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Executives

April Lenhard

Robert F. Moran - Chairman, Chief Executive Officer and Member of Disclosure & Ethics Committee

Lawrence P. Molloy - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Member of Disclosure & Ethics Committee

David K. Lenhardt - President and Chief Operating Officer

Analysts

Gary Balter - Crédit Suisse AG, Research Division

Peter S. Benedict - Robert W. Baird & Co. Incorporated, Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Michael Baker - Deutsche Bank AG, Research Division

Michael Lasser - UBS Investment Bank, Research Division

David Gober - Morgan Stanley, Research Division

Peter J. Keith - Piper Jaffray Companies, Research Division

PetSmart (PETM) Q4 2012 Earnings Call March 6, 2013 4:30 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to PetSmart's Fourth Quarter and Fiscal Year 2012 Analyst Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. April Lenhard, Director of Investor Relations.

April Lenhard

Good afternoon, and welcome to PetSmart's conference call to announce our results for the fourth quarter and for all of fiscal 2012.

With me on the call today are Chairman and Chief Executive Officer, Bob Moran; President and Chief Operating Officer, David Lenhardt; as well as Chip Molloy, Executive Vice President and Chief Financial Officer. Bob will kick off the call with an overview of our results, and then Chip will take you through the financial review, as well as our earnings guidance. David will review the operations of the business and provide insights into our upcoming year. And finally, we'll take your questions.

Please keep in mind, everything we cover during today's call, including the question-and-answer session, is subject to the Safe Harbor statement for forward-looking information you'll find in today's news release.

Thanks, and I'll now turn the call over to Bob.

Robert F. Moran

Thanks, April, and good afternoon, everyone. We are pleased to report another quarter of solid earnings growth. As a reminder, fiscal year 2012 was a 53-week year. The fourth quarter and the year included an extra week.

For the fourth quarter, earnings per share were $1.24, up 36% when compared to $0.91 for the fourth quarter last year. Comparable store sales or sales in stores open at least a year grew 4.6%, and comp transactions, which we use as a proxy for traffic, were up 1.2%.

Our performance in the fourth quarter was solid across all 3 merchandising categories: consumables, hard goods and live goods, as well as across services. As the industry leader, we continue to evolve the customer experience for our pet parents by providing highly differentiated services, including professional grooming, training, boarding, day camp and full-service veterinary care, all under one roof, as well as a full assortment of solutions for the lifetime needs of pets.

We are privileged to have the most passionate associates in the industry who engage with our pet parent customers to offer solutions throughout all the pets' life stages, empowering them to help their pets live long, healthy and happy lives. Our unique portfolio of solutions, centered around our merchandising and service offerings, is further strengthened by our culture of innovation and differentiation and truly sets us apart from the competition.

Through our partnership with PetSmart Charities, the largest funder of animal welfare efforts in all of North America, we are proud that nearly 1,100 homeless pets are saved each day in our stores. And thanks to the strong vendor support from partners like Nestle Pro Plan, with the National Adoption Event Weekends like the one held last month, where the lives of nearly 18,000 pets were saved. We can continue to make a real impact because when you adopt, you not only save a pet's life, you enrich your own.

And this year, we extended our exclusive Luv-A-Pet product line, including plush dog and cat toys with heart designs and apparel, beyond the holiday season and into the month of March. We are proud to be able to donate 10% of the sales price from this exclusive line to PetSmart Charities.

As a side note, last week, I became Chairman of the Board of PetSmart Charities. I look forward to the continued partnership between these 2 companies that has made a real difference in the lives of millions of pets and their pet parent families.

The PetSmart brand is strong and it resonates with our customers. The strength of our results is really a testament to the strength of our management team. Our seasoned management team is strategically aligned across the company, and I am confident in their abilities to execute on our strategic priorities.

We recently announced some planned management succession that will be effective June 14, 2013, following the annual meeting of stockholders. David Lenhardt, our President and Chief Operating Officer, will be assuming the role of Chief Executive Officer and will be appointed to the Board of Directors. At which time, I will be appointed Executive Chairman. David has made so many contributions to PetSmart since joining the company 12 years ago. Under David's leadership, our services business, one of our key differentiators, has grown from annual sales of $90 million to more than $740 million today.

From a store operations perspective, we have developed scalable and effective processes and disciplines to drive results. And we've evolved our customer experience, dramatically increasing overall customer satisfaction scores. And throughout the last year, David has expanded his focus on the entire enterprise, leading us in strengthening the integration across our functions, enhancing our culture and helping ensure we continue on our path to become a best-in-class retailer. David has a deep understanding of our business as well as our culture, and I'm proud that he will be taking the helm of this great company.

Joe O'Leary, Executive Vice President of Merchandising, Marketing, Supply Chain and Strategic Planning, will be named President and Chief Operating Officer in June. Joe has made many significant contributions since joining PetSmart 6 years ago, helping to develop and deliver many strategies that have been a cornerstone to our recent success, including the development of exclusive brands like Martha Stewart, GNC and Bret Michaels, the growth of our proprietary brands, the introduction of flea and tick products, and the formation and development of our new strategic planning function to position us for future success. Joe has proven to be a strategic leader with the right balance of creativity and foresight to help us maintain our momentum.

I'm excited about the future of PetSmart under the leadership of our incredibly experienced, motivated and talented team. As we look ahead to 2013, this planned management succession will allow us to remain focused on executing the strategies that have been a key to our success over the past several years and continuing to drive top quartile shareholder returns.

And with that, I will now turn the call over to Chip.

Lawrence P. Molloy

Thanks, Bob, and good afternoon, everyone. Today, I will be reviewing our fourth quarter and full year results for fiscal year 2012 and providing 2013 guidance for both the full year and first quarter.

As Bob mentioned, fiscal 2012 consisted of 53 weeks, resulting in a 14-week fourth quarter that ended on February 3, 2013. Comparable store sales and comp transactions are calculated on an equivalent basis on our versus the 14 and 53 weeks ended February 5, 2012. I will initially provide results on a GAAP basis for both the quarter and the year, and then provide details relating to the extra week. Earnings for the quarter were $1.24 per share. Comparable store sales growth was 4.6%, and comp transactions were positive for the 11th consecutive quarter at 1.2%.

Total sales for the quarter were $1.9 billion, up 15%. The increase in total sales included a favorable impact from foreign currency fluctuations of $3 million. Services sales, which are included in total sales, increased 15% to $194 million. Other revenue, which is also included in total sales, was $10 million, representing reimbursements from Banfield for the space they utilize in our stores.

The sales mix for the quarter included consumables at 53.5%, hard goods at 34.2%, services at 10.3%, live pets at 1.5% and other revenue at 0.5%.

Gross margins for the fourth quarter were up 120 basis points to 31.6%. Within the gross margin line, merchandise margins were 40.3% of total sales, while services were 2.8%.

Store occupancy and warehouse and distribution costs were 7.8% and 3.7% of total sales, respectively.

Operating, general and administrative expenses were 19.8%. Net interest expense for the quarter totaled $13.3 million, and overall earnings before tax increased to $208 million, or 11.1% of sales. The tax rate for the quarter was 37.7%.

Now for the full year 53-week results. Earnings per share were at $3.55, up 39% compared to $2.55 last year. Comparable store sales growth was 6.3%, and comp transactions were up 2.4%. Total sales were $6.8 billion, up 11%. The increase in total sales included an unfavorable impact from foreign currency fluctuations of $2 million.

Services sales, which are included in total sales, increased 10% to $740 million. Gross margins for the year improved 100 basis points to 30.5%. Within the gross margin line, merchandise margins were 39.9% of total sales, services margins were 3.1% of total sales, rent and occupancy costs totaled 8.6% and our warehouse and distribution costs were 3.8% of sales. OG&A expense for the full year was 20.9%.

For the year, earnings before tax increased to $597 million, or 8.8% of sales, and the tax rate was 37.4%.

Now I'd like to outline the impact of the extra week. Bear in mind, the extra week includes sales, margin dollars and variable costs associated with those sales. It does not include any fixed costs. Total sales for the extra week were $126 million. The total sales included $113 million in merchandise sales and $13 million in services sales.

Within the gross margin line, the week added $50 million in merch margin dollars, $3.5 million in services margin dollars, $1.5 million in rent and occupancy cost and $4 million in warehouse and distribution cost. The OG&A cost for the week totaled $18 million while interest expense was 0. The combination of margin and cost produced an extra $30 million of earnings before tax and $0.17 of EPS.

Excluding all the impact of the extra week, the company still produced rate improvements in all 4 buckets of gross margin during the quarter resulting in continued EBT expansion.

During the year, we opened 60 new stores and closed 14, which included 11 new store openings and 2 closings during the fourth quarter. We also opened 5 PetsHotels and closed 1, including 1 opening in the fourth quarter, bringing our year-end totals to 1,278 stores and 196 hotels. We ended the quarter with average inventory per store of $531,000, up 1.5% compared to the end of last year.

During the year, we generated $696 million in operating cash flow and spent $138 million on capital expenditures. In addition, we distributed $84 million in dividends, with $35 million being paid in the fourth quarter.

We repurchased $457 million of PetSmart stock during the year, with $175 million repurchased during the fourth quarter. Our weighted average share count for the full year was 110 million shares, and for the fourth quarter, it was 108 million.

Depreciation and amortization expense was $238 million for the full year. We ended the year with $407 million in cash, cash equivalents and restricted cash and 0 borrowings on our credit facility.

Although the macroeconomic environment remains challenging, we are confident in our ability to influence those things within our control to continue to deliver on our commitment of driving strong operating results while maintaining a healthy balance sheet.

Guidance for 2013 will also be on a GAAP basis. Therefore, all comparisons will be 52 weeks for 2013 versus 53 weeks for 2012. For 2013, we anticipate comp store sales growth of 2% to 4%, total sales growth of 2% to 4% and earnings per share from $3.76 to $3.92. We expect gross margins to be flat to slightly up. OG&A to grow in dollars approximately 3%, interest expense to be down a bit from a dollar perspective and EBT margin to expand slightly.

We anticipate the tax rate to be around 38% and expect the equity income from our Banfield investment to grow approximately 10%. The guidance also assumes that we utilize the $347 million remaining on our current share repurchase authorization, which should reduce our weighted average share count to approximately 105 million shares for the year.

Our 2013 capital expenditures are expected to be between $140 million and $150 million. We plan to use approximately 25% of that CapEx to open 45 to 50 net new stores of our 12,000 and 18,000 prototypes. We will also be testing 12 micro stores this year, ranging from 6,000 to 7,500 square feet, which David will speak to a bit later.

We also expect to open 3 new PetsHotels. The remaining 75% of our CapEx will be spent on store remodel type projects, supply chain, IT, maintenance and other infrastructure improvements.

We continue to fund our needs with our cash flows from operations and currently have no plans to borrow against our revolving credit facility. Our free cash flow, defined as our operating cash flow, less our capital lease obligations and capital expenditures, is expected to be between $430 million and $450 million for 2013. Operating cash flow is expected to be between $640 million and $660 million, and capital lease obligations are expected to be approximately $70 million.

For the first quarter of 2013, we are expecting comparable store sales growth of 2% to 4% and earnings per share of $0.92 to $0.98. EBT margin is expected to improve 25 to 35 basis points when compared to the first quarter of last year. The improvement should come from gross margin expansion, while OG&A costs grow 5% to 6% when compared to the first quarter of last year. The tax rate is expected to be approximately 36%.

We remain committed to our long-term guidance of delivering 11% to 17% EPS growth and believe we have a 2013 operating plan that can deliver on those goals.

And with that, I would like to turn it over to David Lenhardt who will highlight our 2012 operational activities and provide insights into our 2013 priorities.

David K. Lenhardt

Thanks, Chip, and good afternoon, everyone. As Bob mentioned, our fourth quarter performance was solid across all of our merchandising categories: consumables, hard goods and live goods, as well as services. 2012 was another year of innovation and differentiation as we continued to make strides on our journey to becoming a best-in-class retailer.

Within consumables, we continue to see strength in the super premium natural category. Following our consumables reset in the first quarter, our penetration of channel-exclusive foods sold only in pet specialty stores or through vets is now more than 75% of our food sales.

In hard goods and specialty, we've added a lot of innovation through resets, most recently with the Toy Chest reset in the dog toy aisle and the aquatic and small animal resets this year.

We've also expanded our offerings of exclusive and proprietary brands and increased our penetration to 24%, including Martha Stewart Pets, KONG, GNC Pets, Toys "R" Us Pets and the Bret Michaels Pets Rock collection, as well as our own proprietary brands including Top Paw, Grreat Choice, Top Fin, Authority and Simply Nourish. These highly differentiated brands represent innovation, quality and value and really resonate with our pet parents.

The key customer insights and strong vendor partnerships that we've developed allow us to maximize the potential of our key brands, which we showcase through our fully integrated and compelling marketing campaigns.

In services, our quality of care and grooming continues to drive sales with the Grooming Look Great Guarantee, and we continue to see strength in PetsHotels. This year, we rolled out our PetsHotel call center to all of our hotels just in time for our peak holiday season. And I'm pleased to report that we achieved a milestone this year of overall profitability in our PetsHotel business.

We've shown our customers how we're different from the competition and how we offer the best choice. But we are not done. Looking ahead to 2013, we are very excited about our robust pipeline of innovation to drive even further differentiation.

In the first quarter, we will continue to support the growth in the super premium natural aisle by optimizing the assortment within categories and brands. We'll be expanding the space dedicated to BLUE Buffalo, as well as to our own proprietary super premium brand, Simply Nourish. And we'll be introducing new formulations in both dog and cat across top channel-exclusive brands.

As the humanization of pets trend continues, novel new proteins like bison and venison and new meatloaf and casserole-inspired wet formulas are further expanding the grain-free and high-protein offerings in both wet and dry food across breeds and life stages.

We will also see some relaunches during the first quarter from top channel-exclusive brands like Hill's, Purina and Nutro with updated formulations and packaging.

By expanding our grain-free, limited-ingredient and high-protein options for our pet parents, we continue to strengthen our position as the leading provider for the proactive care of well pets by providing the right breadth and depth of solutions for all of the pets' health and nutritional needs.

In hard goods, we continue to innovate and differentiate our assortment. And we just announced the newest addition to our portfolio of exclusive brands, with an exclusive partnership with Disney to introduce a new line of pet apparel and toys, including well-known characters like Donald Duck, Tinker Bell, Kermit the Frog, Tigger and Mickey Mouse. These Disney characters have a special place in many pet parents' hearts, and we're proud to be able to partner with Disney to create this exclusive collection which allows our pet parents the ability to share the magic of Disney with their pets in a fun and fashionable way.

Further innovation in this category will continue this year within our existing brands as well, including the ongoing fresh new assortments in the Martha Stewart Pets collection and newness in the Bret Michaels Pets Rock collection.

In the second quarter of this year, we will reset reptile, the fastest-growing species in the specialty category, with improved adjacencies and layout, brand launches and improved educational signage with clear, good, better, best brand positioning. We will continue to differentiate with an innovative assortment and a focus on solutions driven by our extensive customer research to drive an easier customer shopping experience.

In services this year, we have new initiatives to drive improved productivity, efficiency and new offerings, including better integration with the core store and fully leveraging synergies between grooming, training and PetsHotels.

In grooming, we'll continue to brand exclusive products and services in our salon that have strong customer connections in our core business, like our Bret Michaels top dog grooming package that includes a Bret Michaels bandanna and cologne, and our Top Dog SPAW package that includes GNC paw cream and Very Berry facial wash. And our newest offering, K9 Advantix II flea and tick services allows pet parents to purchase the product in our stores with the added convenience of having the product applied right there in the salon.

In PetsHotels, we will continue to leverage our PetsHotel call center to drive efficiency and increased hotel sales and add-ons. Delivering authentic customer connections is at the core of our customer experience. We will continue to evolve this experience in our stores through investments in our associates with training and development so they can continue to engage with our pet parents in an authentic and genuine way.

Our customer-centric focus is also the foundation of our 3-pillar Omni-channel strategy, which includes e-commerce, e-influence and building new capabilities. PetSmart.com has been and continues to be the #1 most trafficked website in the pets supplies category.

In 2012, we outperformed the industry in sales growth and grew our dot-com customer base, including strong growth in channel-exclusive foods. We added over 7,000 extended isle SKUs, grew our e-influence sales and launched 21 site and mobile enhancements to improve the overall user site experience.

We continue to remain focused on this important area of our business in 2013, with a number of initiatives that are grounded in the 3 pillars of our strategy around e-commerce, e-influence and building new capabilities. The customer benefits of these initiatives will include a better web experience with simplified navigation, enhanced search optimization, product comparison, product swatches and zoom images, as well as proactive product recommendations. We will also be laying the foundation this year for building even more Omni-channel capabilities centered around the core goal of simplifying the shopping experience for our customers whenever and wherever they choose to engage with us.

The last area that I want to talk to you about, as Chip mentioned, is our store prototype. We continue to innovate around the size of our prototype store, while still retaining the essence of our brand. This year, we are going to be testing 12 6,000- to 7,500-square-foot micro stores which are scheduled to open in the first half of the year.

All of the initiatives that we have planned for 2013 would not be possible without the integration and alignment across merchandising, marketing, supply chain and store operations. It is the strength of this alignment that will allow us to continue to navigate our way on our journey to becoming a best-in-class retailer.

With a culture of innovation and differentiation across the company, strong vendor partnerships and support from integrated marketing campaigns that highlight our exclusive and innovative assortments, we will continue to challenge ourselves to improve on the key strategies that define our brand. While we expect the macro economy will continue to hold challenges in 2013, we believe that the strength of our seasoned management team, coupled with our focus on our strategic and operational priorities, will allow us to continue to navigate through these uncertain economic times.

Looking forward, we will continue to build on the solid performance of 2012 with an unwavering focus on our strategic priorities. And we're intent on executing them at every level of the business to deliver top quartile shareholder returns in 2013 and beyond.

And with that, we would like to take your questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Gary Balter of Credit Suisse.

Gary Balter - Crédit Suisse AG, Research Division

Did we talk -- 2 questions, and they're both related to numbers. One is talk about kind of the comp from this quarter. It's not a terrible number by any means, the 4.6%, but I think it was a little bit below what some people were looking for. And then second part -- second question is you guided 2% to 4% and you guided essentially what works out to about 13.6 average increase over this year, which is right in your waterfall. And was there something in that 2% to 4% -- is that just following kind of your slide or is there something that's says, "Hey, things are going to be a little bit slower, so we better be more conservative for 2013"?

Lawrence P. Molloy

Gary, it's Chip. Well, if you think about it at the beginning of the quarter, we said we were going to have a mid-single-digit, so we came in at 4.6%. And one could argue we were off a little bit, 40 bps, but pretty much in line with what we thought. I think, for the quarter, we were just a hair lighter on sales, a little bit better -- right in line with gross margin, a little bit better on the cost side, a little bit better on tax and had a slightly better quarter, solid on the earnings side. As it relates to the comp guidance, it's not just following the fishbone, it is -- we're now coming up on our third year. It's comp on top of comp on top of comp. And as we go into the year, we feel comfortable in that range for now and we'll see how the year plays out.

Gary Balter - Crédit Suisse AG, Research Division

When you think about inflation, because that's helped a little bit in past years, what are your thoughts on what the inflation impact is going to be?

Lawrence P. Molloy

Yes. This year, it was almost 200 basis points this year. It will be slight -- as we see the world today, it will be slightly less than that for the upcoming year, not dramatic but slightly less.

Gary Balter - Crédit Suisse AG, Research Division

So then if you get, let's say, 1 point, 1.5 points, and you talked about Disney and some of these -- what sound like pretty exciting product introductions and some of the resets. Does 2% to 4% strike you as being a little bit on the conservative side?

Lawrence P. Molloy

Well, we're comfortable with it for now, Gary. We'll see how the year plays out.

Operator

Our next question comes from Peter Benedict of Robert W. Baird.

Peter S. Benedict - Robert W. Baird & Co. Incorporated, Research Division

Couple of questions. First just when you think back to the fourth quarter, was there any measurable impact from Sandy in that 4.6% comp? And then as you think about how this year has started off, I know you had the spring break early last year that helped flea and tick sales, just talk to us about maybe what's going on so far here in the first quarter?

Lawrence P. Molloy

Yes. Peter, it's Chip. So we don't typically talk about the intra-quarter, but I think it was a little volatile over the quarter, so it's worth speaking to for now. The quarter started off slow primarily because of Sandy. We spoke to you guys on the call, we were at a point where we could talk about that and started out slow. It came back as expected, really comfortable through most of the quarter. And then, right towards the end of the quarter, it sort of lightened up a little bit and that flowed into the beginning of this quarter. So traffic is not as strong as it was. However, we're encouraged just of recent -- sequentially, this quarter has gotten better each week, and we're encouraged just that recent performance has improved.

Peter S. Benedict - Robert W. Baird & Co. Incorporated, Research Division

Okay, that's helpful. That sounds very familiar to actually a number of retailers. I guess turning to the micro stores, can you maybe help us understand how the offering is going to be edited in those versus the core box, would have services, et cetera?

David K. Lenhardt

Yes, Peter, it's David. As we talked about, in our intent here is as we continue to innovate around our store prototype, one of the things we're going to be testing this year is 12 stores. We're going to open them in all Q1 and Q2. They're going to be 6,000 to 7,500 square feet, and the intent here is to keep our brand essence with a broad assortment in services and to reach new pet parents. Now having said that, in a 6,000 to 7,500-square-foot, what you will see, less SKUs in certain areas. But again, the intent is broad assortment and retain our services in terms of grooming, pet training and having adoptions.

Operator

Our next question comes from Christopher Horvers of JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Can you talk about -- Chip, you quoted the merchandise margin components as a percentage of sales this year. Can we talk -- can you restate those and talk about what the change was versus last year in the fourth quarter?

Lawrence P. Molloy

Yes. I would do that on a 53-week basis, so I'll do that for now, and then you'll just have to back into it. I was trying to give the dollars so you guys can get there and be very specific, so hold on just a second. So on a 53 versus -- or a 14 versus a 13, year-over-year, we're looking at -- for Q4, on the margin side, you're down -- the gross margin is down about 30 bps. You're looking at merch margin essentially flat. You're looking at DC or warehouse and distribution flat -- oh, I'm sorry, take that totally away, never mind. Never mind, no, I won't do this. That didn't make any sense, did it?

Christopher Horvers - JP Morgan Chase & Co, Research Division

No.

Lawrence P. Molloy

Sorry about that. So it started to hunt [ph] with me. So on a gross side, we're up almost 120 basis points. Merch margin was up, call it 15. Services margin was up, call it 5. Store occupancy was up, call it 90. And DC was up about 10, and that's 53 versus 52.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Understood. And then so as we think about the year ahead and how you're contemplating gross margin, do you expect the growth rate in the dollars in something like occupancy and DC? Do you think that occupancy grows in line with footage, or does the smaller store base and smaller store sizes that you're opening have a mitigating factor one way or the other?

Lawrence P. Molloy

Yes. I'm looking at -- if you assume the midpoint of our guidance on top line, I think that you're going to be looking at a little bit of leverage on a 52 to 52, you're going to be looking at a teeny bit of leverage on the store occupancy side, and I would call it a push on the warehouse and distribution side, and you're going to get some improvements -- slight improvements on the merch margin side, and call it a push on services.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And then in terms of the category performance, can you talk about how the different components of the food category performed between super premium and bridge and premium and grocery?

Lawrence P. Molloy

Yes, it's continuation of the same. Our super premium, and especially our super premium or what we call natural now in the house, is -- continued to be really strong, very strong, double-digit comps in those spaces. The premium mile is okay. And then on the lower-end foods, not so good. And that's been -- I guess that's been going on now for a significant amount of time, and that's both in dog and cat.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And then one final one. Can you talk about the average unit retail growth during the quarter? What drove that and how you think about that in 2013?

Lawrence P. Molloy

Yes, yes. So on average, if you take the components, we had traffic of 1.2, so call it traffic was up slightly. Units in the basket was essentially flat, was just a hair down. Overall units were up a bit. And then AUR was pretty decent, we won't give it specifically, but about 1/3 of the AUR increase was driven by inflation and the other 2/3 is really mix. And it's all the higher-end things that we talked about.

Operator

Our next question comes from Matt Fassler of Goldman Sachs.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

I want to talk about your decision to re-up with GSI for the Internet business. I'm assuming, I guess, you initially signed your deal with them. And I'm not sure when it started. The online business was extremely small, and I know it's still a small business for you today. Clearly, the focus on this business, both by you and by your competition, has increased to some degree. There are some retailers that view -- control over distribution and other facets of online as very critical although GSI obviously has other customers. So how did you make this decision relative to your -- around the choices here?

David K. Lenhardt

Yes, Matt, it's David. As we've been really focusing much more on our Omni-channel strategy over the past year and really focusing on those 3 pillars of e-commerce, e-influence, the idea of driving traffic into our stores and then building the Omni-channel capabilities. And as we look at our website as the key foundation for that, and as you said, we've been working with GSI for a period of time, I would say that one of the things that we're very excited about in working with GSI that is different from when we first started working with them is the fact that they were acquired by eBay. And as we have continued to partner with GSI but also with eBay, we've been very impressed with the capabilities that eBay can bring to bear in addition to GSI, again, against all 3 of those priorities, both the e-commerce side and the distribution side, but also from a website perspective and, again, building Omni-channel capabilities for the future. So all of that led us to the decision to continue to work with GSI.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And then a second question if I could. David, you're set to take over as CEO imminently. If you could talk perhaps about some of the vision you have that might be different from Bob. Obviously, you've worked together for a long time, but what changes might we might expect as a result of this transition?

David K. Lenhardt

Yes, thanks, Matt. I would start by saying I would characterize it probably as an evolution. I think as a company, we've been very focused and I think very appropriately so on innovation, differentiation, coupled with very strong financial disciplines. And I would expect that we will continue on that focus. And I would anticipate probably sometime post June, I'll elaborate a little bit more on how I think about that evolution. But I would highlight that evolution would be the key word because I think we've got a strategy that works, and I think we are having success in the marketplace, and we'll continue -- plan on continuing to grow and build upon that strategy.

Operator

Our next question comes from Michael Baker of Deutsche Bank.

Michael Baker - Deutsche Bank AG, Research Division

So a couple of follow-ups from some topics that have already come up. Start with the canine [ph] exclusive if I could. So I think you said it's 75% of the food now. Can you compare that where it might have been last year or a couple of years ago? And more importantly, I guess, what can that ultimately get to? At some point I assume you're not going to be 100% channel-exclusive, but where do you think it tops out?

David K. Lenhardt

Yes. Mike, it's David. Off the top of my head, I don't know what it was a couple of years ago. I would tell you it was less. I think in terms of the question of, where can it go, hard to put a number on that. But I think that we, as Chip said, we're continuing to see very attractive growth in that space. And I think, as we talked about before, the ongoing trend of humanization of pets is really continuing to drive this business, and you're seeing that play out from a consumables perspective. And so as we think about 2013 as an example, some of the things that I think gives us confidence that, that's going to continue to grow is we're going to be expanding the space. You'll see us expand space for BLUE Buffalo. And what you're going to see us introduce around BLUE Buffalo are new proteins like bison and venison. You're going to see us expand Simply Nourish with new grain-free, new high-protein. On the cat side, you will see us expand our Simply Nourish cat and cat treats. And you're going to see us introduce new meatloaf and casserole-inspired wet formulas. And when you think about some of the descriptions I just gave you, these are some human trends you're seeing us continue to be able to bring in to the pet marketplace. And I think that, that trend continues, and I think we continue our merchant team to innovate both with our proprietary brands, but also to partner with other consumable vendors and that pipeline looks very strong to us going forward.

Michael Baker - Deutsche Bank AG, Research Division

So in terms of square footage for the food aisles, is it -- I assume it's a smaller percent than that 75%, so I imagine it as higher ticket and higher turnover, is that right? And so what percent of the food aisles is it now and what can it go to, just concerned with the square footage?

Lawrence P. Molloy

Michael, it's Chip. I would say I don't know where it was and don't even actually know where it is without going digging -- someone has it in the building. That being said, if you go into the store, you can walk the aisles and get a really good estimate of how much square footage is dedicated to the different aisles. It has moved in our 2 big food resets that we've done over the last 3 years. The whole intention of that, those resets, the primary intention really was to give more space to the higher-velocity growing businesses such as the super premium natural aisles while taking away from those businesses that were actually declining like grocery. So the space has been reshifted twice, and we'll probably be looking at another food reset at the beginning of 2014 if we continue the cadence of every 2 years. And I think, based on velocities today and based on all the introductions that David just spoke to, you're going to continue to see more space dedicated to that. What we haven't done is expanded consumable space in the box. That's something that we'll probably have to think about before our next consumables reset next year, but that's to be determined.

Michael Baker - Deutsche Bank AG, Research Division

Okay, that's helpful. One more if I could on a different subject is the side [ph] and is the online business, and you said it's growing. I guess can you describe what the margins look like on the online business, and what you're doing about shipping? I know you've had some free shipping offers. But generally, not free shipping, what's the response rate for the free shipping offers and how does that impact the margins?

Lawrence P. Molloy

So we have a policy that -- as it relates to pricing that we are utilizing the same pricing online as we are in the stores. So therefore, at the gross line, you're going to get very similar, almost exact margins both online and in the store. Where you're going to get actual net profit is really -- comes down to the big driver's going to be free shipping or not. And so when we play in the free shipping game, we're not free shipping all the time, we play with the price points, we move that around and see how it works and how it drives velocity. But at the end of the day, when you're giving free shipping and you're at the same price point as you are in the store, obviously it's going to be less profitable.

Operator

Our next question comes from Michael Lasser of UBS.

Michael Lasser - UBS Investment Bank, Research Division

Chip, would you mind expanding on the puts and takes within the merch margin for the quarter? The comparison was easier for the period and yet it was only up 15 basis points.

Lawrence P. Molloy

You're talking about on the merch side?

Michael Lasser - UBS Investment Bank, Research Division

Yes.

Lawrence P. Molloy

Yes, I mean, on the merch side, hold on just a second -- so we had -- we had merch -- give me just a second again. I want to make sure I'm talking to the right place like I was before. On the merch side, yes, I mean, it was still solid. It was -- the first 2 quarters of the year, we were looking at, on average, high single digits and we had about 30 bps in Q3. And in Q4, we still had 15 bps. So I mean, it's not dramatic. But yes, it was last year, in Q3 and Q4, we were pretty promotional, which we weren't as -- and this was on low-end, essentially low-end, primarily cat. And we weren't as promotional in the back half for this year. So yes, that helped, but it helped both in Q3 and Q4. The quarter generally looked pretty similar to Q4 -- to Q3 from a merch perspective.

Michael Lasser - UBS Investment Bank, Research Division

And were there any offsets that may have dampened the merch margin expansion you would have otherwise gotten?

Lawrence P. Molloy

No. No, I think it was generally in-line with what we were expecting. Actually, it was right on line with what we're expect coming into the quarter.

Michael Lasser - UBS Investment Bank, Research Division

Okay. And then a bigger question, you guys have mentioned that over the last few years you comped on top of comp on top of comp, in part because of all the great merchandising work that you've done. Do you feel like the magnitude of the potential that's in front of you is not as great as what's behind you?

David K. Lenhardt

Michael, it's David. The short answer is no. I think we've got a very strong merchandising team that continues to work with our vendors. And I think in a world of humanization of pets, and I just talked a little bit about the consumables side, but I think it also carries over into the hard goods and into the specialty side, you're going see us continue to innovate and differentiate. And I think we've got a lot of runway ahead of us. And I think we talked a little bit about consumables, but we're starting to talk about Disney. We're going to continue to evolve with Bret Michaels and Martha Stewart from a hard goods side. We're going to be resetting the reptile section of specialty, which is the fastest-growing section of specialty. And so I think we have absolutely continued runway.

Michael Lasser - UBS Investment Bank, Research Division

Last question for Chip. With the escalate -- a slight escalation in capital expenditures, are you expecting that depreciation and amortization is still going to come down by a double-digit rate in 2014?

Lawrence P. Molloy

Just the timing -- it's going to come down high single digits, not quite double digits, and you'll see a couple of years of that, '14 and '15. It may slide a little bit into the latter part of '14 into '15. And the CapEx as a percentage of sales is really pretty steady year-over-year.

Michael Lasser - UBS Investment Bank, Research Division

So for 2014, 2015, for the full year, we can still expect the high single-digit decrease in the dollars of D&A?

Lawrence P. Molloy

Yes, beginning about the middle of '14, you'll start to see high single digits in -- so in '14, it's off, it'll probably be mid-single-digits, and then going into '15, high single-digits. And you'll get essentially 2 years of that.

Operator

Our next question comes from David Gober of Morgan Stanley.

David Gober - Morgan Stanley, Research Division

Dave, you mentioned some of the improvements on the services business. I was just curious if you could give any color around the performance in that business, around some of the implementation of the new call center and if you're expecting to see any flow-through in that business in 2013 in addition to some of the other changes you're making there?

David K. Lenhardt

Yes, David, with respect to the call center, that's really our PetsHotel business where, and again, we rolled that out nationwide just in time for the holidays, which is obviously a very busy time for us. And that's really going to enable us and has enabled us to both improve the customer experience for our customers but also to improve sales in our hotels, in particular around things like add-ons where we can more consistently talk to the customers and educate them about the potential solutions that we have for them. And so obviously, this year, in our services business, within the hotels, we'll be comping that against periods of time this past year that we didn't have the call center. So I think you will see some impact of that within our hotel business.

David Gober - Morgan Stanley, Research Division

Okay. And just in terms of product mix, and it looked like hard goods lagged a little bit more this quarter than it has in the past couple. Just curious if there's anything going on specifically in the hard goods business relative to the consumables business? And maybe if you could provide some color on what you're seeing in terms of pet acquisition, if that's lagging for any reason or anything like that?

Lawrence P. Molloy

Yes, David, it's Chip. If you look at the mix and the mix shift, you look at Q3 and then you go into Q4, which I assume that's kind of what you're looking at. It's a little bit more of a mixed shift, not much, I think it's 10 or 20 basis points more this quarter than it was the last quarter. But I would tell you that, one, we had another great quarter with consumables, very strong quarter with consumables. It was ahead of the average comp. But hard goods still was a pretty decent positive comp. It was less than the company average but was still a decent positive comp. And once again, that's a business you just got to constantly work at and all the innovation that you hear about, primarily, there's some of it on the foods side but a lot of it is on the hard good side and we continue to drive that. And the good news there is in spite of that mix, little bit of mix shift, we're still able to manage the margin and have still been able to get some margin accretion in spite of that.

Robert F. Moran

David, this is Bob. I just wanted to answer your question about pet acquisition. Q4 was our fifth quarter in a row that we have had sequential improvement in the adoptions. And we're very encouraged by that, and it also demonstrates the correlation to what's happening in the housing market at this point in time. So we have not seen a fall off on that, if anything -- it's, we've seen sequential improvement over the last 5 quarters.

David Gober - Morgan Stanley, Research Division

Okay. And just one quick clarification for Chip. I think you mentioned that inflation for the full year was about 200 basis points. Could you just give us that number for the fourth quarter?

Lawrence P. Molloy

Yes. We haven't broken it out by quarter, but with -- it was -- for the year, it was slightly less than 200 or right around 200 for the full year. And it sequentially dropped from the beginning to the end, but it was still north of 100 bps.

Operator

At this time, we have time for one final question which comes from Peter Keith of Piper Jaffray.

Peter J. Keith - Piper Jaffray Companies, Research Division

I wanted to talk about the management succession, and certainly, congratulations to everyone involved. But I guess there's some questions and concerns out there that there's sort of a lot of change going on at the company all at once with the last quarter call announcing Chip moving on. Could you guys just provide a little commentary on why the succession planning sort of was executed right now with some of the change in the CFO position as well?

Robert F. Moran

Peter, this is Bob. I think you have to look at the 2 recent announcements as not being related in any way, shape or form. The first announcement was Chip, was related to the personal family decision to move his family to the Southeast. And Chip has been an incredibly invaluable member of our team. And as the transition happens, Chip's going to be the CFO through June of 2013 and act as a special adviser through March of 2014, so he's still part of the family. So I wouldn't look about that as any big issue. Succession planning, I think, is one of the most important things both of the board and of the CEO. And I started looking at succession planning when I first became CEO because of the -- not only the stress testing of the first level and various experiences that one could drive, but it also goes fairly deep into the organization. And we felt that, that was a multiyear journey. So it was always planned out be at this time. There was nothing special about it. And as you watch and look at David and both Joe's experience, they have picked up more and more experiences from looking at a total enterprise. And we feel that the company is ready to have new management team, and I'm going to be around for a while as Executive Chairman. So there's really not a lot of changes even though you're saying there's changes. And as David reiterated, I think you're going to see a lot of the same thing but even better, and better results. So I think this is well-managed. It's very transparent, both internally and externally. And I think it's going to be a very smooth transition. And I don't think anything that's happening with any type of results or anything like that has anything to do with it, so we're totally in control of it.

Peter J. Keith - Piper Jaffray Companies, Research Division

Okay. I greatly appreciate the color around that. Another concern that we hear out there in the marketplace is just on that growth in the super premium. And you've talked about double-digit growth for quite some time, and that was consistent here in the fourth quarter. I guess if you're just looking at that super premium category in 2012, maybe versus 2011, 2010, I know you maybe don't want to give us a number, but I guess that the year-on-year growth rate, what does that trended like? Is that beginning to decelerate or has it been fairly consistent for the last 3 years?

Lawrence P. Molloy

I would say it's been consistent. And then on the dog side, it's maybe come down a little bit, but it's been still really big numbers, really big comps, and the cat has actually accelerated.

Peter J. Keith - Piper Jaffray Companies, Research Division

Okay, that's good to hear. Last question I had for you. At your Analyst Day back in 2011, you had talked about an initiative around localized assortment and price optimization. And you wanted to test that throughout 2012 and maybe roll it out in 2013. It didn't sound like you really brought it up on the prepared remarks, could you give us an update on your thinking around those 2 initiatives?

David K. Lenhardt

Yes. Peter, it's David. I think on the pricing side, that's an opportunity that we've been focused on. And starting in 2012, we've been optimizing different categories from a pricing perspective on a national basis. We expect to continue that in 2013. We're not done in that journey. And then over time, we would -- we are evolving and we'll test our way into pricing, not nationally, but on a more local basis, so that's a journey for us, and I think we're very early days there. I think from a space perspective, what you will see us start to do is, as we do resets, we inject the learnings we're having around space optimization from a national perspective. But again, we feel over time we've got an opportunity to do that on a more local basis. And again, we're in very, very early days with that. So that's kind of the journey we're on.

Robert F. Moran

Well, I think another call has come to an end, and I just want to thank everyone for joining us today. And we're going to be looking forward to speaking with you again in May. Take care.

Operator

Thank you, ladies and gentlemen. That does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.

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