351 Net Debt / Adjusted EBITDA ratio 2.7x 6.9x Liquidity and Capital Resources Overview Our primary sources of liquidity are funds generated by operating activities and available capacity for borrowings on our $500 million secured asset-based revolving credit facility maturing March 4, 2026 (the “ABL 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 of July 31, 2021 was $644.5 million, inclusive of cash and cash equivalents of $203.4 million and $441.1 million of availability on the ABL Revolving Credit Facility. We believe that our current resources, together with anticipated cash flows from operations and borrowing capacity under the ABL Revolving Credit Facility will be sufficient to finance our operations, meet our current cash requirements, and fund anticipated capital investments for at least 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. 22 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. There have been no material changes to our contractual obligations as compared to those described in the 2020 Form 10-K , except for the debt refinancing transaction that occurred on March 4, 2021. For more information regarding our primary obligations, refer to Note 3 , “ Senior Secured Credit Facilities ,” to the Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q for amounts outstanding as of July 31, 2021 related to our debt . Also refer to further discussion on our debt refinancing transaction in “Sources of Liquidity” below. Cash Flows The following table summarizes our consolidated cash flows: Twenty-six weeks ended (dollars in thousands) July 31, 2021 August 1, 2020 Total cash provided by (used in): Operating activities $ 202,404 $ 92,389 Investing activities (102,585 ) (48,674 ) Financing activities (11,193 ) (19,069 ) Net increase in cash, cash equivalents and restricted cash $ 88,626 $ 24,646 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 income (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; other non-operating income; and the effect of changes in operating assets and liabilities. Net cash provided by operating activities was $202.4 million in the twenty-six weeks ended July 31, 2021 compared with net cash provided by operating activities of $92.4 million in the twenty-six weeks ended August 1, 2020. The increase in operating cash flow was due to strong operating performance and working capital benefit generated by higher sales as well as lower interest payments due to the reduction of debt balances in connection with the initial public offering and related recapitalization, and the refinancing transaction that occurred on March 4, 2021 discussed under “Sources of Liquidity” below. The increase in operating cash flows between the periods was partially offset by an increase in cash paid for inventory driven by higher inventory turns, higher payroll, bonus and fringe benefits driven by operating performance and pet care center appreciation bonuses, an increase in advertising spend, and an increase in cash paid on operating leases due to the timing of rent payments. Investing Activities Cash used in investing activities consists of capital expenditures, which in the twenty-six weeks ended July 31, 2021 and the twenty-six weeks ended August 1, 2020 primarily supported our transformation initiatives. Net cash used in investing activities was $102.6 million and $48.7 million for the twenty-six weeks ended July 31, 2021 and August 1, 2020, respectively. The increase in capital expenditures between the periods is partially due to a reduction in capital expenditures put in place for the twenty-six weeks ended August 1, 2020 throughout the early stages of the 23 COVID-19 pandemic. The majority of our capital expenditures are discretionary in nature and made to expand our business. Financing Activities Net cash used in financing activities was $11.2 million for the twenty-six weeks ended July 31, 2021, compared with $19.1 million used in financing activities in the twenty-six weeks ended August 1, 2020. Financing cash flows in the twenty-six weeks ended July 31, 2021 primarily consisted of borrowings and repayments of debt in connection with the March 4, 2021 debt refinancing transaction. For more information regarding these activities, refer to Note 3 “ Senior Secured Credit Facilities ,” to the Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q . Financing cash flows in the twenty-six weeks ended August 1, 2020 included a precautionary draw on the Amended Revolving Credit Facility of $250.0 million in March 2020 at the start of the COVID-19 pandemic. As operations stabilized and financial results improved, the balance was repaid in full in the second quarter of fiscal 2020. Sources of Liquidity Senior Secured Credit Facilities As of January 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, subject to a borrowing base. On March 4, 2021, the Company completed a refinancing transaction by entering into the $1,700 million secured term loan facility maturing on March 4, 2028 (the “First Lien Term Loan”) and the ABL Revolving Credit Facility, which matures on March 4, 2026 and has availability of up to $500.0 million, subject to a borrowing base. The refinancing transaction, in combination with the application of the proceeds from the Company’s initial public offering and other recapitalization transactions in connection therewith, reduced the Company’s total debt by 48.6% as compared with August 1, 2020. Net Debt as a result of these transactions decreased $1,619.5 million or 52.3% to $1,475.2 million at July 31, 2021. Our Net Debt to Adjusted EBITDA ratio as a result of these transactions improved from 6.9x at August 1, 2020 to 2.7x at July 31, 2021. 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 on June 30, 2021. The terms under the ABL Revolving Credit Facility are substantially similar to those of the Amended Revolving Credit Facility. For more information regarding this indebtedness, refer to Note 3, “ Senior Secured Credit Facilities ,” to the Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q . Critical Accounting Policies and Estimates The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States (“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. There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in the 2020 Form 10-K . 24 Recent Accounting Pronouncements Refer to Note 1, “ Summary of Significant Accounting Policies ,” to the Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q for information regarding recently issued accounting pronouncements.