Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

PetSmart, Inc. (NASDAQ:PETM)

Q3 2009 Earnings Call

November 18, 2009 4:30 pm ET

Executives

David Cone – Vice President Investor Relations & Treasury

Robert F. Moran – President, Chief Executive Officer & Director

Lawrence P. Molloy – Chief Financial Officer & Senior Vice President

Analysts

Matthew Fassler – Goldman Sachs

Alan Rifkin – Bank of America Merrill Lynch

Michael Lasser – Barclays Capital

Analyst for Matt Nemer – Wells Fargo Securities LLC

David Mann – Johnson Rice & Company

Peter Benedict – Robert W. Baird & Co., Inc.

Michael Baker – Deutsche Bank Securities

[Christian Buss]

[Daniel Hopkin]

Mitchell Kaiser – Piper Jaffray

David Strasser – Janney Montgomery Scott LLC

Operator

Welcome to the PetSmart third quarter 2009 analyst conference call. At this time all participants are in a listen only mode. Later, we’ll conduct a question and answer session and instructions for audio questions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference Mr. David Cone, Vice President of Investor Relations and Treasury.

David Cone

Welcome to PetSmart’s conference call to announce our results for the third quarter of fiscal 2009. With me on the call today are Chief Executive Officer and President Bob Moran as well as Chip Malloy, Senior Vice President and Chief Financial Officer. Bob will kick off the call with an overview of our third quarter results and then Chip will take you through the financial review of the quarter as well as our earnings guidance. Bob will provide a review of the operations of the business and finally, we’ll take your questions.

Please keep in mind everything that 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

I am pleased to report our results for the third quarter was strong EPS growth and positive comparable store sales. I am proud of the dedication of our 46,000 plus associates who are driving impactful execution in expense management and strategic alignment throughout the organization. Our ability to deliver positive comp sales while still battling a challenging retail environment in a difficult inflationary comparison continues to show the strength of the PetSmart brand and the loyalty of our customers even in tough times.

For the third quarter earnings per share were $0.31 and comparable stores sales for sales in stores open at least a year remained in positive territory with growth of 3%. Comp transactions which we use as a proxy for traffic declined .9%. Overall, we are pleased with our performance for the third quarter and feel that we are well positioned to improve these trends going forward. Throughout the year we have remained focused on aligning the efforts of our organization while working on leveraging customer insights, improving merchandising capabilities and most importantly engaging our customers.

As we shared with you on our recent analyst day, we have made significant progress in each of these areas and I will update you with more details in a few moments. Before doing so, I’ll turn the call over to Chip who will provide more details on our financial performance for the quarter as well as our outlook for the remainder of the year.

Lawrence P. Molloy

Today, I will be reviewing our third quarter performance as well as providing guidance for the fourth quarter and full year. As Bob mentioned, earnings for the quarter were $0.31 per share, a 10.7% increase over the $0.28 per share for the third quarter of last year. Total sales for the quarter were $1.29 billion, up 3.5% from the same quarter last year. The increase in net sales included a favorable impact for foreign currency fluctuations of less than $1 million. Services sales which are included in total sales increased 8%.

Our comparable store sales grew .3% for the quarter while operating income was 5.5% of sales, a 30 basis point decline compared to 5.8% for the same period last year. Gross margins declined 110 basis points to 27.5%. Within the gross margin line, merchandise margins were down 160 basis points with mix representing 45% and rate representing 55% of the decline. Services provided a 15 basis point improvement primarily due to continued strength in grooming, our largest services business.

While our PetsHotel and training businesses remain a bit weak. Supply chain was favorable 45 basis points as we continued to experience benefits from lower fuel costs, improved productivity and transportation efficiencies in our network. Store occupancy was unfavorable by 10 basis points. Our decision to slow unit growth combined with lower negotiated rents through lease renewals and various rent abatement benefits have now allowed us to now establish a rent and occupancy base line that helps mitigate dilution in a relative low sales comp environment.

Operating, general and administrative expenses were 22% of sales for the quarter representing 80 basis points of leverage. We continue to benefit from lower advertising rates and we also leveraged other areas such as store labor, travel, depreciation and pre-opening expenses. During the quarter we opened seven new stores and closed three. We also opened five PetsHotels. This compares to 32 new stores and 11 PetsHotels in the third quarter of last year.

During the quarter we generated $91 million in operating cash flow and spent $28 million on capital expenditure projects. Year-to-date we have spent $87 million for cap ex projects which is more than a 55% reduction when compared to this time last year and we are projecting total cap ex spend for the year to be in line with our guidance of $115 to $125 million.

We are on track to generate a low double digit free cash flow yield for all of 2009. Our ability to generate significant free cash flow allows us to consistently distribute cash to our shareholders in the form of share repurchases and dividends. During the quarter we purchased $35 million of PetSmarts stock and distributed $12.5 million in dividends. We ended the quarter with total cash, cash equivalents and restricted cash of $240 million and zero outstanding borrowings on our credit facility. We will continue to remain focused on a strong cash position as we navigate through this challenging macro environment.

Going forward we expect fourth quarter earnings per share between $0.52 and $0.56 and comparable store sales from flat to low single digits. For the year we are expecting earnings per share between $1.50 and $1.54. We anticipate continued gross margin pressure for the fourth quarter. Overall gross margin relative to the fourth quarter of last year should be down 130 to 140 basis points assuming we achieve our sales guidance. Product margins should be less dilutive than they were in previous quarters but are still expected to be down 110 to 120 basis points while services margins to be essentially flat.

We anticipate the combination of supply chain and rent and occupancy to be unfavorable by approximately 20 basis points. Our ability to leverage the supply chain will be more challenging as we anniversary lower fuel costs and improved productivity and transportation efficiencies which provided us significant leverage beginning in the fourth quarter of last year. We anticipate OG&A expenses to be generally in line with the third quarter in terms of dollar spent.

We continue to further strengthen our balance sheet while funding our business through cash flow from operations. We expect cash to total between $320 and $345 million by fiscal year end exclusive of any additional share repurchases we may make in the fourth quarter.

Now, I’ll turn it over to Bob who will provide a more detailed update of our operations.

Robert F. Moran

Although many fundamentals in the economy remain weak, we continue to be cautiously optimistic about the fourth quarter and our opportunities headed in to 2010. As we shared with you at our recent analyst day we are intently focused on leveraging customer insights, improving merchandising capabilities and engaging our customers. I’m confident in the strength of our management team to focus on these strategic priorities and to deliver success.

Overall, our hard goods business is beginning to see some slightly recovery. At the end of September we completed the major reset efforts that we started back in the later part of the second quarter. As you may remember, those efforts were focused on four key categories that make up approximately 50% of hard goods sales including containment, collars and leads, waste management and toys.

While some of these reset categories are still experiencing negative comp sales, overall the trends are improving and we are encouraged by the early results. We recently relaunched our Authority brand dog food. We reformulated the product and redesigned the packaging. The product is competitively priced in the bridge isle however, it is exclusive to PetSmart and the quality and margin dollars per pound are more in line with the premium isle. Early response in this relaunch has been very positive and we are experiencing increases from our customers and significant increases in unit sales.

We are excited about our plans for the holiday season and I can confidently say that the organization is working more cross functionally than ever with the goal of driving a successful fourth quarter. This year’s holiday strategy will be strengthened by our focus on providing pet parents with thousands of gift ideas at a great value. We have competitive opening price points and increased offerings within our proprietary brands. This year our Black Friday promotion and our three day sales events will combine with our increased TV, radio and online advertising to drive incremental traffic and increase high goods sales.

It is too early to read the strength of the holiday shopper however, we were generally pleased with our Halloween performance which we believe may be a good indication of our potential during the months of November and December. In addition, this past weekend we held our fourth national in store adoption event which resulted in the adoption of nearly 17,000 pets. Going forward, we are expanding our adoption events which include our quarterly in store events as well as increased partnerships with our vendors and local shelters for additional adoption opportunities. Ultimately new pet acquisition is vital to the success of our company and we believe that each new adoption not only creates the opportunity to sell that first time large basket of goods but also provides a unique opportunity for the customer connection driving loyalty and life time customer value.

We continue to enhance our merchandise assortments through strategic partnerships with strong brands. Our recently announced partnership with Martha Stewart Living will included a wide range of new pet accessories including apparel, collars, leashes, bedding, grooming supplies, toys and more. We believe that this partnership will allow us to connect with Martha’s existing customer base creating new customer opportunities as we roll out the products in the second quarter of 2010.

We also continue to create and grow dominate hard good brands. During the third quarter we further expanded our assortment of PetSmart exclusive Kong products including our newest Kong bed which has done exceptionally well. On the pricing front, inflationary benefits dramatically dropped as expected as we cycled through the majority of last year’s vendor price increases.

While we have experienced some price declines due to direct vendor cost reductions and through temporary vendor sponsor promotions, those declines have been offset by a slight improvement in unit sales. On the services side of the business we remain intently focused on selling, grooming, training, hotel and day camp services while providing an engaged customer experience. Our associates are uniquely positioned to gain the trust and loyalty of our pet parents and our multiple service offerings which continue to be key differentiators.

I feel extremely confidence in the diligence and capable execution of our management team. Our ability to reverse previous trends in hard goods as well as targeting our efforts on our most profitable customer, provide opportunity as we enter the fourth quarter and begin our planning for 2010. While we have made significant progress thus far in 2009 we know that there’s still a lot of work to be done. We continue to evolve our merchandising capabilities while at the same time ensuring that we stay connected and engaged with our pet parents.

Our merchandise pipeline heading in to 2010 is the most robust and exciting that we have ever had. We have been encouraged by the progress made on our key strategic initiatives which could provide significant opportunities when the economy improves. I am confident that the best days for PetSmart still lay ahead as we look to capitalize on our efforts of becoming a better merchandising company and delivering significant shareholder return. Thank you and now we’ll take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matthew Fassler – Goldman Sachs.

Matthew Fassler – Goldman Sachs

I want to first focus if I could on gross margin. If you could talk about the drivers of the mix delta to the extent that you saw prices coming down on some food areas and hard goods look a little bit better, what might have explained that? Then also, if you could talk about the sources of the rate decline including how much of that is sort of self inflicted as you think about clearing out products for the resets?

Lawrence P. Molloy

I’m going to give you a little more detail on the margin line just to help with the transparency, give you guys some more insights. We have three buckets of costs that impact our margins or our cost of goods. The first is obviously the net price we pay our vendors for the inventory and this is obviously the largest bucket and the net of those costs versus our selling prices is what we would refer to as true product margins. The second of course, is shrink which is missing, expired or damaged goods. The third is what we internally refer to as unit cap and we, like some other retailers, capitalize a portion of our inventory handling costs and as we sell through that inventory that asset is amortized through the merchandise COGS line.

The way to think about unit cap is when inventory levels are growing faster than sales it’s essentially accretive to margin and if inventories are growing slower than sales unit cap can generally be dilutive to margin. We have the latter situation going on. In fact, our inventories are declining while our sales are still growing and our inventory position in Q3 was a lot better than we expected and planned and we expect it to be that way in Q4 as well. What’s that doing is that unit cap line has hit us by about 30 basis points in Q3 and it’s going to hit us by about 60 in Q4.

The good news here is that true product margins are sequentially getting better. They were down Q1 about 180 bips, Q2 160 and this quarter 130 and we expect the true product margins to be down about 60 in Q4 so we are getting better. All of that will be mixed in Q4. The rate piece of it is all driven by the disruption we put in the store with the resets, it’s not about promotional activity it’s really the disruption we’ve put in the stores. The unit cap piece, actually at the end of the day it’s negatively impacting margins but it’s still a good thing for the shareholder because our turns are better, our inventory levels are lower and we’re producing more cash flow there and we think we can stabilize that going in to ’10 so that should go away going in to ’10.

Matthew Fassler – Goldman Sachs

That series of numbers you gave us from 180 down to 160 does that recommend a combination of mix and rate or is that just one or the other?

Lawrence P. Molloy

It’s a combination of mix and rate and the 60 in Q4 is entirely mix driven.

Matthew Fassler – Goldman Sachs

A quick follow up on margin, are you seeing anything different on the pricing front from either the mass market or specialty competitors.

Robert F. Moran

No actually, it’s been pretty calm. We are competitively priced especially on our consumables side because we look at that as the trip driver and also on our hard goods side where we can actually do some comparisons of like items, we are also competitively priced. But, it’s been relatively calm in the competitive market from a pricing point of view and we’re not anticipating any aggressive pricing in the fourth quarter.

Matthew Fassler – Goldman Sachs

Then finally, your tax rate was a bit lower than most of us expected, if you could just talk about what drove that and what kind of tax rate is embedded in your fourth quarter guidance?

Lawrence P. Molloy

There’s a little bit of volatility on the tax rate right now. It’s associated with our deferred comp plan and the underlying assets and the way that funnels through our taxes. When there are large fluctuations year-over-year in the stock market, as the stock market goes up those underlying assets go up and it gives us a benefit on the tax rate line and if the stock market those underlying asset values go down and it actually hurts us on the tax line and that’s what’s driving the difference. For the fourth quarter we’re looking at – give me a second. We’ll take the next question and then I’ll get back to you.

Operator

Your next question comes from Alan Rifkin – Bank of America Merrill Lynch.

Alan Rifkin – Bank of America Merrill Lynch

With respect to the four hard goods categories that you reset could you maybe give us some color on what you saw in terms of the volume trends because I believe that you said comps in a couple of categories were negative.

Lawrence P. Molloy

I’ll talk about hard goods and I’ll talk about consumables as well for the quarter if you don’t mind. The consumable side of the house for Q3 was actually really encouraging. It’s the first quarter since 2007 that we actually had comp units up and so even though comp sales were not as high in consumables the underlying business is healthier, we’re just not getting the big bang from the AUR increases so the consumables business really was a good quarter.

On the hard goods side of the business I would say that August, to put it lightly, was miserable. We went through a lot of things in the stores. We were resetting, still getting through all of that and August was a very tough month for us both in terms of units and sales on the hard goods across the board. In September it got a little bit better and October was significantly better. So, we’ve gotten through that reset activity, it’s behind us now and the month of October was probably one of our best months. Still negative, still negative both on units and comp sales but sequentially seriously better.

Alan Rifkin – Bank of America Merrill Lynch

Bob, maybe just a follow up on the hard goods side, as you stand to hopefully benefit on this side of the business in 2010 as the economic environment continues to stabilize and hopefully even improve. Can you just maybe shed some color on your ability to change advertising expenditures and target that side of the business specifically? And, how quickly can you do such a thing to capitalize on an environment that’s stabilizing in 2010?

Robert F. Moran

Well, as I said on the call Alan, we’re cautiously optimistic in the fourth quarter and obviously that will carry over in to 2010. I think we’re pretty nimble when it comes to marketing. Obviously as we look at radio and TV and how we can actually do and leverage off of brand advertising and put promotional messages at the end are very effective, radio is pretty quick for us to do and obviously a lot of our Internet and also database marketing, we can move pretty fast so I think we’re pretty nimble to take advantage of any slight upturn of the consumer and we can react pretty quickly to it.

Operator

Your next question comes from Michael Lasser – Barclays Capital.

Michael Lasser – Barclays Capital

Within the sequential improvement that you’re seeing in the hard good category, is it consistent with how you intended it to be? Are you seeing a lift in all three categories good, better and best or is one disproportionately improving such that maybe the margin rate might be a little different than you anticipated?

Lawrence P. Molloy

At first, if you don’t mind I’ll finish answer Matt’s question on the tax rate, we’re looking at 38.5 to 39%, somewhere in between there for Q4. Then Michael, as it relates to the hard goods, a couple of things, I would say first off those were primarily around dog and I would say both the dog and cat business on the hard goods has gotten better and those areas that we reset I wouldn’t say that all have been created equal so not every single one of them is sequentially better than any other one. Some are better, they’re all better but some are I would say poor English but some are a little better than the others. Generally, we’re encouraged by all of them.

I would say on the hard goods side of the business the area that we’re struggling a little bit is on the specialty side of the house which is related to aquatics and reptiles those areas. That’s a tough business but the areas that we’ve reset are generally better.

Michael Lasser – Barclays Capital

As a quick follow up, with the guidance implying that SG&A dollars would be flat from the third quarter, that means they would be up maybe $10 to $13 million year-over-year, is that the run rate that we should expect as we’re moving in to 2010 given that a lot of the costs that have been run out of the system have already been achieved?

Lawrence P. Molloy

I would say two things Michael, first is it’s early for 2010, we’re in our planning process as we speak. I would say that we are going to work hard to make sure that we’re going to stick with our longer term guidance to create a cost structure next year that leverages a 2 to 2.5 comp and backing [inaudible] from there. I do think that sequentially where we are today is pretty much going to be in line with where we run with some mild volatility.

Michael Lasser – Barclays Capital

Just as a housekeeping note, could you provide the breakdown between ticket and traffic for the comp?

Lawrence P. Molloy

Michael we’ll get back to you on it.

Operator

Your next question comes from Analyst Matt Nemer – Wells Fargo Securities LLC.

Analyst for Matt Nemer – Wells Fargo Securities LLC

Just a couple of questions, first of all can you comment on the performance of premium food this quarter? You mentioned consumable units as a whole were actually up but I believe you were seeing some specific weakness in the premium volumes in 2Q. Has this stabilized somewhat now that some manufacturers have been focused more on promotions?

Lawrence P. Molloy

I would say that premium is still a challenged aisle for us although it’s a little less challenging but it’s also still definitely a challenged aisle for us.

Analyst for Matt Nemer – Wells Fargo Securities LLC

Then just curious on your outlook for services in 4Q as we approach the holidays, can you provide any color on what your capacity looks like and hotel versus last year and how booked are the grooming calendar versus last year, etc.?

Lawrence P. Molloy

On the hotel side of the house, we feel really good about the bookings. They’re in line with where they have been. For the holiday period, our bookings we have a waiting list so I feel really good on the hotel side there. As far as grooming, grooming has been very strong for us and we anticipate it will continue to stay relatively strong in the fourth quarter.

Analyst for Matt Nemer – Wells Fargo Securities LLC

Then just lastly, given the initial success from the hard goods resets, we’re just wondering if you can provide any more color on the reset schedule and plans for more categories in 2010 as well as the smaller pet food resets slated for February?

Robert F. Moran

We’re still working on the list for 2010 and again, what we want to do also is access the performance of the resets that we’ve done as we go through the holiday period.

Analyst for Matt Nemer – Wells Fargo Securities LLC

In terms of the pet food reset I assume that is a much smaller percentage of SKUs? You mentioned the 50% of sales on the hard goods side but it’s a much smaller reset on the food side, is that correct?

Lawrence P. Molloy

We haven’t spoken a whole lot about the food side of the resets so we’ve just mostly talked about the major hard good resets which were the biggest ones. Any of those going forward should be less disruptive. And Michael, I know you’re still on the phone, the comp for transaction was -.9 and from ticket was 1.1.

Operator

Your next question comes from David Mann – Johnson Rice & Company.

David Mann – Johnson Rice & Company

Just following up on your last comment about traffic, it looks like it’s been slowing the last couple of quarters. Are you expecting that to pick up in the fourth quarter to drive the comp increase and if so, why?

Lawrence P. Molloy

First off David, I would say that we had a -.5 in Q2. If you look at it on a two year stack it’s -2.1. In Q3 we had a -.9, if you look at it on a two year stack it’s a -1.7. it kind of depends on the math how you get there but the end of a day on a two year stack it’s kind of getting better on a one year it’s kind of getting worse but it’s generally in line with that. Considering where we were last year in the fourth quarter we feel pretty good that we’ll have something in line with flat to maybe even positive in Q4.

David Mann – Johnson Rice & Company

In terms of traffic, right?

Lawrence P. Molloy

Yes.

David Mann – Johnson Rice & Company

Then on the question on services, do you expect the services growth rate to decelerate in the fourth quarter or be more consistent with the third quarter growth rate?

Lawrence P. Molloy

It’s probably going to be more in line with the third quarter. If you can just give me a second and I’ll give you a little bit more specifics. It will be generally in line with Q3.

David Mann – Johnson Rice & Company

One last question, if I remember correctly last year Black Friday you sort of had a small emphasis on some items to see how you could do on Black Friday. Can you just compare in terms of how comprehensive the effort this year would be versus what you did last year, give us a little more color there?

Robert F. Moran

It’s a night and day comparison as we go in to this Black Friday. We have a lot more offers, we have a lot more vendor participation. We’re pretty excited about this year and there are a lot of pools going around the company with how high high could be. We feel really good, we’ve worked really hard to really support Black Friday and use that as a spring board to go in to the rest of the holiday season.

Operator

Your next question comes from Peter Benedict – Robert W. Baird & Co., Inc.

Peter Benedict – Robert W. Baird & Co., Inc.

A couple of things, first on the hard goods improvement that you’ve been seeing sequentially here, Chip how did that look on a two year basis versus recent months? Are you making any headway there and if so, how are do the trends look so far here in November?

Lawrence P. Molloy

Well obviously the November one I won’t comment on because it’s in the guidance but as it relates to the sequential I would say that when I look at year-over-year and I look at the periods we were generally very pleased with the momentum that we’re gathering in the month of October.

Peter Benedict – Robert W. Baird & Co., Inc.

On the services margin front, they’ve been up nicely. I think you said in the fourth quarter you think your services margins are going to be flat, is that just a comparison issue from last year?

Lawrence P. Molloy

Yeah, it’s more of a comparison issue. We’re getting to the place where it’s generally a push.

Peter Benedict – Robert W. Baird & Co., Inc.

Then lastly, I know inflation wasn’t really a factor in the third quarter, either way as you look to the fourth quarter do you think a slight deflation is what you’re going to see? And, as you guys look out the next couple of quarters are you going to be battling a little bit of deflation or is it not going to be meaningful?

Lawrence P. Molloy

I don’t think so because even today as we look at it I see the AUR comp every single day and the price changes that have happened and even the promotions that our vendors have been using, we’re still in a place where I would say that we have, although small, a AUR that’s actually in positive territory.

Operator

Your next question comes from Michael Baker – Deutsche Bank Securities.

Michael Baker – Deutsche Bank Securities

I guess three question, one on the rate which is still down and I think on your guidance will still be down as much in the fourth quarter when you consider that the mix is getting better when you consider the impact of the unit cap. Can you remind us what’s going on with rate? Why has rate been so negative?

Lawrence P. Molloy

Michael, I guess going back it’s been negative for several quarters. If we’re talking about the merch rate which is what I assume that you’re talking about. It’s been negative for several quarters over Q1, Q2 and even Q3, it’s been 180, 165, 160 it’s been both mix and rate. The rate has been I would say in the first quarter was pretty promotional driven and price driven and the second quarter was a mix of both promotional and some disruption. Q3 was really the disruption around the resets trying to get out of some older product that we’re trying to flush through the system, some cannibalization.

Then, as we go in to Q4 we don’t think rates is going to be an issue at all, it’s going to be more in line with just the mix. So of the 110 to 120 basis points on the merch side, 60 of it is essentially all mixed driven, the other 60 is the unit cap and hopefully that will disappear. We believe that will start to disappear quickly in to ’10. So, it’s a onetime thing.

Michael Baker – Deutsche Bank Securities

The second question, traffic is down, ticket is up yet you have inflation so it’s not coming from pricing so I presume that the units per basket is up? Is that a correct assumption?

Lawrence P. Molloy

Yes, our units per basket is up a little bit and this was probably the first quarter essentially our comp units were flat and it’s the first quarter it has been there since ’07.

Michael Baker – Deutsche Bank Securities

That was for food?

Lawrence P. Molloy

That’s all in for the company.

Michael Baker – Deutsche Bank Securities

Then the last question I have, just simply how should we model the investments in equity, that $2.2 million is that about right going forward? Equity and income from investors?

Lawrence P. Molloy

That’s our investment in MMI or Banfield as most of us all know. On the investment in Q4 we’re looking at probably about $1 million in Q4.

Michael Baker – Deutsche Bank Securities

Because it is up in the third quarter versus previous quarters. It sounds like it’s not going to be up as such in the fourth quarter. Was there something one time that happened in the third quarter?

Lawrence P. Molloy

Two and three are the good quarters for Banfield, fourth quarter is not. They have a different seasonality in their business.

Operator

Your next question comes from [Christian Buss].

[Christian Buss]

Could you provide a little bit more perspective in to some of the new marketing initiatives that you have underway?

Robert F. Moran

A couple of things, we’re really looking at how we can track new customer and also keep our current customers. For attracting new customers we do a lot of increased brand advertising, we do national in store adoption events, we improve the brand awareness both on radio and also TV and we also do a lot of key promotions and events inside our stores. That’s been working out fairly well because we’re attracting far more new customers than we’re losing comparing this year versus last year. Then, we do a lot of work off our database to keep our current customers.

Once we see customer behavior changing we start triggering emails or customized offerings so that we can attract the customer back in to our store both from a share of wallet and a frequency side.

[Christian Buss]

Just a follow up there, can you provide some color on the in bag and the on bag couponing you guys have added to the pet food?

Lawrence P. Molloy

We’ve done that with some selected vendors and what’s great about the coupon is it’s not just directed at the consumable side, it’s really a coupon to sell the whole store especially in the hard goods and discretionary items. That has been very successful. Our challenge to our consumable partners is really the strategic intent of why you’re a particular brand at PetSmart and what else can you offer that would really sell the whole store. We’ve been really very happy with that and it’s created a lot of great ideas and creativity especially not only for fourth quarter but we see a lot more of that activity happening in 2010.

[Christian Buss]

Has that been helping drive the basket?

Lawrence P. Molloy

I believe that’s been one of the contributors but it’s not just one thing it’s a series of things that we’re working on. As we said at the analyst call we’re working on things that we control and that we can control our destiny on. Obviously, as we look at new products, we look at new partnerships with vendors, we look at resets and we also look at how we do promotions, especially as we go through the holiday season in to next year. I do believe it’s one of the contributors.

Operator

Your next question comes from [Daniel Hopkin].

[Daniel Hopkin]

Just curious on the gross margin, first of all were there any sort of aspects of that that were particularly better or maybe a little worse than what you might have thought three months ago in particular? Then, I just wanted to see if you could run through the overall sales mix percentages for the major groups that you have in the store and then finally a question on the adoption environment out there.

Lawrence P. Molloy

I’ll talk about the gross margin and I’ll talk about the mix shift and Bob will talk about the adoption. As far as the gross margin is concerned I think gross margins is generally occurring as predicted as we’ve flowed through the year. I would say the one thing that has been a little bit surprising was the unit cap and that’s why I wanted to explain it. It’s a little surprising because the inventories, our supply chain team along with our merch team has actually done a much better job than originally planned with managing inventory. I feel really good as we go in to the Christmas holidays and we haven’t gotten fat if you will.

What’s that doing is it’s putting that strain, it’s still counter intuitive, it’s putting the strain on the gross margin line which is a little bit of a surprise. Outside of that I think everything is happening as we plan. The true product margins are sequentially becoming less dilutive and we’re driving towards and overall gross margin next year that hopefully can be in line with our long term guidance of flat to slight accretion.

As far as mix is concerned, if you give me a sec, the mix shift as we’re looking at all of our consumables for Q3 was 54.5% of sales, our hard goods was 33.2% and our live was 1.8% of sales. So the shift from that, I didn’t do the actual shift but it looks like we’re on the food side of the house we’re up about 170 basis points on the food side of the house, on the hard goods side we’re down 200 basis points and on the live side we’re down 10 basis points.

[Daniel Hopkin]

Just to be clear, that last point was just regarding the third quarter year-to-year, correct?

Lawrence P. Molloy

That’s correct. For adoptions, we just had an adoption event and I think Bob can talk about that.

Robert F. Moran

We just had a great weekend, an adoption weekend. We had close to 17,000 adoptions and there have been a lot of key learnings of these events in 2009 and as we get ready for 2010 we have worked with our vendor partners, especially on the consumable area to give not only everyday sponsorship but quarterly sponsorship for major events. We’re looking at adoptions being one of our key goals for next year, to increase it at a high rate. We do believe there is some stabilization out there in pet acquisition and we believe we can grow it next year with all these sponsorships and key events.

[Daniel Hopkin]

Just to be clear, when you refer to some stabilization out there are you talking ex your internal initiatives where you’re gaining share? Are you seeing stabilization in just the overall pet acquisition environment?

Lawrence P. Molloy

We’re starting to see stabilization in the pet acquisition environment.

[Daniel Hopkin]

What do you think is driving that?

Lawrence P. Molloy

More housing, opportunities out there but also at the same time, we’ve been down for two years now so we’re coming up with comparable rates that we should be able to improve on.

Operator

Your next question comes from Mitchell Kaiser – Piper Jaffray.

Mitchell Kaiser – Piper Jaffray

Maybe if you could just step back, the original guidance was $0.20 to $0.24 and obviously you came in much higher than that. Could you just talk about the delta relative to what you were originally thinking? Then, I do have a follow up question.

Lawrence P. Molloy

I would say two things, one when we gave the original guidance we didn’t change our sales guidance, we said essentially flat which could be anywhere from -1 to 1 I guess you could call it. At the time we gave the call we were in the negative territory, we were much closer to that -1 and as I said earlier, August on the hard goods side because of the disruption we actually self inflicted to some degree, was very challenging to us as we were leading in to that call therefore we gave the guidance we gave.

The reality is we actually went from running at about a -1 comp, we started to come back in to positive territory and although we landed at .3 it was in a place that was much better than where we were running and sounds like it was in line with our guidance but it was actually a little bit better than we hoped. That was number one. The other big item is we did see some improvements going in to October on the hard goods side that we were hoping for and some of that showed up. I would say on the last piece of it is the cost management, the organization has done, and obviously as a CFO person you’re always looking for costs it’s part of the job but I am just amazed and I appreciate this organization every single day and the work that they have done to look under every nook and cranny to find some opportunities.

We haven’t done it by cutting a lot of people, we haven’t done it by taking away their 401K match, we’ve done it through just good old blocking and tackling. Our people in our stores are trimming on the supply side. Our stores are doing a wonderful job managing labor and back here at home people are really focused on the expense side. It’s been much better than I would have ever anticipated coming in to the quarter. I thought we were done but we weren’t and now it looks like we at a place where it is getting tighter and more difficult but we’re in a good place.

Mitchell Kaiser – Piper Jaffray

Then just a housekeeping question, what was the mix in Q3 for last year amongst the categories?

Lawrence P. Molloy

Last year in Q3, once again it was 52.8 on the consumables side, 35.2 on the hard goods side and 1.9 on the live goods side.

Operator

Your last question comes from David Strasser – Janney Montgomery Scott LLC.

David Strasser – Janney Montgomery Scott LLC

I wanted to follow up a little bit on the adoption, going back to the meeting back in October you had talked about adoptions and the number of adoptions mattering but then you talked more about your ability to capture a larger share of basket from each adoption. After the success you had last weekend which I followed pretty closely have you been able to monetize that or is that something that still needs to improve going in to 2010?

Robert F. Moran

We’re still learning how to monetize it and what I mean by that is we feel really good inside the company about the adoption event. What we’re doing is really building the programs around it to monetize it and also connect with our database so we can follow up with the customer. We picked up a lot of key learnings in 2009. We think we’re going to have a lot more activity to make some significant changes on how we can monetize it within our stores but that’s why we put it as one of our major goals for 2010.

David Strasser – Janney Montgomery Scott LLC

Just as an analyst and sort of the next time you’re doing the event or the one after that, anything that we can look for going in to the store to get a sense of how that’s going? I just think it’s a really big opportunity that’s sort of why I’m hounding on it a little bit.

Robert F. Moran

We think it’s a big opportunity too. It creates a great excitement within the stores. You see a lot of community events but the best way of looking at it when you’re in the store is just look at the cash register and the cash register line. We do believe that we do monetize a good portion but we think we can do better and that’s what we’re going to focus on for next year. I think we’ve come to an end and I just want to thank you for listening and we’ll come back and talk to you in March for the Q4 call. Thank you.

Operator

Ladies and gentlemen this does conclude today’s program. Thank you for your participation and have a wonderful day. You may now all disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: PetSmart, Inc. Q3 2009 Earnings Call Transcript
This Transcript
All Transcripts