PetSmart (PETM) CEO David Lenhardt on Q1 2014 Results - Earnings Call Transcript

May.21.14 | About: PetSmart, Inc (PETM)

PetSmart, Inc. (NASDAQ:PETM)

Q1 2014 Earnings Conference Call

May 21, 2014; 10:00 a.m. ET

Executives

David Lenhardt - President & Chief Executive Officer

Carrie Teffner - Executive Vice President & Chief Financial Officer

April Lenhard - Director of Investor Relations

Analysts

Gary Balter - Credit Suisse

Michael Lasser - UBS

Brian Nagel - Oppenheimer

Matthew Fassler - Goldman Sachs

Alan Rifkin - Barclays

Peter Benedict - Robert W. Baird

Scot Ciccarelli - RBC Capital Markets

Mark Becks - JPMorgan

Omair Asif - Wells Fargo Securities

David Mann - Johnson Rice

Peter Keith - Piper Jaffray

Dan Wewer - Raymond James

Operator

Good morning ladies and gentlemen, and welcome to PetSmart’s, first quarter 2014 analyst conference call.

At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (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. Ma’am you may begin.

April Lenhard

Good morning everyone. Joining me on today’s call are David Lenhardt, President and Chief Executive Officer; and Carrie Teffner, Executive Vice President and Chief Financial Officer.

To begin, David will highlight our first quarter business performance and discuss our strategic priorities. Carrie will then review the detailed financial results, as well as our earnings guidance. At the end of our prepared remarks we will open up the call for questions. Please limit your time to one question and one follow-up question, if necessary.

Before I turn the call over to David, let me remind you that today’s call, including the question-and-answer session, includes forward looking statements that are subject to the Safe Harbor statement for forward-looking information you’ll find in today’s news release. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.

These risks and uncertainties include, but are not limited to those factors identified in the release and in our filings with the Securities and Exchange Commission, and we do not undertake any obligation to update our forward looking statements.

Now, I will turn the call over to David.

David Lenhardt

Thanks April and good morning everyone. We are pleased with the company’s ability in the first quarter to achieve earning per share growth of 6.1% and drive earnings before tax margin expansion. However, we did not achieve our sales goals, which were impacted by a challenging and volatile consumer environment in a competitive market.

Our comparable store sales decreased 0.6%, which was driven by comp transactions of negative 2.2%. We know there was work to be done in order to drive traffic and generate positive comparable store sales growth. I’m going to take the opportunity on today’s call to outline our plans and discuss the initiatives that are underway to drive traffic and generate positive comp store sales growth.

First, we are focused on driving our consumables sales and are pursuing a more powerful and effective marketing plan and in-store execution that emphasizes the value and breadth of our consumables offerings. Second, we are intensifying our omnichannel efforts to better capture the valuable online customer. Third, we are launching an inspirational and engaging brand campaign to differentiate PetSmart and elevate how the consumer relates to the PetSmart brand.

We are confident that these initiatives, combined with our long-term strategies and our proven record of managing operating expenses are the right course of action to address our recent performance, drive positive comps and enhance shareholder value.

PetSmart provides an extensive assortment of products and services, an engaging in-store experience and great value, backed up by our unbeatable price guarantee. As we outlined in our Analyst Day last October, we are well positioned as the industry leader and are focused on three key strategies that are critical to driving long-term growth: Expanding our proprietary and exclusive products and services, growing our most valuable customers and connecting with pet parents in an authentic and personalized way.

Since that time, we’ve experienced a challenging and volatile macroeconomic and consumer environment, as well as an intensified competitive landscape. Consumer behavior is shifting and change is happening faster than ever. In a world of increasing choices in the pet specialty market, along with increased online competition, we know we must accelerate key elements of our strategies to drive top line sales growth.

Let me begin with what we know is working. We are pleased with our progress in growing our exclusive and proprietary products and services. A key competitive advantage for PetSmart is that we offer customers the widest assortment of proprietary and exclusive products and services that customers simply cannot find anywhere else.

As I outlined on our fourth quarter call, our intent is to drive double-digit proprietary and exclusive product sales growth over the next three to five years. Sales of our exclusive and proprietary products and services account for roughly 36% of our total sales. During the quarter we drove increased penetration of proprietary and exclusive products to 27.5% of merchandise sales, a 250 basis point improvement versus Q1 last year.

On the services side, we drove growth of 4.5%. Progress in both of these areas reflects the value of PetSmart’s differentiated products and services offering.

Looking ahead, we have a strong pipeline to drive future growth. Examples include National Geographic, our new Puppies R Us line, a re-launch of our Martha Stewart product line and an exclusive line of Bayer Expert Care veterinarian formulated products.

Turning now to where we’ve identified the need to accelerate; I will group these into three areas of opportunity. We are focused on driving our consumable sales and are pursuing a more powerful and effective marketing plan and in-store execution that emphasizes the value and breadth of our consumables offerings. We are intensifying our omnichannel efforts to better capture the valuable online customer. We are launching an inspirational and engaging brand campaign to differentiate PetSmart and elevate how the customer relates to the PetSmart brand.

As it relates to consumables, which are a key traffic driver to our stores, our consumables reset has positioned us for future growth with the increased offerings and solutions we have introduced in the natural and channel-exclusive category. That said, we recognize that we have an opportunity to more powerfully market the value and breadth of our assortment in channel exclusive food.

Additional, we believe that there is untapped potential in food and that there are customers we should be serving that are currently not using channel-exclusive foods. Over 70% of the consumables market is not channel-exclusive, and these widely distributed food customers, both cross-shop the store and are an important pipeline to growing our channel exclusive customers.

We recognize that we need to continue attracting the widely distributed foods customer, so that we can keep our channel-exclusive customer pipeline full. Going forward we will see a distinct change in our marketing and in-store messaging for both channel-exclusive and widely distributed foods with bold messages promoting our extensive selection and unbeatable price guarantee.

In addition, you will continue to see newness introduced into the channel-exclusive category. Starting in June with Nature’s Variety, Kibble in raw and frozen. We expect these actions to improve traffic and drive stronger sales growth in the consumables business.

Moving to online, we are not satisfied with where we are and we are committed to expanding our omnichannel capabilities and fully leveraging our e-commerce presence. We know that online customers are among the most valuable customers we have, both in the store and online and we believe it is critical to compete with these customers in the online space more aggressively.

We have already made progress during the first quarter, including completing the launch of our new website platform and expanding our online in-store availability feature across all product categories. Additionally, we recently began offering more aggressive free shipping and site-wide promotions and will launch a newly re-designed mobile website to drive e-commerce conversion in the second half of the year.

We are also continuing the acceleration of our omnichannel capabilities, which we believe are a key differentiating asset that online only players cannot offer. We are now live with order online pickup in-store in 19 stores and are pleased with the initial results.

We will begin rolling out this capability to all of our stores later this quarter beginning in Canada. We will also begin the roll out of mobile devices such as iPad minis to our stores later this quarter, which will enable our associates to take extended aisle orders in the store and assist with food selection.

Turning to the third area of opportunity; elevating how the customer relates to our brand. We know from our extensive research that our pet parents believe that pets make them better people and that we have a unique role to play in creating more moments for people to be inspired by their pets. This understanding is the basis for an inspirational and engaging brand differentiation campaign that we are launching in June.

The campaign includes a vital social marketing element, as well as TV advertisements, pet parent participation, enhancements to the store environment and a more robust digital experience. This will be the most comprehensive brand differentiation campaign PetSmart has ever had and will be integrated into all elements of our business over time.

Overall I am confident that PetSmart has the right long-term strategies, but I also recognize that we have work to do. We are aggressively pursuing the actions we have discussed today in order to drive traffic in our stores and deliver top line sales growth. At the same time, we will continue to actively manage our costs to enhance value for our shareholders.

With that, I would now like to turn the call over to Carrie, who will discuss our first quarter financial results and earnings guidance.

Carrie Teffner

Thanks David and good morning everyone. First, I will walk you through some of the highlights of our financial performance for the first quarter 2014 and then I will discuss guidance for both the full year and the second quarter.

Total net sales for the first quarter were $1.7 billion, an increase of 1.1% over last year. As David mentioned, comparable store sales decreased to 0.6% with comp transactions of negative 2.2%. Foreign currency fluctuations negatively impacted comp sales by approximately 40 basis points, and we estimate that weather negatively impacted comps by an additional 40 basis points.

The sales mix for the quarter included consumables at 54.5%, hardgoods at 31.7%, services at 11.6%, live pets at 1.6%, and other revenue at 0.6%. Gross margin for the quarter was 30.7%, representing 30 basis points of deleverage versus the prior year period. This was driven by warehouse and distribution costs, primarily associated with the opening of our new Northeast distribution center in Bethel, Pennsylvania. We did have some merchandise margin deleverage that was more than offset by services leverage.

Operating, general and administrative expenses were 20.8% of sales, representing 40 basis points of improvement from the prior-year period. This was primarily driven by lower professional fees and travel, partially offset by increased advertising. Overall, earnings before tax increased to $159 million or 9.2% of sales. This represents 3% growth and a 20 basis point improvement. The tax rate for the quarter was 36.9% and earnings per share growth was 6.1%.

Turning to the balance sheet, at the end of the first quarter we had $301 million in cash, cash equivalents and restricted cash and zero borrowings on our credit facility. We ended the quarter with average inventory per store of $591,000, up 3% compared to the first quarter last year.

From a cash flow perspective, we generated $137 million in cash flows from operating activities during the quarter. Depreciation and amortization expense for the quarter was $58 million. We spent $32 million on capital expenditures, opening seven new stores and one PetsHotel, bringing our total to 1,340 stores and 200 PetsHotels. We also repurchased $130 million of PetSmart stock during the quarter and distributed $20 million in dividends.

Turning now to our guidance for fiscal year 2014 and for the second quarter, we have updated our guidance for the fiscal year 2014 to reflect our Q1 results and the challenging and volatile consumer environment and competitive market landscape that we are operating in. We now expect comparable store sales growth to be relatively flat and total sales growth of low single digits.

We expect earnings before tax growth in the mid-single digit range with some gross margin deleverage and OG&A leverage. We anticipate the tax rate to be around 38% and earnings per share growth between $4.29 and $4.39. Operating cash flow is now expected to be between $600 million and $625 million.

For the second quarter of 2014, we are expecting comparable store sales growth to be flat to slightly down. Earnings before tax growth is expected to be in the low to mid single digit range. We are expecting some gross margin deleverage associated with our Northeast distribution center, while we complete the closure of our Hagerstown distribution center in the second quarter and we expect OG&A cost leverage.

The tax rate for the second quarter is expected to be around 39%, and earnings per share is expected to be between $0.92 and $0.96. For the remainder of 2014, we are committed to a balanced and disciplined approach to capital allocation, which we believe is in the best interest of our company and our shareholders. As we think about enhancing value, our first priority is to invest to drive growth. After that, we will continue to return capital to our shareholders via dividends and share buybacks.

In conclusion, as David noted, we are not satisfied with our results and we are committed to changing the trajectory of our cost. While we are working aggressively to do that, we will continue to manage our operating expenses in order to deliver earnings growth.

Now that concludes our prepared remarks. I would like to open the call up for questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from Gary Balter from Credit Suisse. Your line is open. Please go ahead.

Gary Balter - Credit Suisse

Thank you. You mentioned in the press release and Carrie you just mentioned again, the competitive environment, but we didn’t hear what’s the discussion of it? What’s changed in the competitive environment that’s leading to the lower guidance and leading to some of the steps that Dave talked about to accelerate business?

David Lenhardt

Gary, its David. I think what we’ve seen is there is an increasing amount of choices in the pet specialty market, whether that be smaller players that are now focused on natural food as natural food has grown. We are also continuing to see intensifying competition online, and given that, we think it’s really important for us to focus on driving our traffic trends and we think that there are things we can be doing better, and that’s why we are taking you through today, those actions that I just outlined very specifically.

Gary Balter - Credit Suisse

The online, is that more price oriented or is it just a matter of availability?

David Lenhardt

I wouldn’t say it’s necessarily price oriented. I think what we’ve seen is that we know that the online pet market overall has been growing faster than the overall pet market and we’ve seen a continued higher growth within the online food side of that market and we believe that that is an absolutely valuable customer for us, and that it’s a customer that we need to be relevant to.

So it’s critical again, against that backdrop, we believe to compete for those customers and we think through the actions I just outlined, both from an e-commerce perspective, but also with our omnichannel capabilities, we believe we need to accelerate those and compete with those customers.

Gary Balter - Credit Suisse

I just got a follow-up before April throws me off the phone. It looks like you’re down about 80 bps in hardlines year-over-year and that follows the reset that you did in the whole dog area. Could you talk about what’s happening there?

David Lenhardt

Is this on the hardgoods side, Gary?

Gary Balter - Credit Suisse

Yes, on the hardgoods, yes.

David Lenhardt

I think if you look at our hardgoods reset, really right after we executed that, we’ve really been again in this very volatile environment, and again which is competitive, but also macroeconomic and from a consumer perspective, so there is that noise there, but what I would say and we’ve said this on the last call, that we continue to evaluate the areas of the hardgoods reset that we were focused on growing. We continue to see positive trends there.

So very specifically in terms of some of the adjacencies that we were doing, we’ve seen waste management continue to have very nice growth, we improved the shopping experience around collars and leashes and beds; we continue to see improvement there. So the categories that we intended to drive through that reset, we have seen growth.

Gary Balter - Credit Suisse

Okay, thank you. Thanks very much.

David Lenhardt

Thank you.

Operator

Thank you. And our next question comes from Michael Lasser from UBS. Your line is open. Please go ahead.

Michael Lasser - UBS

Good morning. Thanks a lot for taking my questions. I’m wondering about your guidance in the context of your long-term shareholder value framework. Does based on what you are seeing now kind of render what you’ve put forth over the long-term previously, maybe not as relevant, because now you’re going to maybe have to invest in the business a little bit more, perhaps 2% to 4% comp over the long term is going to be harder to achieve? Maybe you can give us a sense for how to think about the business over the long term?

Carrie Teffner

Absolutely, thank you Michael. Our shareholder value framework is where we believe the business should operate over time, and I recognize that our current guidance is not how that’s operating within the framework, but believe that the strategy that we are aggressively pursuing and executing against, will put us back into the framework. So we are not backing away from that as to where we need to be operating.

Michael Lasser - UBS

Okay, and it looks like your services business was still pretty good during the quarter, up about 4% and I know you’ve talked in the past that customers who use services to buy channel-exclusive food tend to be your best ones. So (a) can you talk about your services business and what drove the performance there, and would that suggest that you’re starting to see the marginally attached consumer – that’s the customer that you’re losing, and is that the one that you think you can get back over time? Thank you very much and I’ll turn it over.

David Lenhardt

Yes Michael, it’s David. I mean we are pleased with our services performance. It was our fastest growing business overall of our businesses. It was driven by our grooming and our hotel business and I think we continue to see that services are a very differentiated offering for us. It’s a resilient business even in tough economic climates and we continue to see that happen and we are very pleased with that.

With respect to your second question, we do continue to think it’s a very valuable customer. It’s one of the key valuable customers in that long-term strategy that we are focused on driving and we’ll continue to do that.

Michael Lasser - UBS

Okay, thanks very much.

Operator

Thank you. Our next question comes from Brian Nagel from Oppenheimer. Your line is open. Please go ahead.

Brian Nagel - Oppenheimer

Hi, good morning. A couple of questions. First off, I want to go back to Gary’s question about some of the, I guess competitive threats you’ve seen lately. Is there a way to sort of say break that apart? Is the bigger effect from online competitors where you’re seeing more of a competitive entry from let’s say the grocery stores, other pet supply retailers and then even geographically across the country, there are certain regions that are weaker on that front than others. Then I will give you my follow-up?

David Lenhardt

Yes Brian, in terms of the geographic, we are not seeing any really big geographic differences. In terms of looking at the landscape, I would separate it into the mass and the grocery, and then separate that from the pet specialty market, which would be the big bar, the big pet superstores, the independents, these emerging smaller store chains that are focused on natural food and then online.

If I start with mass and grocery, we’re not seeing much of an impact from the mass and grocery perspective. We’re really seeing this in the pet specialty space and again, it’s a world of increasing choices, both brick-and-mortar, but also online.

Brian Nagel - Oppenheimer

Okay. And then if I look at the gross margin trajectory and at least in the past couple of quarters it’s been weaker, does that pertain directly to this as well? So in other words, are we seeing the same trajectory gross margins we are in sales or is there something else that plays in gross margins?

Carrie Teffner

Specific to this year, as I’ve called out on the call previously, we do see the margins, the gross margin impacted by the opening of our Bethel Distribution Center. We have that overlap in the first half of the year, while we close the Hagerstown facilities. So we are seeing a negative impact related to that in the first half, which abates in the back half of the year.

That said, with the lower comp guidance that we provided, there is a level of deleveraging in occupancy that does occur, but with respect to the product margin and services margin, we continue to be focused on driving gross margin expansion at each and every one of the individual lines within the product categories.

Brian Nagel - Oppenheimer

Okay, and Carrie I apologize if you called this out, but is there a way to quantify the impact from the distribution center shift?

Carrie Teffner

I would say specific to the quarter or overall? (Cross Talk) Let me tell you that the majority of the impact overall for the year and for the quarter is the warehouse and distribution.

Brian Nagel - Oppenheimer

Okay, okay. Thanks.

David Lenhardt

Thank you.

Operator

And our next question comes from Matthew Fassler from Goldman Sachs. Your line is open. Please go ahead.

Matthew Fassler - Goldman Sachs

Thanks a lot and good morning. I have sort of two twined questions if you will on e-commerce. First of all, if I contextualize your comments on the relevance of the channel today versus the way you had framed it in prior quarters, it seems like you are signing more credibility to that channel now as a sustained competitive act and I guess do you think that the economics of that channel are working better for your online competition than you would previously have thought or is it that regardless of that it seems to be a fact of life that you need to deal with?

And then last, my second question is kind of attached to it. Are you seeing any change in the willingness of some of your better vendors and the higher end vendors to do business with the online-only players? Thanks a lot.

David Lenhardt

Thanks Matt, and please let me know if I don’t answer all elements of that. To your first point, we do believe that there is an increasing relevance in terms of the online channel and we’ve seen that over time and that’s something that we’ve been monitoring closely.

As I said, we have seen the consumables in particular continue to grow at a faster rate than the overall online rate, and we think it’s critical for us to compete for those customers. We know that they are more valuable customers, both in the store and online.

We also know to your point around economic that the economics of these customers are less than the overall economics of our business, due to the fact that food in particular has such a high rate in the economics of shipping food.

Having said that, that is where our focus on omnichannel capabilities that we have that the online players do not have are focused for us that we are accelerating, so very specifically, order online pick-up in store and ultimately order online shipped from store are ways for us to mitigate those economic costs. But the reality of those economics of shipping food, which I would suggest all competitors, all players have to live with continue to be the case.

In terms of your second question, in terms of our vendors and willingness, I would say we haven’t seen any big change. I think when you look at kind of the supply online, there are many ways to get that supply, whether it be direct or whether it be through distributors. I think that it’s a little bit of a mix in terms of which vendors are doing what, whether they’re direct or not, but we haven’t noticed a substantial change there.

Matthew Fassler - Goldman Sachs

You got the full range of it and thank you for that and the only quick follow-up I’ll ask is, are you seeing any of the newest and most innovative competitive distribution channels, like for example AmazonFresh in a couple of markets making a difference or is it harder to pinpoint it to something that precise?

David Lenhardt

It’s really hard to pinpoint, because it’s so new, but I think the early results would be no.

Matthew Fassler - Goldman Sachs

Okay, thank you so much.

David Lenhardt

Thank you.

Operator

Thank you and our next question comes from Alan Rifkin from Barclays. Your line is open. Please go ahead.

Alan Rifkin - Barclays

Thank you very much. It was mentioned that advertising as a percent of revenues increased. I was wondering, is that more or so in dollar terms or is that more of a function of the sales being below your plan. And as a follow up to that, where is the cadence for incremental advertising? Is it more online or you’re still going after the stores?

David Lenhardt

Yes Alan, it’s David. You did see advertising; it really was both to your first question. So we have continued to increase our advertising investment. We think it’s critical to market who we are, how we are different to the customer in this competitive environment.

To your second question in terms of the cadence of it, it’s a mix, but I think you’re going to continue to see us, again as I talked about both the more powerful and stronger message around food, that will be aimed at both brick-and-mortar and online, but you’ll see that in television, in digital and then the brand differentiation work that we are doing. We will also see kind of digitally, as well as TV. So I think the mix would be relatively the same as it probably has been, although we will be adding to it and changing the actual messaging.

Carrie Teffner

And then the one thing just to clarify Alan, it has increased both in absolute dollars and as a percentage of sales.

Alan Rifkin - Barclays

Okay, thank you and a quick follow-up if I may, any effect of commodity deflation on the comp?

Carrie Teffner

No. As we’ve been talking about inflation for the last couple of quarters, we’ve expected inflation to come down in 2014 and it did. As compared to last year for example, inflation was around 125 basis points. This quarter it was about 25 basis points. So we are not seeing deflation by any means, but as expected we’ve seen inflation decelerate.

Alan Rifkin - Barclays

Okay, thank you.

David Lenhardt

Thanks Alan.

Operator

Thank you. And our next question comes from Peter Benedict from Robert W. Baird. Your line is open. Please go ahead.

Peter Benedict - Robert W. Baird

Yes, hi. Thanks guys. I guess Carrie just dovetailing off of that, the outlook for inflation, does your buying pattern suggest that you’ll stay around 25 basis points or is there a chance that’s negative?

Carrie Teffner

I don’t think the shift is negative. I think it goes relative – it kind of stays there and decreases and we still have though some lingering lapping of increases from last year. So as we work through that, it will be more flat in the back half of the year.

Peter Benedict - Robert W. Baird

Okay, thank you. And then I guess David, you were talking about the competitive shifts out there. What does this mean for your small store strategy? Do you have eyes to accelerate that, try to compete in that way or is there any impact on your plans for kind of your smaller stores and smaller markets?

David Lenhardt

Yes Peter, we are very excited about the smaller stores that we have been opening. As you know we opened the first 12 last year. We’re opening 18 to 22 of them this year and we’re on track for that. Many of those are going into in-fill markets. So to your point, we do think that this is a key piece of our strategy going forward. It does allow us to get into locations that we previously could not, because of the size of our box. So this allows us to get into some very attractive in-fill markets, whether it be in L.A., Chicago, Boston and really compete in those areas in a way that we couldn’t before. So that will continue to be a key piece of our strategy.

Peter Benedict - Robert W. Baird

Okay great. Thank you.

David Lenhardt

Thank you.

Operator

Thank you. And our next question comes from Scot Ciccarelli from RBC Capital Markets. Your line is open. Please go ahead.

Scot Ciccarelli - RBC Capital Markets

Its Scot Ciccarelli, how are you guys? The question is, are you guys done with your consumables reset and given the fact that traffic declined in the quarter, obviously we’ve lowered guidance. Should we assume that the reset really hasn’t had any impact on the business?

David Lenhardt

Yes Scott, let me take you through kind of the dimensions around the reset. We have finished it. We’ve finished it about four weeks ago in the entire chain. Let me start by reminding you of the intents of the reset, which was to grow our proprietary brands and natural foods, in particular in cat, which is not as we’ve talked about earlier had nearly as much innovation as dog.

The other thing to point out as we’ve added 900 new skews, as well as shifting the layout of the food. So what we’re seeing right now is customers are still learning both what our new offerings are and how to navigate the store.

Now having said that, let me take you through what we’ve learned so far, knowing that it’s still early. On the positive side, we have seen a lift in both naturals and proprietary brands’ growth since the reset.

In terms of opportunities and learnings, we’ve reduced the holding power of our widely distributed brands to give space to naturals and we didn’t fully recognize the challenge that this would have on our in-store stocking processes, so with less phasing, we had to change our filling processes in the store and that is what we have recently done. So we’ve since increased the frequency of our in-store filling to keep those shelve stocked.

Additionally, we reduced too much holding power in a couple of our widely distributed food brands and we are in the process now of adding space back to those brands. So overall, while it’s still early, we think with these adjustments the reset has positioned us well to offer the consumer the broader selection of food solution.

Scot Ciccarelli - RBC Capital Markets

Okay, thanks and then a follow-up is, it looks like service margins were up pretty nicely. Can you provide any more clarity on that? Is that a function of just higher pricing? Is it a capacity utilization concept or is there something else going on there? Thanks guys.

David Lenhardt

Yes Scot, again we had nice growth in our services business and as we get that utilization going up in the hotels and in our groom shops, we see margin expansion when that happens, so that was the big driver.

Scot Ciccarelli - RBC Capital Markets

Thank you.

David Lenhardt

Thank you.

Operator

And our next question comes from Chris Horvers from JPMorgan. Your line is open. Please go ahead.

Mark Becks - JPMorgan

Hi, it’s actually Mark Becks on for Chris. Thanks for taking the question. The first one, can you about merch margin, which was down slightly in the quarter? Can you talk about what was mix and what was pricing, and then also in regard to merchandize margin, can you talk about an outlook for 2Q and the rest of the year? Do you see the need to invest price to drive traffic, given the issues with traffic? Thank you.

Carrie Teffner

Yes, with respect to the merch margin in the quarter, I would tell you that the majority of the deleverage there which wasn’t significant was related to mix and not as much related to pricing. As we look at Q2 specifically, again, we’ve got the continued headwind we’ve discussed about relative to mix is there. We do have some promotional activity going on, that’s normal operations. We have our friends and family events in the second quarter, that is a driver, but again its normal course of business, nothing out of the ordinary.

Mark Becks - JPMorgan

Okay, and then I guess for the full-year outlook for merch margin?

Carrie Teffner

Yes, I would say merch margin for the full year will be slightly down.

Mark Becks - JPMorgan

Okay, and then on the sales and in sort of the competitive environment, can you talk about the volatility your experiencing in trends on a monthly basis, perhaps maybe what the quarter-ended versus what it started, and then is there any way you guys can actually measure if you’re gaining or losing share out there in the channel? Thank you.

David Lenhardt

Yes, let me start with your last question Mark. Our latest Nielsen market share data in 2013 shows us holding share, but clearly with a negative comp we need to be focused on driving traffic.

As the industry leader we continue to have a differentiated offering to the customer with a wide assortment, strong value and engaging in-store experience in our pet services. We’re not happy with our traffic trends and that’s really the outline of the actions we’re taking that we’ve talked to you about today. We are very focused on to drive traffic going forward.

Carrie Teffner

And then specific to the first part of your question regarding what do we see relative to trends during the quarter, and that’s part of the volatility that we’ve talked about, but overall the trends were relatively consistent throughout the quarter.

Mark Becks - JPMorgan

And then one just quick follow-up; what’s embedded in your comp outlook, relatively flat between traffic and ticket? Thanks.

Carrie Teffner

Sure. As we look to that guidance, specific to Q2 we assumed that we would continue to see negative traffic, but slightly improving, and then again improvements in the back half of the year, but not significant.

Operator

Thank you. And our next question comes from Matt Nemer from Wells Fargo Securities. Your line is open. Please go ahead.

Omair Asif - Wells Fargo Securities

Good morning. This is Omair on for Matt. Thanks for taking the question. First off, could you talk to the outlook for omnichannel spend, and maybe as a percentage of revenue and as a percentage of CapEx, and then do you still think most of the omnichannel invasion will occur at eBay or will some of this shift in-house? Thank you.

David Lenhardt

Yes, thanks. Its David. Our overall omnichannel investment continues to be a significant piece of our overall CapEx, our overall expenses. That will continue to be within the ranges that we talked about in terms of our CapEx and our expenses. That’s all embedded in our guidance going forward, but it is significant and that has continued to be a focus for us over the years.

In terms of your second question about how we are building in the omnichannel capabilities, I think eBay continues to be a key partner to us, but we also continue to partner with them to build capabilities side by side.

Omair Asif - Wells Fargo Securities

All right. And then just a quick follow-up. Could you talk to what the impact of incentive comp was to SG&A this quarter please?

Carrie Teffner

Yes, we have a little bit of favorability, but not significant.

Omair Asif - Wells Fargo Securities

Thank you very much.

Operator

Thank you. And our next question comes from David Mann from Johnson Rice. Your line is open. Please go ahead.

David Mann - Johnson Rice

Yes, thank you, good morning. My question is about your customer base. When you look at PetPerks and other data that you have about your customer, with the traffic decline, are you able to see whether you’re just not getting new customers or is there some slowdown in frequency from existing or some of your better customers?

David Lenhardt

David, its David. We have been able to look at that data and what we’ve seen generally speaking, we have seen a decline in both new and existing customer growth, but it’s really been centered on the new customer. So our existing customers have been pretty stable, the new customers have been the area of challenge.

David Mann - Johnson Rice

Okay. And then given the spend that you’re looking to do in terms of branding and some of the things to convert some of your customers, any sense that there is a big opportunity here or could there be some inertia amongst your customers that you’ve basically converted the bulk of them already?

David Lenhardt

David, a couple of things. As I said, our opportunity has been much more on the new customer side, so we really believe we’ve got an opportunity to bring new customers into our stores and that’s really one of the key drivers if you look at our focus on more powerfully communicating both channel exclusive and widely distributed foods. That’s really going after both customers who are purchasing channel exclusive food elsewhere, but also the widely distributed food customers, which if you’ll remember, 70% of the food market is not buying channel exclusive foods. We believe that is an opportunity for us and that WGS customer is important for us to bring into the store, where we can then educate them and trade them up. So that will be a big focus for us.

David Mann - Johnson Rice

Okay. And Carrie, just one housekeeping, the CapEx is at still $150 million to $160 million this year?

Carrie Teffner

Yes.

David Mann - Johnson Rice

Okay, great. Thank you.

Operator

Thank you. And our next question comes from Peter Keith from Piper Jaffray. Your line is open. Please go ahead.

Peter Keith - Piper Jaffray

Hi, good morning. I have a question on the OG&A. It looks like this year you would below the time framework of 3% to 4% growth. So I’m wondering (a) where are the costs coming out of? And then (b), just looking out to maybe 2015, do you actually potentially run above that as you’re making some of these investments into your business?

Carrie Teffner

Yes, with respect to OG&A for the balance of the year, how we expect to continue leveraging there is really around driving continued operational efficiencies. But one of the key elements that we are being very deliberate about is ensuring that as we look to managing the expenses of the business, that we continue to be able to have the funds to continue to invest behind our strategic initiatives.

So I would tell you, when we’re guiding to a relatively flat comp for the year, you’ll make choices a little bit differently within the business, but one thing we are absolutely not doing is shortchanging our growth strategies.

Peter Keith - Piper Jaffray

I guess just to follow-on, the investments that you’ve outlined in order to drive traffic, are these OG&A related? Does it require step-up investment activity?

Carrie Teffner

To some level, yes, but it’s also capital investment as well. As you think about the devices we’re rolling out to the store and things like that, but with respect to the brand differentiation and marketing campaign, that’s real expense dollars into the P&L.

Peter Keith - Piper Jaffray

And then a question for David. As you’re looking at this stepped up competitive environment, have you considered looking at potential acquisitions, maybe as you say, maybe a small-box retailer that you could use for filling or even an online player that has some unique capabilities that could enhance your omnichannel business?

David Lenhardt

Yes, we are continually evaluating the landscape for potential opportunities with our substantial cash flow generation. We have the flexibility and the ability to go after adjacent growth opportunities and that is certainly something that we evaluate and monitor.

Peter Keith - Piper Jaffray

Okay, thank you very much. Good luck in the coming quarters.

David Lenhardt

Thank you.

Operator

Thank you. We have time for one final question and our final question comes from Dan Wewer from Raymond James. Your line is open. Please go ahead.

Dan Wewer - Raymond James

Thanks. David, I wanted to talk about a different scenario that could be leading to the traffic challenges and that’s the fact that PetSmart store base is maturing. Five years ago, it looks like 30% of your selling space was three years of age or less. Today it’s less than 10% and that’s had a big benefiting your sales per foot. It’s run from what, $205; now you’re tracking it to $45. But now you have a network of old material stores and that seems to sync up with your comment that your new customer growth is slowing. So do you think that could be contributing to the traffic?

Carrie Teffner

This is Carrie. Certainly, the newer stores delivered the higher comp, albeit on the lower sales base, but they also deliver lower EBT and (inaudible) cash flow until they reach maturity, so you are absolutely right. There is some impact on the top-line in our comps, relative to the fact that since 2009 we’ve reduced the number of store openings. But we are looking at it holistically against the P&L and that comp is offset by improved profitability and cash flow generation.

Dan Wewer - Raymond James

Right, yes. I understand there is puts and takes with the older store base. Then just also wanted to follow-up on your comment about the change in the advertising effort. You are going to be focusing on the breadth of assortment at PetSmart. I’m surprised that’s even an opportunity. I would think that all pet owners are already aware of the breadth and selection at PetSmart is greater than any other competitor. So is there really a big payback?

David Lenhardt

Yes Dan, I mean going back to our knowledge of the customer and as the customer talks about it in terms of new customers, we do know that we have the broadest assortment, but also from a pricing perspective and a value perspective, we’re in a really good position. We feel that we have an opportunity to more powerfully communicate that proposition against the both channel exclusive and to widely distributed food customer.

Dan Wewer - Raymond James

Okay, great. Well, thank you very much.

Carrie Teffner

Thank you.

David Lenhardt

Thank you Dan. And I think we’ve come to an end and I want to thank you for joining us today. We look forward to speaking with you again in August. Thank you.

Operator

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

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