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PetSmart (NASDAQ:PETM)

Q1 2013 Earnings Call

May 22, 2013 4:30 pm ET

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

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

Gary Balter - Crédit Suisse AG, Research Division

Michael Lasser - UBS Investment Bank, Research Division

Alan M. Rifkin - Barclays Capital, Research Division

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

Christopher Horvers - JP Morgan Chase & Co, Research Division

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

David Gober - Morgan Stanley, Research Division

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Operator

Good afternoon, ladies and gentlemen, and welcome to PetSmart's First Quarter 2013 Analyst Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Ms. April Lenhard, Director of Investor Relations. Ma'am, you may begin.

April Lenhard

Good afternoon, and welcome to PetSmart's conference call to announce our results for the first quarter of fiscal 2013. 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 the remainder of the 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. For the first quarter, earnings per share were $0.98, up 15% when compared to $0.85 for the same period last year. Comparable store sales, or sales in stores open at least a year, grew 3.5%, and comp transactions, which we use as a proxy for traffic, were up 0.8%.

As the industry leader, our focus on providing solutions for the lifetime needs of pets through an innovative merchandising assortment, a suite of differentiated services offerings and a unique in-store experience, has kept our pet parent customers highly engaged with our brand, resulting in positive comparable store sales growth and transaction growth. We are privileged to have the most passionate associates in the industry, who engage with our pet parent customers to help them help their pets live long, healthy and happy lives.

Through our partnership with PetSmart Charities, we continue to make a real impact in our local communities by providing space in our stores for adoptable pets to find loving homes. And we are proud to be able to help even more homeless pets with the launch of our exclusive new Tommy Bahama Pets clothing and toy line. 5% of the purchase price of each limited edition item, available exclusively at PetSmart through August, will be donated to PetSmart Charities in the United States and Canada to help save homeless pets.

Switching gears, I would like to update you on our CFO search. I am pleased to report that last week, we announced that Carrie Teffner will be joining the company as Senior Vice President and Chief Financial Officer on June 3, 2013. Carrie brings more than 20 years of financial management experience to PetSmart, most recently as Executive Vice President and Chief Financial Officer at Weber-Stephen Products, a leading manufacturer and exporter of barbecue grills and outdoor room products worldwide.

And before I turn the call over to Chip, I would like to take the opportunity to thank Chip for his service and contributions as CFO over the past 5.5 years. Chip has been a tremendous asset to PetSmart, and his contributions have been integral in helping PetSmart become the company we are today. We wish him all the best. Chip will be assisting with the CFO transition over the coming weeks and months and will stay with the company as a special adviser through March of 2014.

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 first quarter performance, as well as providing guidance for the second quarter and full year.

As Bob mentioned, earnings for the quarter were $0.98, which represents 15% growth when compared to $0.85 for the same period last year. Comparable store sales growth was 3.5%, and comp transactions were positive for the 12th consecutive quarter at 0.8%. Total sales for the quarter were $1.7 billion, up 5%. 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 6% to $192 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 54.0%, hard goods at 32.5%, services at 11.2%, live pets at 1.8% and other revenue at 0.6%.

Gross margins for the quarter were up 45 basis points to 31.0%. Within the gross margin line, merchandise margins were down 15 basis points, while services margins added 15 basis points to the overall rate. Store occupancy and warehouse and distribution were favorable 30 and 15 basis points, respectively.

Operating, general and administrative expenses were 21.2%, representing 15 basis points of deleverage when compared to the same period last year. Year-over-year increases in OG&A expenses were primarily due to planned incremental advertising spend focused on our differentiated offerings and professional fees associated with various IT projects.

Net interest expense for the quarter totaled $13.2 million. Overall earnings before tax increased to $154 million or 9% of sales. This represents 10% growth and a 40-basis-point improvement. The tax rate for the quarter was 36%.

During the quarter, we opened 13 new stores and closed 2, bringing our totals to 1,289 stores and 196 hotels. We ended the quarter with average inventory per store of $573,000, up 4% compared to the first quarter last year.

During the quarter, we generated $147 million in cash flows from operating activities, including our third annual dividend from our investment in Banfield of $15 million.

During the quarter, we spent $35 million on capital expenditures and repurchased $180 million of PetSmart stock. Depreciation and amortization expense for the quarter was $59 million. We ended the quarter with $324 million in cash, cash equivalents and restricted cash and 0 borrowings on our credit facility.

Although the macroeconomy 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. As a reminder, the annual guidance for 2013 is on a GAAP basis. Therefore, all comparisons will be 52 weeks for 2013 versus 53 weeks for 2012.

For the fiscal year 2013, we are expecting comp store sales growth of 3% to 4% and total sales growth of 3% to 4%. We are raising our earnings per share guidance from a previous range of $3.76 to $3.92 to our current expectations of $3.82 to $3.94. We expect gross margins to be flat to slightly up, OG&A to grow in dollars approximately 4%, interest expense to be flat from a dollar perspective and EBT margin to expand slightly. We anticipate the tax rate to be around 38%.

For the second quarter of 2013, we are expecting comparable store sales growth of 3% to 4% and earnings per share of $0.82 to $0.86. EBT margin is expected to improve 40 to 50 basis points when compared to the second quarter of last year. The improvement should come primarily from gross margin expansion, while OG&A costs grow 5% to 5.5% when compared to the second quarter of last year. The tax rate is expected to be between 38% and 39%.

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

And with that, I'd like to turn it over to David Lenhardt, who will highlight our first quarter activities and provide insights into the remainder of 2013.

David K. Lenhardt

Thanks, Chip, and good afternoon, everyone. As Bob mentioned, our innovative merchandise assortments, suite of differentiated services offerings and uniquely engaged in-store experience demonstrates the strength of our brand and really resonates with our pet parent customers.

In the first quarter, we supported the growth in super premium natural foods by expanding the space dedicated to BLUE Buffalo, as well as our own super premium proprietary brand, Simply Nourish, and introduced new formulations in both dog and cat across top channel exclusive brands. The addition of novel new proteins like bison and venison and new meatloaf- and casserole-inspired wet formulas have further expanded the grain-free and high-protein offerings in both wet and dry food across breeds and life stages.

PetSmart has always been a best destination for food with an unmatched selection at great value. And by providing the right breadth and depth of solutions for all of the pets' health and nutritional needs, we are listening to our pet parents when they express their desire to give their pets the best quality nutrition.

In our specialty business, we are resetting the reptile space this month, with improved adjacencies and layout, newness in our proprietary brands and improved educational signs with clear good, better, best brand positioning. With a focus on solutions driven by our extensive customer research to drive an easier customer shopping experience, we'll continue to support the growth in reptile, our fastest-growing species in the specialty category.

In hard goods, we continue to innovate and differentiate our assortment with exclusive new partnerships and expanded fresh new assortments. In March, we added a new line of Disney pet apparel and toys to our portfolio of exclusive partnerships. And last month, we launched an exclusive clothing and toy line with Tommy Bahama Pets available exclusively at PetSmart through August.

We're also refreshing the assortments in existing brands like Bret Michaels Pets Rock with a 1980s retro neon-themed line of apparel, toys and accessories and in Martha Stewart Pets with seasonal new assortments like Out at Sea, featuring tropical inspiration sea life creatures and Camp Martha with outdoor camping inspiration and travel solutions.

This summer, we will be executing the dog hard goods reset across the chain, which will be the largest merchandising reset in the company's history with almost 1,000 new items. We will be adding newness to our core brands, bringing in new category-relevant brands, as well as in and out buzzworthy brands. With the focus on space and adjacencies and new fixtures across categories, this reset will support better brand positioning, simplifying the customer shopping experience and improving the stores' operational execution. Leveraging our key customer insights and strong vendor partnerships, we will continue to maximize the potential of our key brands through fully integrated and compelling marketing campaigns.

Moving on to services. Our highly differentiated services businesses continue to show strength. In grooming, our quality of care continues to drive sales with the Grooming Look Great Guarantee. We rolled out several new services offerings in the grooming salon during the first quarter, including new Puppy Bath packages and K9 Advantix II spot-on solution and application. We are continuing to develop a pipeline of innovative services and exclusive offerings that are integrated with our core merchandise brands and supported by marketing, including the newest offering, our exclusive Tommy Bahama Top Dog SPAW package, and that's with a W, featuring the signature orange bandanna and coconut mango spritz.

In boarding, the PetsHotels business achieved profitability for the first time in 2012. We continue to drive profitability by leveraging our PetsHotel call center, driving more awareness through increased marketing integration and improving our overall operational efficiencies. We've shown our customers how we're different from the competition and how we offer the best choice, but we are not done. Delivering authentic customer connections is at the core of our customer experience, and we will continue to evolve this experience in our stores through investments in our associates with training and development so that 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 approach to Omni-Channel, which includes e-commerce, e-influence and building new capabilities. We remain focused on this important area of our business with a number of initiatives that are grounded in these 3 pillars, centered around the core goal of simplifying the shopping experience for our customers whenever and wherever they choose to engage with us.

We continue to invest in improving and enhancing our website experience with richer content and better navigation and new tools like our online food selector. In just a few simple steps, the food selector helps pet parents narrow our wide assortment down to the choices that offer the best nutrition for their pets' unique health needs and preferences. And it's just another example of the investments that we are making to provide a better and richer website experience on petsmart.com.

All of the innovation and initiatives that we have talked about today would not be possible without the integration and alignment across merchandising, marketing, supply chain and store operations. While we expect the macroeconomy will continue to hold challenges in 2013, we believe that the strength of our differentiation and pipeline of innovation will allow us to continue to execute on our strategic priorities at every level of the business to deliver strong shareholder returns through 2013 and beyond.

Before we open it up for Q&A, I would like to take the opportunity to thank Bob for his tremendous leadership to PetSmart over the past nearly 14 years. We are fortunate that he will remain active as Executive Chairman. I would also like to thank Chip for his leadership and contributions and for bringing a financial discipline to the company that will remain a key pillar of our strategy well into the future. We wish him all the best.

I'm excited to have Carrie join the leadership team next month as Senior Vice President and Chief Financial Officer, and I look forward to her contributions in the role. She will be a valuable addition to the team in support of our strategy of financial focus and discipline to drive shareholder value.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Matt Fassler of Goldman Sachs.

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

My question really relates to sales. I'll ask it in 2 quick parts. First of all, if you think about the traffic ticket combination implied in your sales guidance for the rest of the year, how would you see those mixing? And then secondly, you took up the low end of your sales guidance, and I'm interested, and given that we had a very volatile quarter across retail, how the trends over the past 8 or 9, 10 weeks since we last spoke to you influenced your thought process on the annual outlook?

Lawrence P. Molloy

Matt, it's Chip. I would say that if you just take this quarter on the way that the composition of sales, you have a little bit of traffic, you have units per ticket down a bit, and overall units, comp units down a bit, and you're picking it up in AUR. The primary drivers of that is teeny bit of inflation, call it, 100 basis points, and the rest is really the quality of goods continuing to go in the basket, driven a lot by the high-end foods that are continuing to perform extremely well. And as I think about the rest of the year, I would suggest if you ticket -- we would like to have a higher traffic than 28. We're driving to try to do that. But as we sit today, our expectations are that this is the world we're kind of living in for right now and our expectations are that the makeup will probably look fairly similar for the remainder of the year. We did take up the bottom end, just -- we got a quarter in the bank, so it's closer for the year. And also, I would say that it was extremely volatile in the beginning of the quarter and started to stabilize somewhat, and it's a bit more stable and it feels a bit more predicable today than it did at the beginning of the quarter.

Operator

Our next question comes from Gary Balter of Crédit Suisse.

Gary Balter - Crédit Suisse AG, Research Division

Bob and Chip, I guess, Chip, you'll be on future calls, but, Bob, I enjoyed working with you, first of all, for all these years.

Unknown Executive

Thanks, Gary.

Gary Balter - Crédit Suisse AG, Research Division

A question is -- I'm surprised you guys are even on this call because the clients are calling me, telling me you're about to go bankrupt because of the Internet. Could you talk about what you're seeing in terms of more availability, pricing, et cetera, and any reactions you've done, because the quarter looked pretty good for a company that's going under.

David K. Lenhardt

Yes. Gary, it's David. And we've talked in the past about this. As we think about what we call Omni-Channel, online and e-commerce sales are a piece of that. We've seen that portion of our business in terms of the industry from our perspective remain relatively stable. We think it's a -- today, growing at about 12% to 14% a year. In terms of the industry, we think it's about a 2% to 3% online penetration of the pet industry. We continue to, from our own e-commerce business, outpace those growth rates. But we've seen a relatively -- in terms of the customer response to the competitive environment out there from an online perspective, we've seen that, that 12% to 14% growth, as best we can tell, has remained pretty stable. And having said that, we continue to focus on improving our website experience. We continue to focus on building new Omni-Channel capabilities because we do think it's important to be relevant to our customers as they interact with us both online and in our stores.

Gary Balter - Crédit Suisse AG, Research Division

Just on a different topic, you had one of your big suppliers -- and I know you're not going to want to discuss specific suppliers, but one of your bigger suppliers changed their format and their advertising approach and their pricing and I think the formulation of their products. Did that help or is that something that you view as a potential driver of your business for the next few quarters?

David K. Lenhardt

Yes. I mean, again, we work with all of our vendors. Innovation is really important for us. And I think each of our vendors adjusts and reacts, and we partner with them very closely, our merchant team, to deliver what we feel the customer needs. And so I think as particular vendors work with the mix of everything you just said, whether it be price, whether it be marketing, they're driving different results. And I think -- I wouldn't point to any one vendor or any one product. I think we're seeing momentum, particularly on the consumables side, across the board.

Gary Balter - Crédit Suisse AG, Research Division

And then finally, and then I'll get off. Is there any special feed for cicadas that you sell?

David K. Lenhardt

Gary, not that I can off at the top of my head think of. But I'm glad you're thinking of us for that.

Robert F. Moran

But we're going to be ready 17 years from now.

Operator

Our next question comes from Michael Lasser of UBS.

Michael Lasser - UBS Investment Bank, Research Division

And at the risk of sounding like a broken record, very best of luck to both Bob and Chip. You've done wonderful things for the business. So the question I have is on the merch margin decline in the quarter. Can you expand on what drove that? Are you at the point right now where your merch margin is tapped out? Or do you think that as you get through the bulk of the dog reset that you still have more opportunity in the horizon?

Lawrence P. Molloy

Michael, it's Chip. The merch margin rate is down a little bit. It's really mix driven, hard goods versus consumables. Hard goods was not -- it was a solid quarter, but it wasn't as good as it's been in the past. Consumables continue to make up the bulk of the growth in the company. But we feel very good about our hard goods business, as you heard David speak to. And we're going to continue to innovate. We have to continue to drive demand in that space. We have to continue to innovate. We have to continue to introduce new products. And with our hard goods reset this year, we bringing in new SKUs, and we're going to continue to drive what we believe is demand in that space. As it relates to the margins, it was just down a little bit from the merch side. I think as we go through the rest of the year, we're working hard to keep that flat to slightly up. The good news for us is, especially in this quarter, and I think you'll see it for a couple of quarters to go, is the services is kind of making up for that. So what you saw in services pick up, that's -- we have some new people running our Services division. They're doing a really nice job. They have -- they're working it, the hotels. We did a price increase on the hotels, while at the same time, they continue bring out some cost efficiencies. They're leveraging the call center. They're getting add-ons through the call center. And it's less expensive to operate from that perspective. So that's going to help from a go-forward perspective to sort of net it out.

Michael Lasser - UBS Investment Bank, Research Division

And Chip, when you talked about some variability in the comp trend over the quarter, now it's stabilized, what piece of it was more volatile, the ticket piece or the traffic piece? And what's kind of stabilized?

Lawrence P. Molloy

Oh, traffic. So it really was -- I don't think we were any different -- not to make excuses. I don't think we were really any different than most of the retailers out there. You sort of see the ebbs and flows of the tide. And we'd love to be always be sort of exclusive of where the tide goes. But we -- like other retailers, when there's more traffic in the parking lot, we're going to benefit from it. When there's less, it's also going to impact us slightly as well.

Michael Lasser - UBS Investment Bank, Research Division

Okay. And then my last question is on the segmentation of your customer base. You've done a fantastic job in the past of breaking down your customer group in 3 different buckets. Can you talk about how -- it's been a little bit since you've updated Smart, Smart with Heart. What are you seeing from each different customer base? Do you see any risk that maybe the least attached customer could gravitate online or maybe even more ominously that your most committed customer will start to be better served by some other competitor?

David K. Lenhardt

Yes. Michael, it's David. As we look at all 3 of those segments, as well as new customers coming into our store, we're actually seeing pretty consistent growth rates across all of those segments. So we feel good about that. We'll give you a more detailed breakout of that in our Investor Day coming up. But like I said, we've seen very consistent growth across all of the categories, which we're happy to see.

Operator

Our next question comes from Alan Rifkin of Barclays.

Alan M. Rifkin - Barclays Capital, Research Division

I will add my well wishes as well, to both Bob and Chip. Best of luck in the next chapter of your lives. With last year being so warm, coupled with this year being so cool, could you, Chip, describe the effect on flee and tick in particular?

Lawrence P. Molloy

Yes. It was material for that category on flee and tick, and then it did drive our overall hard goods performance down. I mean, we were essentially flattish to slightly up in hard goods overall. But the expected performance of hard goods was down than what we thought, and it was driven primarily because of flea and tick.

Alan M. Rifkin - Barclays Capital, Research Division

Did flea and tick in and of itself have any negative impact on the comp or just not enough weight?

Lawrence P. Molloy

It's a pretty big category for us now. And yes, it did. We wouldn't break it out, but it would have some impact on the overall comp and -- because now, it's a product that we got shrink under control a couple of years ago. It's actually at a margin rate that's above the corporate average. It's not in line with a lot of the hard goods, but it's above the corporate average. So when you're selling less of it than you expected or less than year-over-year, it does put a little bit of a drag on the rate as well.

Alan M. Rifkin - Barclays Capital, Research Division

Okay. And then on -- just a little bit more information on the dog reset, since it's so material. How long will it go for? How disruptive will it be? Will this be a significant cost in and of itself on the P&L in the quarters in which you're doing the reset? If you could just give any more color that you can on that program in particular?

David K. Lenhardt

Yes. Alan, it's David. We're going to start it in June. It's going to go through August. In terms of disruption, I would say we're going to see minimal. I think we've gotten very good over the years at planning resets, both the actual execution of them in the store, the markdowns prior. And in terms of the costs, that's all baked into our guidance for the year. In terms of kind of the details of it, and I think this is going to be a continued evolution of our innovation, and I think this is a big piece of it, a couple of things: First of all, this is the biggest reset we've done actually in the company's history. It's about 1/3 of the total space in the store. And as we said earlier, we're introducing 1,000 new items. Now I do want to point out, when I say new items, on a net basis, it's going to be flat. So we're bringing in those new items, but as part of this, we're optimizing and taking out the slower movers. A couple of things you'll see us introduce as part of this. One is we're going to with exclusivity and really leveraging this humanization of pets trend to bring human brands into the pet space. So you're going to see Burt's Bees in health and beauty. You're going to see Off in flea and tick. You're going to Shout in stain and odor. We were very excited last year with what we did with Marvel. So you're going to see us coming out again with limited-edition Marvel sets that are going to be related to the summer movie, some of which are out now. And then there's going to be some more fundamental space and it's adjacency changes. So we are going to be expanding the space in the more profitable categories. And from an adjacency perspective, if I can give you a couple of examples, we've got a number of our stores today, and I'll use the toy aisle as an example, where we have half the toy aisle is on one side of an aisle and then the other one, you have to go all the way around to the other. We're going to combine those into a valley in all of our stores. And we tested that. We like the answer there [ph]. Things like puppy pads and stain and odor. Today, in many of our stores, the puppy pads are in one aisle and you've got to walk 50 feet to get to the stain and odor. Now they're going to be right next to each other. So this is again really the first time we've been able to holistically look at our entire dog hard goods section, and we're excited about both the innovation and the productivity it's going to drive. And you'll also see some new fixtures in our store, for example, around things like beds. Today, if you go into our bed wall, as we call it, very hard to maintain, very messy from a customer perspective. We have some new fixtures that are much more organized that we know our customer likes. So again, we'll start in June and go through August with that.

Alan M. Rifkin - Barclays Capital, Research Division

All right. Will these resets be done in off hours? And with the majority of the resets in Q2, I mean, is there an earnings impact that you've already factored into your guidance? Or what is the typical reset? Or what are we talking about in terms of cost, Dave?

David K. Lenhardt

Yes, it is absolutely in our guidance, both the cost and the revenue side of it. It is all going to happen overnight.

Operator

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

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

The -- my first question is, when you get back to the online stuff, and obviously, your business is doing well there. What is selling online though? There's been a lot of talk about food, but then we hear from some of our contacts that kind of some of the higher, bigger ticket hard lines are what sell. Can you give us a sense of maybe what's been performing particularly well online? And do you make any adjustments in your in-store merchandising mix to account for that?

David K. Lenhardt

Yes. I mean, to answer your last -- this is David, to answer your last question, this is such a small portion of our business, it's not influencing kind of our assortments in the store. Having said that, what we have been doing is adding SKUs online that you can't find in our stores, and we've been happy with the results there. I mean, as we looked at the online pet space and as we look at our own business, the categories that do better are the categories that are higher ticket, higher margin and lower weight. And if we -- when you think about our store, things like flea and tick, our natural category, and I think you see that today in the online space, so those are the types of categories that do better.

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

Okay, that's helpful. And then when you think about the food category, can you talk about maybe how the gap in performance between your grocery brands and your premium food brands? I mean obviously, it's been big for a while. Has that gap -- did that expand during the first quarter? So is that getting wider or pretty much the same? What's going on there?

David K. Lenhardt

Yes, I -- yes, I would say, Peter, it's pretty much the same. It's been pretty consistent. And as you said, we've seen that trend be pretty consistent over many quarters now.

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

Okay. And then last question just on the small store tests, any initial commentary? I know you've been testing for smaller stores. Just what's the latest thought there?

David K. Lenhardt

Yes. No new commentary yet. I mean, we're working our way through opening all 12 of them through this quarter. And again, the attempt is to really learn once they're up and running, both customer demand, how to operate them, and then we'll evaluate from that point forward. So nothing -- it's too early to tell right now.

Operator

Our next question comes from Christopher Horvers of JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

A question for you on the OG&A side. You guys took up the growth here to 4% from 3%. Can you just talk about what's driving that and what's changing versus your original forecast?

Lawrence P. Molloy

Chris, it's Chip. It's subtle nuances. So it's advertising. It's just the -- some of the IT projects as we run through them this, it's a little bit more than they were. But at the end of the day, ones a rounding number of 3, ones a rounding number of 4. It's not materially different.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Okay. So I guess is -- is it the Omni-Channel effort is stepping up here and that's just causing the round up versus what you previously thought?

Lawrence P. Molloy

No, no. Some of it is discretionary choice on the advertising side. I would say it's predominantly on that side, and the IT projects and Omni-Channel efforts. Those are well planned before the beginning of the fiscal year. So we have a good understanding as to how that's going to go through.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Understood. And then in terms of the new Wag program, I don't know if you saw, they're just going to test out a prime-like membership, where you sign up for free shipping, and then at some point, they're going to charge, and you can order from Wag and Soap and Diapers.com. And I was just -- and also at the same time this year, they took the free ship level down from $50 to $35. Granted, I would guess, if you have a 40-something-dollar average ticket, 40% actual food, it's maybe high teens average food ticket within there. So I guess is that right? And how do you think about those 2 changes? Is it incrementally worse? Is it -- it's something where you still feel like the moat's wide enough?

David K. Lenhardt

Yes. Chris, it's David. We're not seeing any discernible impact at all from that. And I think when you look at Wag, I think you can't look at the pets side in isolation as you look at the economics. And I think that's what's different in particular about Wag, because given that they're a part of Quidsi, which has Diapers and Casa and YoYo, they're much adopting kind of a vertical strategy, going after moms and going after convenience. And so those changes, in terms of the potential prime membership and the lowering of the shipping fees, apply to anything you buy on any of their vertical. So I think when you look at them, it's a totally different model that is attaching across multiple verticals.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And then just on a final one, I mean, is it -- just in your comment about the trend in the business throughout the quarter, it sounds like most retailers, February, there was a tough start with the tax refunds, and then March, obviously, weather was awful. So does ending at the 3.5 and seeing more stability suggest that you ended at the high end of the range, just especially in light of you've narrowed down sort of a 3% to 4% comp growth, whereas previously, you had a bit of a wider range in your guidance?

Robert F. Moran

Yes. Chris, I would say that it is all embedded in our guidance for the quarter and for the rest of the year. And so yes, we have narrowed down. Typically, we would give sort of a 200-basis-point range. We have set of narrowed that down for the next quarter, this quarter that we're in today, and that's just the predictability of it. But we feel pretty confident that we're going to be -- land somewhere in that range.

David K. Lenhardt

And maybe just to add a little bit more color to that, Chris, I would say that as we said, the first couple of weeks of the year were very, very choppy, and I think we saw stabilization after that period that continued for the rest of the quarter.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Best of luck, Bob and Chip.

Operator

Our next question comes from Scot Ciccarelli of RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

First of all that, I would say that our survey data would agree with your comments regarding low penetration rates for the Internet channel. But I guess my question is, do you think there's a point at some -- is there a point down the road where you need to accelerate the investments you're making on the e-comm side simply because it is starting to gain traction within the pet space?

David K. Lenhardt

Yes. Scot, it's David. I mean, again, I think we very much think Omni-Channel is important, and we are making investments in it. I think the key is we feel it's really important to be relevant to our consumer, however they want to interact with us. And as the data would show and our best estimate of the market, we're not seeing that consumer in any very big way move online, and I think we're going to let that consumer lead us to where we need to be. And we think right now, the consumer wants to interact with us in whatever form they want. And if you -- as we think about Omni-Channel, we're spending lot of investment and focus on improving our website experience, improving navigation, the pet food selector and making it feel more like our store experience online. And we think that, that's important for us to do, and we're continuing to focus on that.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Okay. And then secondly, Chip, you made the comment regarding the adverse impact on flee and tick. Should we see some catch-up in the second quarter? Or do you simply lose some of those sales at some point?

Lawrence P. Molloy

Typically, you're going to lose some because, if you think about it, it's an application that lasts 30 days and it's in the moment, and if there are no ticks out there for that 30 days, you're not going to sell it.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

All right. So that's not something that you're expecting some sort of catch-up in the second quarter?

Lawrence P. Molloy

I wouldn't expect a catch-up, no.

Operator

Our next question comes from David Gober of Morgan Stanley.

David Gober - Morgan Stanley, Research Division

So I just want to touch on the hard goods business for a second, kind of excluding the resets that are coming up. Obviously, there are some impact from flee and tick, but the last couple of quarters seemed like you had a little bit of a lag on the hard goods business where we -- we probably expect to start to see that kind of catch up here as household formation starts to improve and I think you guys have talked about pet acquisition improving a bit as well. Is there any -- are you seeing any trends in terms of pet acquisition that are additive? Is there something offsetting that? Or is it just that you're not seeing pet acquisition tick up meaningfully yet?

Robert F. Moran

David, this is Bob. The way we look at pet acquisition is the adoptions in our stores is a proxy. We do approximately about 1,100 adoptions per day in our stores. And what we saw with the last quarter of '11, then a sequential improvement through '12, what has happened in Q1 '13 is that sequential improvement has continued. So it's encouraging. Obviously, we're seeing some of the same trends in housing that will support us down the road. But there's a little bit of a lag effect on the housing side before pet acquisition gets a little bit [indiscernible]. We are encouraged. There's no question about it. And we're complementing that in the stores with our adoption kits and our puppy kits to really help our pet parent customers. So it continues.

David Gober - Morgan Stanley, Research Division

Got you. Is there anything else that you're seeing? I mean, I'm assuming that the -- maybe if pet acquisition hasn't picked up, that it hasn't really been there for a while. But is there anything else you're seeing in the hard goods business that's driving that business to lag versus consumables, given that you do have the traffic coming into the stores?

Robert F. Moran

No, I don't think so. I think that the hard goods business -- first of all, when you think about the hard goods business, that's probably the most competitive business that we're in because everybody out there in the world, from Bed Bath & Beyond to the Targets, they've all got hard goods everywhere. So you've got to continue to stay relevant to continue to drive comps there. And I think those are the efforts you see. We had some wind behind our back when we introduced -- just starting a few years ago and really started to make ourselves relevant in that space. And I think you're hearing more and more about the efforts that we're putting behind, as David spoke to, like Tommy Bahama on the reset, et cetera. Those are things you just have to do in that space that can really drive positive comps. And I think we're doing the right things, and we're still driving comps to their -- even slightly positive, but we're in the positive range. And we're hopeful that at some point, the housing market, when you start to see acquisitions move meaningful, that you'll start to see that reverse. We're just not yet seeing that kind of activity take place within really a more pet acquisition front as well as all the way down to the store level and the hard goods space.

David Gober - Morgan Stanley, Research Division

Got you. And just switching gears for a second, could you call out the contribution from inflation this quarter?

Robert F. Moran

Yes. It was -- not to be terribly specific, but it was just a hair above 100 basis points.

David Gober - Morgan Stanley, Research Division

Okay. And I guess just finally, I know you guys have been talking a lot about what you're doing online, and there's a couple of different places that's going to show up, obviously, in terms of IT versus -- on the Capex side versus OpEx. But is there any way to quantify kind of the overall investment that you're making between the integration with GSI and some of the other stuff that you're doing there?

Robert F. Moran

No, I would say that -- we're not going to break it out and quantify it. I would tell you that we are making what we would believe appropriate investment level. I wanted tell you, if you just listen to the activities that David speaks to, it's not a meaningless number. It's a pretty meaningful number both from a CapEx perspective, as well in a headcount perspective, as well as things that we're doing to the site on the operating expense perspective. But I would tell you that you're not going to -- we're not underinvesting because we're not building DCs. And so if you go out there and you want to listen to those companies that are spending huge amounts of money in Omni-Channel, a lot of that is huge investments in the DC networks, and that's not where we're going, and I don't suspect that, that will be a space in this business we would ever need to go.

Operator

At this time, I believe we have time for one final question. Our final question comes from Daniel Hofkin of William Blair & Company.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

I'll jump in and add my congrats to Bob and Chip. You've done a great job, and best of luck, David, going forward. I guess to follow-on a little bit from the last couple of recent questions as it relates to margins within the categories. Can you say specifically whether margins were up within both food and hard goods, just on a -- within the categories themselves?

Robert F. Moran

They are. And we're still seeing accretion there, driven primarily once again by the quality of goods going in the basket. But then it's being offset a little bit by the overperformance of consumables versus hard goods.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Okay. But within hard goods itself, the merchandise margin was up?

Robert F. Moran

Yes.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Okay. If you -- I mean, I was sort of reading between the lines between a couple of the comments. It sounds like even if you take out the flee and tick, the negative impact on the comp, it sounds like maybe the hard goods comp is not quite what it has been the last couple of years or what you might have expected, is that fair to say?

Robert F. Moran

Yes. I would say that the hard goods comp is less than it's been in the last several quarters. However, I would say that there's a meaningful piece to that associated with flee and tick.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

Okay. And I guess as it relates to the initiatives going forward and the impact on the gross margin, looking out over the next couple of years in terms of the Fishbone framework, any comments regarding how much of your pretax margin beyond this year is likely to be gross versus OG&A?

Robert F. Moran

Well, I will come back to the idea that if you look at the Fishbone, the 2 hardest boxes to drive each and every year and each and every quarter. One would be the comp, of course. And then the second, and I would say it's even more challenging each and every quarter, would be the merchant services margin, the combination of that and to have that continue to be flat to increasing. And it is the most volatile box, the hardest box, but it's the one we work on the most. And so when you hear about the innovative products, when you hear about our desire to drive innovation through our hard goods business, you hear about -- you just go in our stores and you -- after our consumables reset and you see how much more space we're giving to the velocity SKUs that are happening both on our super premium and our Rx businesses, we're -- those things are to drive top line but to also keep that merch margin stable to expanding. And I'm pretty confident listening to all the things that we have in the hopper for this year and thinking about the runway of things that we're working on for next year and thereafter that we're going to continue to be able to maybe squirt a little bit out on there. But to say it's ever going to be meaningful, we've never said that, and I don't know that we'll know that, that will happen. But we are very focused on trying to keep it stable to slightly expanding.

Daniel Hofkin - William Blair & Company L.L.C., Research Division

As it relates -- just back to the flea and tick for a second. Can you isolate it as just weather in the first quarter? You did call it out as a category within so-called hard goods, but is potentially more susceptible to migration online, either on your site or elsewhere. Just curious whether you were able to isolate it as just weather or whether there might have been...

Robert F. Moran

I would say we don't -- yes, we try to be the retailer that doesn't use the word weather. And I think we do a pretty good job with that. Yes, it is a business that -- it's clearly, if year-over-year, if it's warmer in any given period year-over-year than it was the previous year, that business is going to react positively. And if it's colder year-over-year in that space, it's going to react negatively. It's just the nature of the product. It's a pretty meaningful product. But that said, we still have a large mix of other goods. It isn't anything to do with online, and yes, we do sell it online, but we're -- we've never -- we keep the same prices in stores as online. So I would argue that we're not as competitively priced online for that product. So we haven't driven volume that way. So it is clearly something driven by the temperatures.

David K. Lenhardt

Yes. And Dan, I would just add into that, that we definitely wouldn't think that it's online, and I think there are online competitors out there who a large portion of their business is flee and tick, that if you look at their results, would suggest that it's not online.

Robert F. Moran

Thank you. Well, I think we've come to an end, I. want to thank everyone for joining us today, and we look forward to speaking to you again in August. Thank you very much.

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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