Petco Out of the Dog House

The filing delay was prompted by the discovery of accounting errors after Petco's fourth-quarter earnings report this March. Some expenses within the company's distribution operation were under-accrued. This sent Petco accountants back to the books for what James M. Myers, CEO, called "a comprehensive internal review."

Petco finally filed its 10-K with the SEC on June 28 and, the following day, received notice from Nasdaq that it was back in compliance and that a hearing regarding de-listing, originally scheduled for June 30, would not be necessary. Case closed. On Friday, July 1, the company's PETC trading symbol will be restored, free of the E that Nasdaq attached during the non-compliance period.

"While it was very disappointing to identify a control deficiency in any part of our company," Myers said, "it is important to note that the comprehensive review, which included the participation of independent, external experts, concluded that the errors in under-accruals were limited to our distribution operation. We acted quickly and decisively to strengthen our controls, processes and oversight responsibilities to prevent such errors in the future."

At the same time, however, Petco projected comp store increases of between 3% and 4% for its second fiscal quarter, down from its previous projection of between 4% and 5%. As a result of this downward revision, plus the after-tax charge of $3.6 million related to the conclusions of the internal review, Petco also said it expected earnings to be at the lower end of its earlier guidance.

Nevertheless, for the most part, Wall Street analysts expressed guarded confidence in Petco. Like Petco itself, Piper Jaffray & Co. lowered its sales and earnings-per-share estimates for PETC stock, but, senior research analyst Michael E. Cox, said it would "maintain our outperform rating as we remain confident in the long-term growth outlook and believe the disappointing near-term results are already reflected in the stock."

At the same time, Cox noted that store traffic at Petco "remains sluggish," and attributed it to a marketing misstep, which he believes is being corrected. The overall pet supply retail sector remains strong, he indicated.

As for the company's review following the accounting errors, Cox said, "while costly, time consuming and an unwelcome distraction for senior management, (it) has resulted in the implementation of strengthened controls that should give investors increased confidence in future reported numbers."

Those sentiments were echoed by Joseph Feldman, analyst with SG Cowen & Co. "Despite PETC's disappointing outlook, we maintain our thesis that the company is positioned to convert favorable industry trends and its strategic initiatives into (between) 17% to 20% earnings-per-share growth over the next several years," Feldman said.

However, Feldman added, "We continue to favor PETM (referring to rival PetSmart's Nasdaq symbol) . . . . (which) continues to execute well and appears to be pulling away from PETC due to its greater store growth, consistent comps, bigger services business, which has greater growth potential given PETM's larger box, and its infrastructure improvements."