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PetSmart (NASDAQ:PETM)

Q3 2013 Earnings Call

November 22, 2013 9:00 am ET

Executives

April Lenhard

David K. Lenhardt - Chief Executive Officer, Director and Member of Disclosure & Ethics Committee

Carrie W. Teffner - Chief Financial Officer, Senior Vice President and Member of Disclosure & Ethics Committee

Joseph D. O'Leary - President and Chief Operating Officer

Analysts

Michael Lasser - UBS Investment Bank, Research Division

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

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

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

Michael Baker - Deutsche Bank AG, Research Division

Jeffrey S. Stein - Northcoast Research

Oliver Wintermantel - ISI Group Inc., Research Division

Denise Chai - BofA Merrill Lynch, Research Division

Peter J. Keith - Piper Jaffray Companies, Research Division

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

Joseph I. Feldman - Telsey Advisory Group LLC

Operator

Good day, ladies and gentlemen, and welcome to the PetSmart's Third Quarter 2013 Analyst Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

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

April Lenhard

Good morning [ph], everyone. Joining me on today's call are David Lenhardt, Chief Executive Officer; Carrie Teffner, Senior Vice President and Chief Financial Officer; and Joe O'Leary, President and Chief Operating Officer. David will provide an update on the business, and then Carrie will review the detailed financial results as well as our earnings guidance, after which we will open it up for questions. [Operator Instructions]

Before I turn the call over to David, let me remind you that 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.

It is now my pleasure to introduce David Lenhardt.

David K. Lenhardt

Thanks, April, and good morning, everyone. We are pleased to report earnings per share of $0.88 for the third quarter, up 17% when compared to the same period last year. Total sales growth was up 4%, with comparable store sales growth of 2.7% and comp transactions up 0.2%.

Given the challenged consumer environment during the quarter, we are pleased with our results and level of execution. Our performance demonstrates the strength and stability of our business and what we can achieve when we focus on the 3 strategic pillars of caring for our customers, caring for our associates and caring for our communities.

In terms of the performance across the business, we continue to see strength in our natural foods and stabilization in the science category in both dog and cat across top channel exclusive brands.

During the third quarter, we also expanded the assortment of natural chews and treats and channel exclusive treats, with newness in BLUE Buffalo and our proprietary brand, Dentley's. In hard goods, we continue to innovate across key categories, with new assortments with Disney, Martha Stewart Pets, DC Comics, Marvel and Peanuts. Collectively, across our portfolio of exclusive and proprietary brands, we are driving increased penetration and brand recognition.

In services, sales growth of 5.2% in the third quarter outperformed the core, driven by strength in both Grooming and PetsHotels. We've built out a portfolio of add-on packages and upgrades, including customizable and seasonal packages with tie-ins to key exclusive brands that really resonate with our pet parents.

We continue to focus on our omni channel efforts, including e-commerce, e-influence and building new capabilities with a goal of simplifying the shopping experience for our customers whenever and wherever they choose to engage with us. During the third quarter, we launched realtime online inventory availability for consumables, which we believe is a key differentiator for us.

Our pipeline of innovation and differentiation is robust. We continue to focus on delighting our customers with solutions for the total lifetime care of their pets, and this holiday season is no exception. We've asked our pet parents about their holiday shopping plans, and we know that, overall, about 75% of pet parents plan to give their pet a special treat or present for the holidays, and more than half plan to get their pet a holiday stocking. At PetSmart, we offer the broadest assortment for the holidays. And this year, we've expanded our exclusive assortments across the categories even more.

In consumables, we've added new and exclusive items that you won't find anywhere else, from BLUE Buffalo's Santa Snack treats and Santa Stew wet food to GOOD BUDDY holiday-inspired sausages and Grreat Choice seasonal decorated treats and rawhide value packs.

In hard goods, we are pleased to announce the arrival of Peanuts-themed dog tees and sweaters for the holiday season and a new holiday assortment of Disney products. Our licensed assortment rounds out with Rudolph and Bumble, Tommy Bahama, Bret Michaels and Martha Stewart. Each collection offers a different holiday look for every type of pet and pet parent.

In grooming, we are offering innovative packages, like our new Holiday Top Dog grooming package with a sugar-cookie cologne spritz, a bow or festive bandana and new holiday-themed charms. And overnight PetsHotel guests can enjoy a turkey dinner and dessert package when they board with us.

This holiday season, we're also focusing on value with our dog and cat toy value packs and holiday Bonus Bucks with coupons to use on a future visit.

Caring for our communities is especially important during the holiday season. And this year, we are thrilled to be able to support local charities through a new donation program with our Luv-A-Pet Chance and Lucky plush dog toys. We're adding 2 new friends to the Chance and Lucky assortment this year, for a total of 5 exclusive toys: Chance, Bret Chance, Mrs. Chance, Superman Chance and Lucky. Just like in years past, 10% of the sales proceeds go to PetSmart Charities. In addition, this year when customers buy a Chance or Lucky toy, they may choose to also donate a Chance or Lucky to a local charity in their community.

Giving back to our local communities is an important part of who we are as a company and what we stand for. In over 1,300 stores across North America, we are saving the lives of homeless pets and serving our local communities through our in-store adoption programs. We are proud that, through our partnership with PetSmart Charities, we continue to find even more homes for homeless pets this year, with adoptions in our stores up both during the third quarter, including the National Adoption Weekend, and up year-to-date versus last year.

While we expect the challenged consumer environment to continue through the remainder of 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.

And with that, I would like to turn it over to Carrie to provide more details on our third quarter financial performance, as well as our earnings guidance.

Carrie W. Teffner

Thanks, David, and good morning, everyone. First, I will walk you through some highlights of our financial performance in the third quarter. And then I will provide guidance for the fourth quarter and the fiscal year.

Total sales increased 4% over last year to $1.7 billion. Comparable store sales growth was 2.7%, and comp transactions were positive for the 14th consecutive quarter at 0.2%. The sales mix for the quarter included consumables at 54.5%; hard goods at 32.4%; services at 10.9%; live pets at 1.5% and other revenue at 0.6%. Gross margins for the quarter were 29.8%, up 20 basis points versus the prior year period, primarily driven by services leverage. Operating and general and administrative expenses were 20.8%, representing 25 basis points of improvement from the prior year period. Overall, earnings before tax increased to $140 million or 8.2% of sales. This represents 11% growth and a 50-basis-point improvement. Tax rate for the quarter was 36.5%.

Turning to the balance sheet. At the end of the third quarter, we had $367 million in cash, cash equivalents and restricted cash and 0 borrowings on our credit facility. We ended the quarter with average inventory per store of $607,000, up 1% compared to the third quarter last year. From a cash flow perspective, we generated $107 million in cash flows from operating activities during the quarter. Depreciation and amortization expense for the quarter was $59 million. We spent $51 million on capital expenditures, opening 16 new stores and closing 3, bringing our totals to 1,314 stores and 196 hotels. We also repurchased $30 million of PetSmart stock during the quarter and distributed $17 million in dividends.

In September, we announced the Board of Directors' approval of a new $535 million share repurchase program that began October 1 and expires in January of 2015. In addition, we also have $113 million remaining as of the end of the third quarter on the June 2012 share repurchase program that expires in January of 2014 for a total of $648 million of share repurchase authorization outstanding. The board also approved an 18% increase in our quarterly dividend, bringing the total quarterly payout from $0.165 to $0.195 per share.

Turning now to our guidance for the year and for the fourth quarter, except for comparable store sales growth, which is calculated on an equivalent basis, I will provide guidance on a GAAP basis, which is 52 weeks for fiscal year 2013 versus 53 weeks for fiscal year 2012 and 13 weeks for the fourth quarter of 2013 versus 14 weeks for the fourth quarter of 2012. I will also quantify how certain metrics compare on a 52 to 52-week basis or 13- to 13-week basis where appropriate. I also want to remind you of the impact of the extra week on 2012's results.

Total sales for the week were $126 million. The impact on gross margin was $48 million. The impact on OG&A was $18 million. Combined, this resulted in a $30 million increase in earnings before tax and $0.17 in earnings per share.

For fiscal year 2013, we are expecting comparable store sales growth of 3% to 3.5% and total sales growth of approximately 3%. This equates to sales growth of approximately 5% on a 52- to 52-week basis. We are updating our earnings per share guidance from a previous range of $3.88 to $3.98 to our current expectations of $3.94 to $3.98. We expect EBT margin expansion of 20 to 40 basis points. This equates to EBT margin expansion of 50 to 70 basis points on a 52- to 52-week basis, with leverage in both gross margin and OG&A. We anticipate the tax rate to be around 37%.

For the fourth quarter of 2013, we are expecting comparable store sales growth of 2.5% to 3.5% and total sales growth of minus 3% to minus 2%. This equates to sales growth of 4% to 5% on a 13- to 13-week basis. We expect EBT margin to expand minus 45 to minus 15 basis points. This equates to a 45- to 75-basis-point increase on a 13- to 13-week basis, primarily through leverage in OG&A and earnings per share of $1.19 to $1.23.

We are currently in the middle of the planning process for 2014, so I won't provide specific guidance for next year. However, we are working to develop a 2014 operating plan that we expect to fall within our shareholder value framework that we updated at our Analyst Day.

And with that, I would like to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Michael Lasser with UBS.

Michael Lasser - UBS Investment Bank, Research Division

Carrie, you said in your remarks that the gross margin performance in the quarter was largely dictated by the services margin. Can you give us the quantified breakdown like you have in the past?

Carrie W. Teffner

Yes, so with respect to the margin, you're right. It was up 20 basis points, driven primarily by services. March margins were slightly down due to some of the softness in our aquatics business, and that some of the highest-margin product that we have in the store, we talked a little about that in Q2. But I'm not going to call out specific numbers, it was slightly down.

Michael Lasser - UBS Investment Bank, Research Division

Okay. And when do you think -- this aquatics issue that's been happening for the last couple quarters, when will that get addressed, you think or...?

Carrie W. Teffner

Yes, I'm going to let Joe answer that. He can give you a little bit more color.

Joseph D. O'Leary

Mike, this is Joe. Yes, with the aquatics business, it's been slowing somewhat since the second quarter. And you'll recall that on that -- in that -- on that last call, we talked about some supply issues, which we've since corrected. But the underlying decline has -- became more apparent once we got back in stock. And we believe that trend is across the whole aquatics sector. In fact, we worked with our 4 largest aquatic vendors that control the vast majority of the sector, and they said it's the same decline across the industry. So what we're doing is really focusing on servicing our existing customers. There are not so many new customers coming into the category, so that's where our current focus is. But then having said that, we're really excited about the launch of National Geographic, which will make it much easier for entrants into this category early next year. So an underlying slowdown across the sector, focus on our current customers and then launch National Geographic early next year.

Michael Lasser - UBS Investment Bank, Research Division

Okay. My -- that's helpful. As my follow-up question, if you look at the comp guidance for the fourth quarter, it suggests a further slowdown on a multiyear stack basis. Can you walk us through your thought process on how you created the outlook on the comp?

David K. Lenhardt

Michael, it's David. Our comp guidance reflects how we're thinking about the business as we sit here today. We feel very good that that's within the long-term shareholder value framework that we just updated at the last Investor Day. And we feel very good about our ability to continue to sustainably and consistently deliver against that framework.

Operator

Our next question comes from Daniel Hofkin with William Blair.

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

Just I guess a follow-up on the comp. Would you mind providing the kind of category breakdown from what this year once more, as well as the comparable numbers for last year, if you wouldn't mind? And I have a related question about that.

Carrie W. Teffner

Specific to Q3, the breakdown of the 2.7 comp, is that what you're asking?

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

Yes, or just the sales percentages, like 50% from consumables, et cetera, kind of thing.

Carrie W. Teffner

Sure, sure. So what we just said in the call was, basically, consumables was at 54.5%; hard goods at 32.5%; live pets at 1.5%; and then other at 0.6%.

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

Okay. And I assume the -- I don't have it right in front of me, but the category breakdown in last year's quarter?

Carrie W. Teffner

Sure, sure. So consumables was at 53.9%; hard goods was at 33.1%; live goods at 1.7%; and other at 0.6%.

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

Okay. And as it relates to the trends within consumables and hard goods, what are you thinking at this point in terms of the recent reset activity and the pretty significant activity within dog hard goods? What -- do you think it is some sort of a payback from that factored into your fourth quarter guidance? Or are you...

David K. Lenhardt

Yes, Dan, it's David. In terms of the hard good reset, the first thing that I would say is it's early days. We just finished the reset in September. We don't break out the detailed financial performance of our reset, but what I can tell you is we have been pleased with the early results. We did see dog hard goods penetration increase in the third quarter. And it's one of the elements that is in, that is reflected in our guidance for the fourth quarter.

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

Okay. And then remind us, the upcoming planned reset activity in early 2014 is kind of even greater scale, and that's across dog and cat food, correct?

David K. Lenhardt

That is our consumables reset, which we talked about at the Investor Day, we will be doing early next year, and that will be the biggest consumables reset we've ever done, and it is across dog and cat.

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

Okay. Would you normally expect -- when do you -- in which type of business do you normally see a faster payback, without putting hard numbers on it?

David K. Lenhardt

Dan, we don't get into that detail. But again, as -- we think about reset as an ongoing piece of our strategy, and it's an ongoing piece of our merchandise strategy. And it's something that we've been pretty consistently doing across the business over the years, and this is a continuation of that.

Operator

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

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

We've seen very good SG&A control. In fact, basically, 2 quarters in a row, SG&A dollars per store have actually been down year-over-year. How should we kind of think about this metric going forward? I'm sure that's not sustainable over a long term, but just in terms of how should we think about that model going forward in terms of SG&A dollars per store.

Carrie W. Teffner

Yes, I would think -- if you think about OG&A growth, obviously, as you've seen this year, there have been some improvements in that as we control expenses. I mentioned we are seeing leverage there. We do expect to continue to see leverage in the OG&A line through labor efficiencies in the store, controlling expenses, et cetera. So I think you should expect to see continued improvement.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Okay. And then just a question on the balance sheet. We've seen payables inventory decline a couple quarters in a row now. And I guess what I'm trying to figure out is, is that a function of slow returns maybe impacting kind of the payable ratio because the sales have slowed? Have you changed terms with suppliers? Just what is that a function of?

Carrie W. Teffner

With respect to the AP relationship to inventory, we have seen a little bit of challenging in terms of our processing of the accounts payable. We implemented a new AP system over the course of the year, so we've seen a little bit of variation due to that, and I would attribute, really, the variance with that. So it's not -- those will get back in line.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

So not a target change in terms of looking for maybe more gross margin or...?

Carrie W. Teffner

No, not all. No -- yes, no underlying change there.

Operator

Our next question comes from David Mann with Johnson Rice.

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

In terms of the traffic, it's decelerated again this quarter. I'm just curious, first of all, is the current trend what you're planning for the component of comps, are you expecting that to stay in sort of slightly positive range for the fourth quarter? And then secondly, any change in marketing that you're looking to do to try and improve the traffic?

David K. Lenhardt

David, it's David. As we said at the Investor Day, in the third quarter, we did see some softer traffic as a result of the challenged consumer environment. We have been absolutely investing in advertising and -- both in the third quarter but year-over-year and continuing into the fourth quarter, we have been increasing our advertising growth. And we feel good about the 2.5% to 3.5% comp guidance as we think about the fourth quarter.

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

And then as a follow-up, in terms of the services revenue growth, that moderated in the third quarter a little bit versus the trend in the second quarter. I'm curious if you can just comment whether that's -- elaborate a little bit on that, whether you think that's the trend we should expect in the fourth quarter. Or some of the initiatives you have, will pick up a little bit?

David K. Lenhardt

Yes, David. We've been very pleased with our services business all year. And as you saw this past quarter, it did outperform the core with a 5% overall growth. That's been driven predominantly by grooming, but also by our hotels. And I think that continues to be a very sticky part of our business that we think is a key differentiator. And you're going to see us continue to invest and focus on it. We talked a little bit about, as we go into the holiday, we've got some great holiday packages in the hotels, whether it be a Thanksgiving dinner or whether it be things like the Bret Michaels Top Dog, a Holiday Top Dog that we're doing in the salons. So that continues to be a business that we're really focused on bringing freshness into.

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

Great. And, Carrie, one housekeeping question on the tax rate, I guess, a little bit lower in the third quarter and a little lower in the guide for the year. Is there -- are there any discrete items we should know about in either of those numbers?

Carrie W. Teffner

Yes. Specific to the third quarter, we did have some onetime state tax credits come through that obviously benefited the tax rate in the quarter. So that did impact, therefore, the full year tax rate assumption.

Operator

Our next question comes from Dan Wewer with Raymond James.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Dave, 5 years ago, the company made a brilliant move in slowing the rate of new store growth down to the 2.5%, 3% rate. It obviously had a big benefit on your sales per store, profit per store, cash flow, et cetera. But I guess one consequence is the store base is getting older. It looks like maybe less than 10% of your selling space is 3 years of age or less. Do you think we're at the tipping point where that's beginning to have some headwind on your traffic trends per store and the overall rate of same-store sales growth?

Carrie W. Teffner

No. As we've looked at the performance of the store portfolio, we're not seeing an impact from that. And obviously, the 2% to 3% square footage growth is still part of the long-term framework that we've outlined.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Well, the reason I ask is that if you go back to the days when the company was growing its selling space 8% to 10% rate, the management that was running the company then would talk about significant sales ramp during the first 4 or 5 years of the store's age. So it's just math. As store base is younger, it leads to better comps. I'm just trying to figure out what changed as -- why wouldn't that be an issue now?

David K. Lenhardt

Well, to your point, Dan, I mean, just mathematically, we are opening, as a percentage of the base, it's a smaller percentage of new stores. But having said that, we feel very good about our ability to deliver against all the key elements of a long-term shareholder value framework and, ultimately, deliver a top quartile shareholder return sustainably and consistently.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Okay. And just as a follow-up, I know that with your smaller store format, you're able to go into more secondary markets. But at the same time, you've got some formidable competitors, such as Tractor Supply, in those same type of markets. How would you compare the value proposition of PetSmart and Tractor Supply in the dog and cat category?

David K. Lenhardt

Yes, Dan, overall, I would say I do think there are some key differences. I think that we've got a broader assortment of full line. If you think about, in particular, our smaller stores that we're testing right now, we've got grooming in there, we've got adoptions in there, we have pet training in there, we've got the full natural food assortment. So I think you're going to see some key differences there.

Operator

Our next question comes from Peter Benedict with Robert Baird.

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

First, just back to the traffic flow, can you give any color as to the flow kind of during the third quarter? I know you guys kind of wanted to defer at the Analyst Meeting to discuss that in more detail. Just trying to understand when it's slowed, how much it's slowed and if it's come back really at all here. That's the first question.

David K. Lenhardt

Yes, Peter, I would say we saw that softer traffic throughout the quarter, and it was fairly broad based.

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

Okay. And then when you think about the average ticket, obviously, that's been very consistent. Can you help us understand a little further there maybe what's been driving that. Has it been a mix in the business? Is -- I mean, inflation doesn't seem to be too material here. Items in the basket, just help us understand how you're keeping this average ticket up so much and doing such a good job there.

Carrie W. Teffner

Sure. Absolutely. So when we think about the AUR, specifically as it relates to Q3, we are seeing a bit of inflation, that's about 1%. And the rest is really quality of goods in the basket.

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

Okay. So that trend sounds like it continues. I guess...

Carrie W. Teffner

Yes, it does.

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

The last question, if I could. If you just talk about the competitive environment out there, I'm thinking more on the brick-and-mortar side as opposed to the online side, how is that evolving? As you guys are going into some of these smaller markets, what are you seeing there? Anything -- we know what Petco is doing with some of their smaller formats. Just talk a little bit about that and maybe how you're seeing that evolve.

David K. Lenhardt

Yes, thanks, Peter. We are continually monitoring the competitive environment. Relative to the small stores, what I would say is, typically, when we go into the smaller markets, there is no national competition there, and we're the first player in, and so that's one of the things, we think, is attractive about the small markets. And so that's what we're seeing there.

Operator

Our next question comes from Mike Baker with Deutsche Bank.

Michael Baker - Deutsche Bank AG, Research Division

So a couple of questions. One, I thought we saw during the quarter some tests for free shipping on dog food online. Just wondering if you can comment on that. Is that an ongoing change of strategy or just a test? Is that funded by you guys or vendors?

David K. Lenhardt

Yes, Michael, we're -- that's really a continuation of testing that we've been doing throughout the year when it comes to our e-commerce business. And what you're seeing us do is a variety of different tests around free shipping, $4.99 shipping, different percentages off given thresholds of the overall basket. And you will see a variation and continue to see a variation of what we're doing on that front. And really, the intent there is to really understand where do we find that sweet spot of what works for us, what works for our customers. I think we continue to be pleased with the overall growth in our e-commerce business. It is growing faster than the overall market, and it is profitable.

Michael Baker - Deutsche Bank AG, Research Division

And are consumers responding to those types of promotional activities?

David K. Lenhardt

Again, it varies based on the tests. And that's, again, really the purpose of the test.

Michael Baker - Deutsche Bank AG, Research Division

Okay, fair enough. One more follow-up on some of the resets. So first, the food reset, so channel-exclusive food is already about 75% of your dog and cat food. What do you think that can get to? And then secondly, I want to follow up on the hard goods resets. Did you say hard good penetration was up year-over-year?

David K. Lenhardt

Yes.

Carrie W. Teffner

With dog and cat.

David K. Lenhardt

Dog hard goods in the third quarter, my comment was we did see that increase through the quarter.

Michael Baker - Deutsche Bank AG, Research Division

Okay. Specifically, dog hard goods, not total hard goods?

David K. Lenhardt

Dog hard goods.

Michael Baker - Deutsche Bank AG, Research Division

I understand. Okay, fair enough. so the food -- what -- how big a percent of your mix can that get to, that channel-exclusive?

Joseph D. O'Leary

Yes, Michael, it's Joe. Yes, we think that's still pretty significant runway around the premiumization of consumables. And clearly, our intention when we do the reset next year is to introduce more channel-exclusive food in terms of new formulas and new products and exclusive products for us. So we don't have a specific target that we would describe today. But clearly, the intent of that reset is to continue to build on the success we've had over recent years and to continue to differentiate and create a reason for the consumer to come to PetSmart. So -- and on the track record of the previous 2 resets that we've done in consumables in '10 and in '12, we're really excited about the upcoming consumables reset, which will be in the first quarter of 2014.

Operator

Our next question comes from Jeff Stein with Northcoast Research.

Jeffrey S. Stein - Northcoast Research

Just a question on the recent launch of your online pharmacy business in association with VetSource, I'm wondering how that's going. And are there any issues with Banfield now that you're kind of competing against them in the pharmacy business?

David K. Lenhardt

Yes, Jeff, it's David. No, we're -- again, early days, but we're pleased with how it's doing. And with respect to Banfield, no issues at all. They know we're doing this. They have an online pharmacy, and we're co-existing.

Jeffrey S. Stein - Northcoast Research

Okay. And any thoughts in terms of the reduction that you saw in your equity and earnings of Banfield during the quarter? Because in Q2, it was down a little bit and down quite a bit more in Q3.

Carrie W. Teffner

Yes. They've had some timing [ph] in terms of some of the expenses coming through on their end. So we're actually expecting them to be, actually, at this point, relatively flat year-over-year for the full year, and that's incorporated into our guidance.

Operator

Our next question comes from Oliver Wintermantel with ISI Group.

Oliver Wintermantel - ISI Group Inc., Research Division

Historically, you talked about your customers as in Smart with Heart and mart [ph] customers. And then looking at the deceleration in traffic in 2013, which of your customers do you think had the bigger impact on that deceleration?

David K. Lenhardt

Yes, again, Oliver, we don't break that out. Again, we saw a fairly broad-based softness in our traffic through the third quarter.

Oliver Wintermantel - ISI Group Inc., Research Division

So that's across all of your customer base?

David K. Lenhardt

Yes, pretty broad-based.

Oliver Wintermantel - ISI Group Inc., Research Division

Okay. And then, Carrie, you mentioned the benefits from costs and EBT margin in the fourth quarter, but you didn't mention merchandise margin. So should we expect this aquatic issue is going on in the fourth quarter?

Carrie W. Teffner

The -- you should expect in the fourth quarter relative to merch margin to be somewhat similar to what we saw in Q3.

Operator

Our next question comes from Denise Chai with Bank of America Merrill Lynch.

Denise Chai - BofA Merrill Lynch, Research Division

Just wondering, in terms of your fourth quarter guidance, what's embedded in terms of traffic? And also, related to that, what do you think is going to have the biggest impact here in terms of the things you're doing, the resets, the exclusive assortments, marketing? I mean, what do you think is going to be the most impactful driver?

Carrie W. Teffner

Yes, with respect to guidance, Denise, we don't break out the traffic versus the various pieces. So I really don't want to comment on that. But relative to the 2.5% to 3.5% comp, what we're looking at in the fourth quarter is it is a holiday quarter, we have a lot of newness and new products in the store to support the holiday, and that's what we're really counting on.

Denise Chai - BofA Merrill Lynch, Research Division

Okay. And just secondly here, you said the consumer is still challenged. It wouldn't be a surprise to anybody, I think. So how do you see the promotional environment heading into holiday?

David K. Lenhardt

Denise, I would say not particularly different than it's been. I think we feel really good about, again, as Carrie said, the holiday assortment, the promotions that we have. We've got a broader assortment for the holidays than we have ever had. Obviously, next week, it's Black Friday. We have a pre-Thanksgiving sale for the first time. And we feel really good about the unique and exclusive holiday assortments we have, both from the product and the services side, and we're excited about the holidays.

Operator

Our next question comes from Peter Keith of Piper Jaffray.

Peter J. Keith - Piper Jaffray Companies, Research Division

I noticed in recent months, there's been a step-up in TV commercials from some of your super premium partners in food, with commercials from BLUE Buffalo, Wellness, Nutro, et cetera. I guess what I'm wondering from your perspective, is that sort of a new step-up in marketing from those partners? And if so, is there any benefit that you're beginning to see with regard to the super premium trend in your stores?

Joseph D. O'Leary

Yes, it's Joe. We -- as you know, we work really closely with our vendors, particularly with channel-exclusive vendors, and it's been a step into TV. Initially, they were more in print. And certainly, as you've seen those vendors advertise on TV and the early results, they're very pleased with those. They've done that in conjunction with us. And as we've met with a number of the vendors, actually, recently as we're heading towards the fourth quarter and they're taking us through their marketing plan and some of the brands are actually diversifying their commercials to be into sport and some major TV programs. So you'll increasingly see that step-up. And we're really pleased to be working jointly with our channel-exclusive vendors to do that.

Peter J. Keith - Piper Jaffray Companies, Research Division

Okay. And then I want to pivot to the merchandise margin. And I guess kind of a 2-part question, is -- with the merchandising margin, if I'm -- to be clear, would that be up if you did not have the aquatics issue? And then as a follow-on, I guess I'm a bit surprised that the merchandise margin, this wouldn't be -- in year-on-year period, it wouldn't be accelerating in general, just given the large -- the dog hard good reset that you did earlier this year.

Carrie W. Teffner

Yes, this is Carrie. Let me take the first part of the question. We absolutely would see in the quarter merch margin up if -- despite -- if not for the aquatics portion that we experienced in the quarter. But with respect to the overall hard good sales penetration, as always, consumables growth continues to outpace our hard goods. But again, we're pleased with the hard goods. And as David mentioned earlier, we do -- we've had seen increased penetration, specifically in dog hard goods.

Operator

Our next question comes from Matthew Fassler with Goldman Sachs.

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

A couple questions on margin. First of all, did you quantify yet the impact of occupancy leverage on your margin in the third quarter?

Carrie W. Teffner

No, we're not going to. So overall, we're going to see overall margin, which is driven primarily by services. And as I mentioned, merch margin is slightly down.

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

So are you sort of changing the detail that you're going into [ph] a margin on a go-forward basis?

Carrie W. Teffner

Yes, I think, as I look at it, we've really gone into a lot of detail in the past, and we really feel like it's not necessary for you to get the gist of what's going on with the business.

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

Right. And then I guess a higher-level question on margin. I know, I guess, globally speaking, last year, if you think about what you attributed to mix and things like that, it was, I think, every quarter, slightly positive for you. This year, I understand there's a variety of reasons, some of which were one-offs, each of the past 3 quarters, it's been a bit of a drag. If you look at the totality of the environment, you consider your own initiatives, you consider competition, you consider what your vendors are doing and you kind of take a 1- or 2-year look, going beyond '13 but not getting specific with any one number for any one year, is this something that we should consider to be roughly stable going forward? Or is there still upside to that number?

Carrie W. Teffner

Yes. I'll take you back to what we've said during the Analyst Day, Matt, which is, really, we're focused on driving stable to expanding overall gross margins. And then within that, we're working every line to deliver the -- to deliver what we can against those.

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

And then second question, on the buyback, I know you bought back, I think, less than what your annual average would typically be. And I know you had a much bigger buyback earlier in the year.

Carrie W. Teffner

Yes.

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

So you're still kind of on track. How should we think about your own thinking as it relates to the timing of the buyback for this quarter in particular?

Carrie W. Teffner

Yes. So our buying back -- buying cadence varies quarter-to-quarter. Our guidance for the year assumed that we would reduce our weighted average share count to approximately $105 million -- 105 million shares for the year, and we're on track to deliver against that.

Operator

Our next question comes from Joe Feldman with Telsey.

Joseph I. Feldman - Telsey Advisory Group LLC

I know you guys launched the realtime inventory for consumables this quarter. And I was just curious, I know it's early, but any initial read on it? Did it help drive incremental traffic to the stores or incremental purchases or anything that you could tell so far from it?

David K. Lenhardt

Yes, Joe, it's David. It is early, and that's something we wouldn't get into that detail with. But we are excited that we have it. That was one of the top capabilities our customers asked for, and our customers are using it.

Joseph I. Feldman - Telsey Advisory Group LLC

And also just to stay with the Internet theme, could you just provide an update on the buy online, pick-up store, where you're at with that rollout and all the other forms of flexible fulfillment?

David K. Lenhardt

Yes, Joe, as we said at the Investor Day, that's something that we're very actively working on developing. We're continuing to develop that. And as we get closer to a test, that's when we would start to talk about it.

Operator

Our final question comes from Mike Baker with Deutsche Bank.

Michael Baker - Deutsche Bank AG, Research Division

So really, just a simple question but maybe a subtle point. You had answered a previous question saying that traffic trends were pretty consistent and broad based through the quarter. I mean, I guess, can we assume then that the comp trend was up, same idea, pretty consistent through the quarter? And if so, why would we necessarily expect at least a slight pickup in the fourth quarter, given your guidance? Is that really just because the comparison is a little bit easier?

David K. Lenhardt

Yes, Mike, I mean, I guess what I would say is, yes. You can -- I think the comps were pretty consistent through the third quarter overall, a little bit of choppiness. But as we look at the fourth quarter, the guidance that we've given you is how we see the business for the fourth quarter.

And I think we've come to an end. I want to thank everybody for joining us today and very much wish everyone a very happy holiday season. We look forward to seeing all of you next year now in March. So have a great day. Thank you.

Operator

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

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