NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.Description of Business
Chewy, Inc. and its wholly-owned subsidiaries (collectively “Chewy” or the “Company”) is a pure play e-commerce business geared toward pet products for dogs, cats, fish, birds, small pets, horses, and reptiles. Chewy serves its customers through its retail website, www.chewy.com, and its mobile applications and focuses on delivering exceptional customer service, competitive prices, outstanding convenience (including Chewy’s Autoship subscription program, fast shipping, and hassle-free returns), and a large selection of high-quality pet food, treats and supplies, and pet healthcare products.
The Company is controlled by PetSmart, Inc. (“PetSmart” or the “Parent”). PetSmart is wholly-owned by a consortium including private investment funds advised by BC Partners, La Caisse de dépôt et placement du Québec, affiliates of GIC Special Investments Pte Ltd, affiliates of StepStone Group LP and funds advised by Longview Asset Management, LLC (collectively, the “Sponsors”), and controlled by affiliates of BC Partners.
Initial Public Offering
On June 18, 2019, the Company closed its initial public offering (“IPO”), in which it issued and sold 5.6 million shares of its Class A common stock. The price at IPO was $22.00 per share. The Company received net proceeds of approximately $110.3 million from the IPO after deducting underwriting discounts and commissions of $6.2 million and offering costs.
Prior to the completion of the IPO, the Company amended and restated its certificate of incorporation to authorize Class A and Class B common stock and reclassify the 100 outstanding shares of common stock into 393,000,000 shares of Class B common stock. In connection with the IPO, 47,875,000 shares of the Company’s Class B common stock were reclassified into shares of Class A common stock on a one-to-one basis. Upon completion of the IPO, 53,475,000 shares of the Company’s Class A common stock and 345,125,000 shares of Class B common stock were outstanding. The Class A common stock outstanding includes the shares issued in the IPO.
2. Basis of Presentation and Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements and related notes include the accounts of Chewy, Inc. and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. The unaudited condensed consolidated financial statements and notes thereto of Chewy, Inc. have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting and, therefore, omit or condense certain footnotes and other information normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as set forth in the Financial Accounting Standards Board’s (“FASB”) accounting standards codification. In the opinion of management, all adjustments necessary for a fair statement of the financial information, which are of a normal and recurring nature, have been made for the interim periods reported. Results of operations for the quarterly period ended May 3, 2020 are not necessarily indicative of the results for the entire fiscal year. The unaudited condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q for the quarterly period ended May 3, 2020 (“10-Q Report”) should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 2, 2020 (“10-K Report”).
Fiscal Year
The Company has a 52 or 53-week fiscal year ending each year on the Sunday that is closest to January 31 of that year. The Company’s 2020 fiscal year ends on January 31, 2021 and is a 52-week year. The Company’s 2019 fiscal year ended February 2, 2020 and was a 52-week year.
Significant Accounting Policies
There have been no significant changes from the significant accounting policies disclosed in Note 2 of the “Notes to Consolidated Financial Statements” included in the 10-K Report.
Use of Estimates
GAAP requires management to make certain estimates, judgments, and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates these estimates and judgments. Actual results could differ from those estimates.
Key estimates relate primarily to determining the net realizable value and demand for inventory, useful lives associated with property and equipment, valuation allowances with respect to deferred tax assets, contingencies, evaluation of sales tax positions, and the valuation and assumptions underlying share-based compensation. On an ongoing basis, management evaluates its estimates compared to historical experience and trends, which form the basis for making judgments about the carrying value of assets and liabilities.
Accrued Expenses and Other Current Liabilities
The following table presents the components of accrued expenses and other current liabilities (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
May 3,
2020
|
|
February 2,
2020
|
Outbound fulfillment
|
$
|
263,791
|
|
|
$
|
182,589
|
|
Advertising and marketing
|
62,317
|
|
|
96,836
|
|
Accrued expenses and other
|
140,832
|
|
|
138,064
|
|
Total accrued expenses and other current liabilities
|
$
|
466,940
|
|
|
$
|
417,489
|
|
Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement. In August 2018, the FASB issued this Accounting Standards Update (“ASU”) to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This update became effective at the beginning of the Company’s 2020 fiscal year. The adoption of this ASU did not have a material impact on the Company’s condensed consolidated financial statements and disclosures.
ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. In June 2016, the FASB issued this ASU to amend the current accounting guidance which requires the measurement of all expected losses to be based on historical experience, current conditions and reasonable and supportable forecasts. For trade receivables, loans, and other financial instruments, the Company will be required to use a forward-looking expected loss model that reflects probable losses rather than the incurred loss model for recognizing credit losses. This update became effective at the beginning of the Company’s 2020 fiscal year. The adoption of this ASU did not have a material impact on the Company’s condensed consolidated financial statements and disclosures.
Recently Issued Accounting Pronouncements
ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. In December 2019, the FASB issued this ASU to simplify the accounting for income taxes by eliminating certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences. This ASU also clarifies and simplifies other aspects of the accounting for income taxes. This update is effective at the beginning of the Company’s 2021 fiscal year, with early adoption permitted. The Company is currently evaluating the impact that the adoption of this standard will have on its consolidated financial statements.
3. Property and Equipment, net
The following is a summary of property and equipment, net (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
May 3, 2020
|
|
February 2, 2020
|
Furniture, fixtures and equipment
|
$
|
74,935
|
|
|
$
|
65,329
|
|
Computer equipment
|
34,719
|
|
|
32,259
|
|
Internal-use software
|
35,832
|
|
|
30,222
|
|
Leasehold improvements
|
40,876
|
|
|
39,447
|
|
Finance lease assets
|
2,861
|
|
|
2,565
|
|
Construction in progress
|
31,920
|
|
|
18,927
|
|
|
221,143
|
|
|
188,749
|
|
Less: accumulated depreciation and amortization
|
76,716
|
|
|
70,018
|
|
Property and equipment, net
|
$
|
144,427
|
|
|
$
|
118,731
|
|
Internal-use software includes labor and license costs associated with software development for internal use. As of May 3, 2020 and February 2, 2020, the Company had accumulated amortization related to internal-use software of $17.1 million and $15.9 million, respectively.
Construction in progress is stated at cost, which includes the cost of construction and other directly attributable costs. No provision for depreciation is made on construction in progress until the relevant assets are completed and put into use.
For the thirteen weeks ended May 3, 2020 and May 5, 2019, the Company recorded depreciation expense on property and equipment of $6.1 million, and $5.0 million, respectively, and amortization expense related to internal-use software costs of $1.2 million, and $1.9 million, respectively. The aforementioned depreciation and amortization expenses were included within selling, general and administrative expenses in the condensed consolidated statements of operations.
4. Commitments and Contingencies
As of May 3, 2020, there were no material changes to the Company’s legal matters disclosed in Note 4 of the “Notes to Consolidated Financial Statements” included in the 10-K Report.
5. Debt
ABL Credit Facility
The Company has a five-year senior secured asset-backed credit facility (the “ABL Credit Facility”) which provides for non-amortizing revolving loans in an aggregate principal amount of up to $300 million, subject to a borrowing base comprised of, among other things, inventory and sales receivables (subject to certain reserves). The ABL Credit Facility provides the right to request incremental commitments and add incremental asset-based revolving loan facilities in an aggregate principal amount of up to $100 million, subject to customary conditions. The Company is required to a pay commitment fee of between 0.25% and 0.375% with respect to the undrawn portion of the commitments, which is generally based on average daily usage of the facility. As of May 3, 2020, the Company had no outstanding borrowings under the ABL Credit Facility.
6. Leases
The Company leases all of its fulfillment and customer service centers and corporate offices under non-cancelable operating lease agreements. The terms of the Company’s real estate leases generally range from 5 to 15 years and typically allow for the leases to be renewed for up to three additional five-year terms. Fulfillment and customer service centers and corporate office leases, including exercised renewal options, expire at various dates through 2034. The Company also leases certain equipment under operating and finance leases. The terms of equipment leases generally range from 3 to 5 years and do not contain renewal options. These leases expire at various dates through 2024.
The Company’s finance leases as of May 3, 2020 and February 2, 2020 were not material. The table below presents the operating lease-related assets and liabilities recorded on the condensed consolidated balance sheets (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
Leases
|
|
Balance Sheet Classification
|
|
May 3, 2020
|
|
February 2, 2020
|
Assets
|
|
|
|
|
|
|
Operating
|
|
Operating lease right-of-use assets
|
|
|
$
|
207,146
|
|
|
$
|
179,052
|
|
Total operating lease assets
|
|
|
|
$
|
207,146
|
|
|
$
|
179,052
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
Current
|
|
|
|
|
|
|
Operating
|
|
Accrued expenses and other current liabilities
|
|
|
$
|
15,321
|
|
|
$
|
15,491
|
|
Non-current
|
|
|
|
|
|
|
Operating
|
|
Operating lease liabilities
|
|
|
229,560
|
|
|
200,439
|
|
Total operating lease liabilities
|
|
|
|
$
|
244,881
|
|
|
$
|
215,930
|
|
For the thirteen weeks ended May 3, 2020 and May 5, 2019, assets acquired in exchange for new operating lease liabilities were $32.0 million and $0.2 million, respectively. Lease expense primarily related to operating lease costs. Lease expense for the thirteen weeks ended May 3, 2020 and May 5, 2019 was $13.4 million and $11.0 million, respectively, and was included within selling, general and administrative expenses in the condensed consolidated statements of operations.
Operating cash flows related to cash paid for operating leases were approximately $10.4 million and $8.3 million for the thirteen weeks ended May 3, 2020 and May 5, 2019, respectively.
7. Share-Based Compensation
2019 Omnibus Incentive Plan
In June 2019, the Company’s board of directors adopted and approved the 2019 Omnibus Incentive Plan (the “2019 Plan”). The 2019 Plan became effective on June 13, 2019 and allows for the issuance of up to 31,864,865 shares of Class A common stock. No awards may be granted under the 2019 Plan after June 2029.
The 2019 Plan provides for the grant of stock options, including incentive stock options, non-qualified stock options, restricted stock, dividend equivalents, stock payments, restricted stock units, performance shares, other incentive awards, stock appreciation rights, and cash awards (collectively “awards”). The awards may be granted to the Company’s employees, consultants, and directors, and the employees and consultants of the Company’s affiliates and subsidiaries.
Service and Performance-Based Awards
Beginning in June 2019, the Company granted restricted stock units that vest upon satisfaction of both a service-based vesting condition and a performance-based vesting condition (“PRSUs”) as described below.
The service-based vesting condition will be satisfied with respect to 25% of an employee’s PRSUs on the first anniversary of the registration date (as defined in the 2019 Plan) and then with respect to 12.5% of an employee’s PRSUs at the end of each six month period thereafter, subject to the employee’s continued employment with the Company through the applicable vesting date.
The performance-based vesting condition shall be satisfied with respect to a percentage of an employee’s PRSUs, as and when the price per share of Class A common stock specified is achieved, on a volume adjusted weighted-average basis, on every trading day during a consecutive 45-trading day period completed prior to the fifth anniversary of the 2019 Plan’s effective date subject to the employee’s continued employment with the Company through the applicable vesting date.
Service-Based Awards
During the thirteen weeks ended May 3, 2020, the Company granted restricted stock units with a service-based vesting condition (“RSUs”). The service-based vesting condition will be satisfied with respect to 25% of an employee’s RSUs on the one-year anniversary of the vesting commencement date and 12.5% of an employee’s RSUs at the end of each six month period thereafter, subject to the employee’s continued employment with the Company through the applicable vesting date. The Company records share-based compensation expense for RSUs on a straight-line basis over the requisite service period. The Company accounts for forfeitures as they occur.
Service and Performance-Based Awards Activity
The following table summarizes the activity related to the Company’s PRSUs for the thirteen weeks ended May 3, 2020 (in thousands, except for weighted average grant date fair value):
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of PRSUs
|
|
Weighted Average Grant Date Fair Value
|
Outstanding as of February 2, 2020
|
21,284
|
|
|
$
|
36.20
|
|
Granted
|
805
|
|
|
$
|
32.30
|
|
Vested
|
(93)
|
|
|
$
|
36.77
|
|
Forfeited
|
(536)
|
|
|
$
|
35.10
|
|
Unvested and outstanding as of May 3, 2020
|
21,460
|
|
|
$
|
36.08
|
|
The total fair value of PRSUs that vested during the thirteen weeks ended May 3, 2020 was $3.2 million. As of May 3, 2020, total unrecognized compensation expense related to unvested PRSUs was $168.4 million and is expected to be recognized over a weighted-average expected performance period of 2.0 years.
The fair value of the PRSUs with share price hurdles was determined on the date of grant using a Monte Carlo model to simulate total stockholder return for the Company and peer companies with the following assumptions:
|
|
|
|
|
|
Performance period
|
5 years
|
Weighted-average risk-free interest rate
|
1.8%
|
Weighted-average volatility
|
49.7%
|
Weighted-average dividend yield
|
—%
|
The risk-free interest rate utilized is based on a 5-year term-matched zero-coupon U.S. Treasury security yield at the time of grant. Expected volatility is based on historical volatility of the stock of the Company’s peer firms.
Service-Based Awards Activity
The following table summarizes the activity related to the Company’s RSUs for the thirteen weeks ended May 3, 2020 (in thousands, except for weighted average grant date fair value):
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of RSUs
|
|
Weighted Average Grant Date Fair Value
|
Outstanding as of February 2, 2020
|
—
|
|
|
$
|
—
|
|
Granted
|
325
|
|
|
$
|
33.31
|
|
Forfeited
|
(2)
|
|
|
$
|
33.31
|
|
Unvested and outstanding as of May 3, 2020
|
323
|
|
|
$
|
33.31
|
|
As of May 3, 2020, total unrecognized compensation expense related to unvested RSUs was $10.5 million and is expected to be recognized over a weighted-average expected performance period of 3.8 years.
The fair value for RSUs is established based on the market price of the Company’s Class A common stock on the date of grant.
As of May 3, 2020, there were 7.2 million additional shares of Class A common stock reserved for future issuance under the 2019 Plan.
Citrus Profits Interest Plan
Subsequent to the PetSmart Acquisition, the Company’s share-based compensation included profits interests units (“PIUs”) granted by Citrus Intermediate Holdings L.P. (the “Citrus Partnership”), a Delaware limited partnership (the “Citrus Profits Interest Plan”). The Citrus Partnership is a parent company of PetSmart and a wholly-owned subsidiary of the Sponsors. The Company recognizes share-based compensation as equity contributions from the Citrus Partnership in its condensed consolidated financial statements for awards granted under the Citrus Profits Interest Plan as it relates to grantees’ services as employees of the Company.
As of June 13, 2019, an aggregate of 768,785 profits interests units under the Citrus Profits Interest Plan were held by employees of Chewy, Inc. and were canceled.
Share-Based Compensation Expense
Share-based compensation expense is included within selling, general and administrative expenses in the condensed consolidated statements of operations. The Company recognized share-based compensation expense as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13 Weeks Ended
|
|
|
|
|
|
|
|
May 3,
2020
|
|
May 5,
2019
|
|
|
|
|
PRSUs
|
$
|
42,010
|
|
|
$
|
—
|
|
|
|
|
|
RSUs
|
219
|
|
|
—
|
|
|
|
|
|
PIUs
|
—
|
|
|
7,230
|
|
|
|
|
|
Total share-based compensation expense
|
$
|
42,229
|
|
|
$
|
7,230
|
|
|
|
|
|
8. Income Taxes
Subsequent to the PetSmart Acquisition, the Company’s losses were included with PetSmart’s consolidated U.S. federal and state income tax returns. Income taxes as presented in the Company’s condensed consolidated financial statements have been prepared on the separate return method as if the Company were a taxpayer separate from PetSmart.
The Company did not have a net current or deferred provision for income taxes for any taxing jurisdiction during the thirteen weeks ended May 3, 2020 and May 5, 2019.
Concurrent with the IPO, the Company and PetSmart entered into a tax sharing agreement which governs the respective rights, responsibilities, and obligations of the Company and PetSmart with respect to tax matters, including taxes attributable to PetSmart, entitlement to refunds, allocation of tax attributes, preparation of tax returns, certain tax elections, control of tax contests and other tax matters regarding U.S. federal, state, local, and foreign income taxes. During the thirteen weeks ended May 3, 2020, the Company recorded a $12.8 million due from Parent pursuant to the tax sharing agreement.
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which was enacted on March 27, 2020, made tax law changes to provide financial relief to companies as a result of the business impacts of COVID-19. Key income tax provisions of the CARES Act include changes in net operating loss carryback and carryforward rules, acceleration of alternative minimum tax credit recovery, increase in the net interest expense deduction limit and charitable contribution limit, and immediate write-off of qualified improvement property. The changes are not expected to have a significant impact on the Company.
9. Net Loss per Share
Basic and diluted net loss per share attributable to common stockholders is presented using the two class method required for participating securities. Under the two class method, net loss attributable to common stockholders is determined by allocating undistributed earnings between common stock and participating securities. Undistributed earnings for the periods presented are calculated as net loss less distributed earnings.
Basic and diluted net loss per share is calculated by dividing net loss attributable to common stockholders by the weighted-average shares outstanding during the period. The weighted-average shares outstanding during the periods presented reflects the reclassification of the 100 outstanding shares of common stock into 393,000,000 shares of Class B common stock.
For the thirteen weeks ended May 3, 2020 and May 5, 2019, the Company’s basic and diluted net loss per share attributable to common Class A and Class B stockholders are the same because the Company has generated a net loss to common stockholders and common stock equivalents are excluded from diluted net loss per share as they have an antidilutive impact. The computation of diluted net loss per share attributable to common stockholders does not include 21.8 million potential common shares for the thirteen weeks ended May 3, 2020 as the effect of their inclusion would have been antidilutive.
Conversion of Class B Common Stock
On May 8, 2020, Buddy Chester Sub LLC, a wholly-owned subsidiary of PetSmart, converted 17,584,098 shares of the Company’s Class B common stock into Class A common stock. On May 11, 2020, Buddy Chester Sub LLC entered into a variable forward purchase agreement to deliver up to 17,584,098 shares of the Company’s Class A common stock at the exchange date, which is expected to be May 16, 2023, determined by reference to the trading price of the common stock at that time.
10. Certain Relationships and Related Party Transactions
The Company’s condensed consolidated financial statements include management fee expenses of $0.3 million allocated to the Company by the Parent for organizational oversight and certain limited corporate functions provided by its sponsors for the thirteen weeks ended May 3, 2020 and May 5, 2019. Allocated costs are included within selling, general and administrative expenses in the condensed consolidated statements of operations.
Certain of the Company’s pharmacy operations are currently, and have been since launch on July 2, 2018, conducted through a wholly-owned subsidiary of PetSmart. The Company has entered into a services agreement with PetSmart that provides for the payment of a management fee due from PetSmart with respect to this arrangement. The Company recognized $11.7 million and $10.5 million within net sales in the condensed consolidated statements of operations for the services provided during the thirteen weeks ended May 3, 2020 and May 5, 2019, respectively.
PetSmart Guarantees
PetSmart currently provides a guarantee of payment with respect to certain equipment and other leases that the Company has entered into and serves as a guarantor in respect of the Company’s obligations under a credit insurance policy in favor of certain of the Company’s current or future suppliers.