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Executives

Dave Cone – VP of IR and Treasury

Bob Moran – President and CEO

Chip Molloy – SVP, CFO

Analysts

Matthew Fassler – Goldman Sachs

Chris Horvers – JPMorgan

David Mann – Johnson Rice

Alan Rifkin – Barclays Capital

Seth Sigman – Credit Suisse

Mike Baker – Deutsche Bank

Michael Lasser – UBS

Peter Benedict – Robert Baird

Dan Binder – Jefferies & Co.

PetSmart, Inc. (PETM) Q3 2011 Earnings Call November 16, 2011 4:30 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to PetSmart’s Third Quarter 2011 Analyst Conference Call.

At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will be given at that time. If anyone should require operator assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host for today, Mr. Dave Cone, Vice President of Investor Relations and Treasury.

Dave Cone

Good afternoon and welcome to PetSmart’s conference call to announce our results for the third quarter of fiscal 2011. With me on the call today are President and Chief Executive, Bob Moran, as well as Chip Molloy, 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 guidance for the remainder of the year. Bob will provide a review of the operations of the business, and finally, we’ll take your questions.

Please keep in mind, everything we cover during today’s call, including the question-and-answer session is subject to the Safe Harbor Statement for forward-looking information you’ll find in today’s news release. Thanks. And I’ll now turn the call over to Bob.

Bob Moran

Thanks, Dave, and hello everyone.

We are pleased to report another quarter of solid earnings growth. For the third quarter, earnings per share were $0.50, up 32% when compared to $0.38 for the same period last year. Comparable store sales or sales in stores opened at least a year grew 6.1% and comp transactions, which we use as a proxy for traffic, were up 2.2%.

The favorable momentum that we’ve experienced during the quarter validates the work that we are doing and continues to move us forward on our journey to becoming a best-in-class specialty retailer. At PetSmart, we are committed to delivering solutions through a broad assortment and an unmatched customer experience all at great value. But it’s our differentiation that makes us the leading pet specialty retailer and sets us apart from the competition. And while the macro economy still faces a number of challenges, we believe we are well-positioned to continue to execute on our strategic priorities and deliver shareholder value.

In a few moments I will update you on some of our accomplishments during the third quarter and where we are focused going forward. But before doing so, I will turn the call over to Chip.

Chris Molloy

Thanks, Bob, and good afternoon everyone. 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 $0.50 per share, which represents 32% growth when compared to $0.38 for the same period last year. Comparable store sales growth was 6.1% and comp transactions were positive for the sixth consecutive quarter at 2.2%.

Total sales for the quarter were $1.5 billion, up 8%. The increase in total sales included a favorable impact from foreign currency fluctuations of $3 million. Services sales, which are included in total sales, increased 9% to $161 million. Other revenue which is also included in total sales was $9 million, representing reimbursements from Banfield for the space they utilize in our stores. The sales mix for the quarter included consumables at 53.3%, hard goods at 33.6%, services at 10.8%, live pets at 1.7%, and other revenue at 0.6%.

Gross margins for the third quarter improved 60 basis points to 28.6%. Within the gross margin line, merchandise margins decreased 10 basis points while services added 5 basis points to the overall rate. Store occupancy and supply chain were favorable, 45 and 20 basis points, respectively. Operating, general and administrative expenses were 21.8%, representing 20 basis points of leverage compared to the same period last year. Year-over-year increases in OG&A expenses were primarily due to store growth, planned incremental advertising spend focused on our differentiated offerings, and higher incentive compensation.

Overall, earnings before tax increased to $87 million or 5.8% of sales. This represents 26% growth and an 80-basis-point improvement compared to the third quarter of last year. The tax rate for the quarter was 38.8%.

During the quarter, we opened 15 new stores and closed two. We also opened four pets hotels, bringing our totals to 1,210 stores and 189 hotels. We ended the quarter with average inventory per store of $585,000, or flat when compared to the third quarter of last year.

During the quarter we generated $124 million in operating cash flow. We spent $28 million on capital expenditures, distributed $16 million in dividends, and repurchased $70 million of PetSmart stock. Depreciation and amortization expense for the quarter was $58 million.

We ended the quarter with $333 million in cash, cash equivalents and restricted cash, and zero borrowings on our credit facility. We are very pleased that we continue to deliver strong operating results while maintaining a health balance sheet.

For the remainder of the year, we continue to believe that the macro economy will be volatile, but we feel that we are managing the business prudently, with a good balance of investing in our success while also seeking and developing opportunities to improve ongoing operations.

For the full year, we expect comparable store sales growth of mid single digits. We are raising our earnings per share guidance from a previous range of $2.46 to $2.52 to our current expectations of $2.50 to $2.54. And we now expect our earnings before tax or EBT margin to expand by 80 to 90 basis points for the full year. The tax rate for the year should be between 38% and 39%.

We are also on track to reduce our weighted average share count to approximately 114 million shares for the year. For the fourth quarter, we anticipate comparable store sales growth in the low to mid single digits range, and earnings per share of $0.85 to $0.89. EBT rate improvement in Q4 is expected to be 80 to 90 basis points. The improvement is expected to come primarily from OG&A expense leverage. OG&A expenses should grow approximately 3% to 4% compared to the fourth quarter of last year. Interest expense is expected to be flat and the Q4 tax rate is expected to be between 38% and 39%. And our equity in income from Banfield is expected to be $3 million for the quarter.

We are currently in the middle of the planning process for 2012 and it is premature to provide specific guidance for next year. However, we are working diligently to develop a 2012 operating plan that we believe will fall within our stated long-term guidance. Based on our fiscal year calendar, 2012 will contain a 53rd week. Excluding the impact of the 53rd week, we expect to deliver between 7% and 12% earnings before tax growth and repurchase 4% to 5% of our standing shares net of long-term incentive plan dilution. The combination of those results would produce EPS growth of between 11% and 17%.

And with that, I will now turn it over to Bob who will provide an update of our operations.

Bob Moran

Thanks, Chip.

The strength of our brand was evidence with another quarter of solid performance, as we continue to remain focused on providing solutions for our pet parents to help them help their pets with long, healthy and happy lives. From our innovative and exclusive merchandise assortment to our suite of services offerings and unique in-store experience with our passionate associates, differentiation ties it all together. As the best destination for high-quality foods, we are the leader in the expert recommended pet nutrition with the right selection that our pet parents desire at great value.

General exclusive foods which are sold only in pet specialty stores represent over 70% of our consumable sales. And that includes the super premium natural category which is the largest and fastest-growing category, with key brands like Blue Buffalo, Royal Canin, Wellness, Innova and our own super premium proprietary brand Simply Nourish. By optimizing our assortment across the aisles, we can leverage this key point of differentiation to drive loyalty, increase profitability, and give our pet parents another compelling reason to shop our stores for the quality foods that they want at great value.

In hard goods, we continue to see sustained momentum in our innovative and exclusive offerings across the key categories. We have built a pipeline of innovation with key partners including Martha Stewart and GNC to develop categories that can continue to grow. In the third quarter we expanded the Martha Stewart pets assortment to include a new line of cat products, and we are pleased with the results. We also recently announced that in 2012 we will launch exclusively-designed Toys R Us pet toys and the Brett Michaels Pets Rock collection of apparel.

We have created a culture of innovation and differentiation within merchandising so that we can continue to bring the best new brands and expanded assortments to our pet parents. And through our customer insights and strong vendor partnerships, we can maximize the potential of our key brands through our fully integrated and compelling marketing campaigns.

We also continue to build on our merchandising strengths with our differentiated assortment of proprietary brands including Grreat Choice, Top Paw and Top Fin, which drive customer loyalty and create sticky behavior. The in-store experience for our customer is unique and highly differentiated, thanks to our passionate and knowledgeable associates who engage with our pet parents to offer solutions.

And our full range of services offerings, including professional grooming, training, boarding, day camp and veterinarian care are key differentiators for us and drive increased frequency, spend per visit, and profitability. Grooming, which is the largest of our services business, continues to show strength, and the response to our grooming, look-great guarantee has been very positive. We are proud to say that as a result of our integrated marketing campaign and the first national TV ad campaign for services in 10 years, we have seen an increase in new customer growth, an increase in the retention rate of our existing customers, and an increase in our grooming customer satisfaction scores.

The PetsHotel business continues to improve in line with the overall improvement in the travel industry, and we are very excited about our plans for the upcoming holiday season. We will build on the success of last year with compelling holiday stories and a focus on our key differentiators, with even stronger integrated marketing behind the events, offering pet parents thousands of gift ideas and great value.

Through our partnership with PetSmart Charities, we help to save the lives of more than 103,000 pets in the third quarter through the in-store and community adoption events. And thanks to the strong vendor support from partners like [Nestle Pro Plan], with the national adoption event weekends like the one held last weekend, where the lives of over 16,000 were saved, we can continue to make a real impact.

I am proud of our success and the results that we have been able to achieve due to our hardworking and dedicated associates and our focus on providing innovative and differentiated solutions at great value. And despite the challenging macro environment, we have continued to perform well. We expect the macro economy will continue to hold challenges for the remainder of the year, but we believe that the strength of our seasoned management team coupled with our focus on our strategic and operational priorities will allow us to continue to navigate through these uncertain economic times. For the remainder of 2011, we will continue to take action to further solidify our position as the pet specialty leader by doing all the right things to drive future sustainable growth and long-term shareholder value.

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

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, if you have a question at this time, please press the star and then the 1 key on your touchtone telephone. If your questions has been answered or you wish to remove yourself from the queue, please press the pound key. If you’re using a speakerphone, please lift the handset before posing your question.

Our first question comes from Matthew Fassler from Goldman Sachs.

Matthew Fassler -- Goldman Sachs

Thanks a lot. Good afternoon and congratulations on your quarter. I have two quick questions. The first relates to the composition of gross margin. I guess you had a bit less merchandise margin improvement this quarter than you had in prior quarters and a bit better performance on the occupancy line. If you could sort of spell out the different puts and takes on the merch margin front and talk about your expectations for how you think occupancy trends, kind of what the break point might look like going forward.

Chris Molloy

Hey, Matt, it’s Chip. Thanks for the congratulations, by the way. On the margin side, so, in the second quarter we had a bigger lift on margins, one, we were anniversarying the reset we did last year, so we didn’t have that going this quarter. But if I look at this quarter year over year, there’s really four buckets that are driving it.

The first one is a drainer, which is overall mix is still leaning towards consumables growing faster than hard goods, although we did have a really good quarter from a hard goods perspective as well. The second drainer was we were a little bit more promotional in some of our traffic-driving items this quarter. We made some decisions early in the quarter to go that direction, and that’ll continue through probably the end of December.

And then on the pick-up side, the mix within the categories is still improving, especially on the food side, higher-end foods are accelerating. And then we picked up a little bit on shrink. And then, I think about next quarter, obviously it depends on which end of the comp guidance we come in, the higher end will get us more leverage on rent (inaudible) than -- and [W&D], but I would call the midpoint of that as probably a push in those areas. And merch margins will probably look similar year-over-year performance in Q4 as they did in Q3.

Matthew Fassler -- Goldman Sachs

Got it. And then just by way of follow-up, you just put up a 6.1%, which is a terrific comp. You guided low to mid. How should we contextualize the guidance for Q4 relative to the quarter you just put up?

Chris Molloy

Yeah. Well, two things. One, I’d say, if you kind of, you know, we look at it lots of different ways, build it from the ground up. But if you look on it just mathematically on a two-year comp perspective, if you take that low to mid and you compare that to the first half of this year, it’s pretty much in line with the first half of this year, which was a really good couple of sets of quarters there.

The third quarter was exceptional. So that was the highest two-year comp we’ve had since the first quarter of 2005, and we’re not really willing at this moment to bet on that kind of performance in Q4. It’s a big quarter for us. But we think we’re still going to have a little solid quarter.

Matthew Fassler -- Goldman Sachs

Got it. Thank you very much.

Operator

The next question comes from Chris Horvers from JPMorgan.

Chris Horvers -- JPMorgan

Thanks and good evening. So, wanted to follow up on a couple of questions, first, within the ticket side of the equation. Can you talk about what the inflation contribution was and how that trended sequentially and how you think about going forward? And then I will have a follow-up as well.

Chris Molloy

Yeah, Chris, on the inflation side, I think we said, coming into the quarter, we’ll be looking at 150-ish to 200. It came in at the low end of that. My expectations is we might see just a hair more in Q4. We did see a couple of price increases towards the early part of the quarter. And then going into the first half, it’ll stay steady through -- probably through the first quarter of next year. And beyond that, it’s uncertain.

Chris Horvers -- JPMorgan

Okay.

Chris Molloy

And the rest of the ticket, we had traffic up 2.2%. We actually had comp units per ticket were up, so the overall units were up. AUR was up slightly, a little bit on the inflation side, some on the hiring goods, and then a little of the promotional activity would have drove that down, but still positive on the AUR.

Chris Horvers -- JPMorgan

Perfect. And then also I think PETCO recently announced that they’ll -- there’s some sort of new 5% rewards program if you are a PAWS member. It’s been a couple of years. But that sounds new to me and I was just curious what your thoughts were about that and how perhaps you could respond.

Bob Moran

Chris, this is Bob. This is recent news and we actually have tested elements like this in the past and felt that it was probably not the direction that we wanted to do to really communicate with our customers. However, if anything goes out new, we’re going to constantly monitor it and make sure that if we have to make any necessary changes, we will, in the future.

Chris Horvers -- JPMorgan

Okay. And has there been any changes that you’ve noticed from PETCo recently besides that?

Bob Moran

Chris, no. Actually it’s been very rational across all the competitive fronts, both from a pricing point of view and also promotional point of view. So, again, rationality continues, and we hope it continues into Q4.

Chris Horvers -- JPMorgan

Okay, perfect. Best of luck with the 4Q. Thanks.

Bob Moran

Thanks, Chris.

Operator

The next question comes from David Mann from Johnson Rice.

David Mann -- Johnson Rice

Yes, thank you. Congratulations as well. On the services piece of the business, can you talk a little bit about how the different pieces are growing? It looks like you had a little bit of an acceleration this quarter. How should we think about growth in the fourth quarter?

And then on the margin side there, I think you had been talking about things being a little bit better this quarter. It didn’t look like that happened. So, could you just expand on services margins as well.

Chris Molloy

Yeah, Dave, it’s Chip. Thanks for the words. On the services side, so, overall comp for services was slightly ahead of the core, which was good, and we did see -- continued to see double-digit comp in the hotels business, grooming was slightly under the quarter but very solid, and training was a pretty decent positive comp this quarter, which we like to see, that’s a good indicator, we hope, for the overall industry, from an adoptions perspective. So that was good.

As it relates to the margin side, we did get some pickups because the hotels are continuing to improve from a profitability perspective. So that’s helping the margin. I would say we didn’t get as much pickup in margin as I anticipated. Part of that was, quite honestly, we’ve gotten better at our hiring process this quarter. We hired quite a few new groomers in Q3. We prepared for the peak times of Q4. And then, going into the first quarter, which is a heavier quarter, and the quarter which is the biggest quarter of the year, so we actually were quite successful in the hiring front and training front of new groomers, it’s a little bit unproductive, so we didn’t get quite as much pick-up as we had anticipated, but generally it’s a good thing for us.

David Mann -- Johnson Rice

Okay. And then just one follow-up, on the gross margin side, you talked about this decision to become more promotional. Can you just talk, you know, give us some background what drove that decision? Was it the additional competition you perhaps were expecting online? Or what did you feel the need for that?

Chris Molloy

No. I would say, number one is we have some pretty heavy traffic compares in the second half of this year. It came in to the, you know, we plan the quarter, we always plan the quarter between four and six weeks before the previous quarter ends. And then, as the quarter started, we got selective about some of our promotional activity. It was really on the high-traffic items. So, to reinforce our traffic comps, we made some decisions on our own that that was the right thing to do. And like I said, I think we’ll continue some of that activity through the end of December.

David Mann -- Johnson Rice

Thank you.

Operator

Your next question comes from Alan Rifkin from Barclays.

Alan Rifkin -- Barclays Capital

Thank you. And I will certainly add my congratulations as well on a fine quarter, gentlemen.

Bob Moran

Thanks, Alan.

Alan Rifkin -- Barclays Capital

A couple of questions, if I may. The TV campaign for grooming, was that an incremental spend that you just started to do in that regard? And what can we expect going forward in terms of the advertising budget for the holiday season in particular?

Chris Molloy

Alan, thank you as well. As it relates to services, it was an incremental spend year over year, yes, but it was very planned. If you remember, we did say that Q3 was going to be heavy on the advertising side on several fronts. And that was a piece of it. But that’s part of our new ad campaign, and you’ll see that continuing to go forward. As we’ve said a couple of times I think over the past year, we really haven’t been very good at advertising services until this year. And so we went out this year, we actually budgeted for a pretty good chunk to services. And the guarantee you’re seeing out there and the actual associated ads, that’s all new, but it’s to help expand our differentiation and drive that business.

Alan Rifkin -- Barclays Capital

Chip, do you think you’re bringing incremental consumers with that campaign? Or do you think it’s existing patrons migrating over to the grooming side?

Chris Molloy

Well, we’re bringing incremental customers to the groom shops, we believe, for sure. Whether they’re incremental customers to the overall box, to be honest, I don’t know that answer, but my guess is yes, but I’m guessing at this point. We have the data some more, I just don’t know the answer.

Alan Rifkin -- Barclays Capital

Okay. And one follow-up, if I may. Specific to the holiday, can you maybe just shed a little bit of color on what the SKU assortment looks like? Will SKUs for the holiday season be up versus last year and in terms of setting of the stores relative to last year? Would you be able to provide some color there?

Bob Moran

Alan, this is Bob. Yeah, actually, you probably have that same number of SKUs but a little bit different segmentation. What I mean by that, we’ve done a lot of work on the proprietary brands, and not only is that the ones that we source but it’s also the exclusive partnerships we’ve worked through Martha Stewart, GNC and the like. And we also have done a lot of work on the Good, Better, Best, and one of the elements that really have worked it well. We have moved the bar on the proprietary brands from about 18% last year at this time to 22% at the end of the third quarter. So, the SKUs are different, and the focus on how to drive the SKUs to drive traffic are different. However, the number of SKUs are the same.

Obviously, the fourth quarter is a gift-giving season. There’s a mini shift towards hard goods sales during this period of time. We anticipate that. And what we like about the holiday too is that it also elevates the month of January and February because new pets are entering in households, and not only do we get a bump going in through Christmas, we pick up a bump into the January and February side too that we anticipate will happen this year too.

So, again, the mix is different, the number of SKUs are about basically the same, but we have a lot more innovation, differentiation in our assortment today.

Alan Rifkin -- Barclays Capital

Thank you, Bob. Best of luck.

Bob Moran

Thank you.

Operator

The next question comes from Seth Sigman from Credit Suisse.

Seth Sigman -- Credit Suisse

Hey, guys, good afternoon. It’s Seth. Congratulations on a great quarter. Just a follow-up on the improving profitability of the hotel business. Can you provide a little bit more color on what’s driving that? And any incremental steps you’re taking that may be helping that?

Chris Molloy

Hey, Seth. Once again, thank you. As it relates to the hotel, we are on a path, we’re on track. As of the fourth quarter we think we’ll be on an annualized run rate to actually generate some profit all in for the portfolio. Year over year, the incremental loss -- the losses have diminished significantly year over year. We actually had a positive quarter in the second quarter of this year from a profitability perspective. That is the biggest quarter of the year seasonality-wise.

So we’re in good shape. What’s driving is really a combination of things. We have taken some of the operating costs out of the hotels, specifically around the labor side. We’re getting smarter with labor, and we’ve done a lot of work there. We still have a little bit of work to do.

And then we’ve been running double-digit comps for several quarters now and the top line growth is starting to help as well. So we’re -- it’s a combination of both cost and growth.

Seth Sigman -- Credit Suisse

Got it. Thanks. And then on the expense side, it seems like you guys are doing a really good job of managing expenses, came in a little bit lower than I think we were expecting in light of the better comps and the lift from FX. Can you discuss maybe what changed from the initial plan, and then why the lower expense growth in Q4?

Chris Molloy

A couple of things. One, the third quarter, we were -- we guided to about 8% growth. I think we came in at around 7.1%. So that was pretty close. It’s a mix of a lot of different little areas. There’s nothing -- no one area that’s significant that drove that number down, because it’s relatively small.

The 3% to 4% growth in Q4 is really the -- add the sales ratio year over year in Q4 is going to be essentially flat. So we are going to grow advertising expenditures Q4 in line with sales growth, whereas in Q3 that was a delivered line by design.

Seth Sigman -- Credit Suisse

Okay, great. Good luck.

Chris Molloy

Thank you.

Operator

Your next question comes from Mike Baker from Deutsche Bank.

Mike Baker -- Deutsche Bank

Thanks, guys. A couple of questions. One, just a clarification. So, I think you said your fourth quarter operating margin will be up 80 to 90 and it would all come from SG&A. So, are you going to flat gross margins? I just want to make sure I understood that. That’s not my real question, that’s just a clarification.

The real question is, I’m just curious, do you analyze your basket, and what do you see in terms of how many of your customer baskets include food or services or anything along those lines? And has that changed in the last six months, in particular, I’m wondering if you’ve seen more or less baskets with the shopper putting some kind of food item in the basket? Thanks.

Chris Molloy

Hey, Michael, it’s Chip. On the operating margin side, our EBT margin, we did guide 80 to 90 basis points. If you take the cost to OG&A growth and the interest expense growth numbers that we gave you, you’ll see the vast majority of that is going to come on the cost side. We are expecting to get a little bit, based on the midpoint of our comp guidance, we are expected to get a little bit on the gross margin side. Obviously, if we come in higher, you’ll leverage the cost components in there, and if we come in lower, you’ll delever those a little bit. But generally, it’s going to come from the cost equation in Q4.

As it relates to the basket, if you just look at our mix, our mix is continuing to grow more on the consumable side than the hard goods, but both very health. So I would say, as you look through it, the units in the basket and the goods in the basket, it hasn’t changed dramatically. In fact, I would say this was a really healthy quarter with really solid comps and hard goods and great comps and consumables and continues to be that. So, I would say the basket, we haven’t seen anything dramatically different.

Mike Baker -- Deutsche Bank

Okay. If I could ask a follow-up to that, the inflation of maybe 150 basis points or so this quarter, that primarily, that 150 basis points helped the entire comp, that primarily comes in the consumable part, I would assume. Is that right?

Chris Molloy

It does. It becomes virtually all in the consumables part. If you remember, I think I’d given some clarity on that, is really about -- we have about, on average, the average, we have about 6% increases on about 30% of our business, that would mathematically give you about 180 basis points. It came in lower than that, probably start to creep more towards that as you go into Q4.

However, some of the traffic-driving items that we’re being a little bit promotional on are also on the food side as well. So, from an AUR perspective, you’re really not getting all of that inflation falling to your AUR.

Mike Baker -- Deutsche Bank

Okay. So, sort of it doesn’t -- all right, it’s before those promotional. Thanks. Okay. Thank you.

Chris Molloy

Yeah.

Mike Baker -- Deutsche Bank

Thank you.

Chris Molloy

Sure. Thank you, Michael.

Operator

Your next question comes from Michael Lasser from UBS.

Michael Lasser -- UBS

Good afternoon. Thanks a lot for taking my question. So, as you kind of continue the comp and comp and comp, are you finding that trends are becoming a little bit more volatile from week to week, or is the business running pretty steady?

Chris Molloy

Michael, I would say, you know, it was a really good very steady quarter. So there weren’t any, you know, the last time, up through Q3, the last time we sort of saw a week to week hiccup, I think it was back in May, I think everybody in retail, there were two or three weeks back in May, there was some noise. But outside of that, it was a very steady quarter. You know, at Analysts Day, which was a couple of weeks before the quarter ended, we guided a 5.5% to a 6% comp at that point, we were really on the high end of that. And they stayed through the rest of the quarter.

Michael Lasser -- UBS

Okay. And then longer term, as you see a positive return on some of the incremental advertising and promotional investments that you’re making, how do you think about the decision to maintain that? Could you -- could the flow of your wishbone financial model change a bit where maybe you see a little bit less leverage but slightly higher comp growth?

Chris Molloy

Well, Michael, we actually thought the fishbone, not the wishbone.

Michael Lasser -- UBS

I’m sorry.

Chris Molloy

But that said, yeah, the way we think about it on there is, you know, we want to try, assuming we’re going to put 40 to 50 units in the ground every year, we want to try to keep our costs growth in that 4% to 5% range, would be all of our cost buckets combined. And to do that, you have inflationary -- you have new stores going in the ground, you got inflation on -- you got pay raises. So, you got to manage that all the time.

Yes, we’d like to spend more on advertising, but it’s not going to change our overall 4% to 5% growth. We have to find other areas of the business to do that investing. And that’s the way we think about it.

Michael Lasser -- UBS

And just to follow up on that, you’ve done a great job in merchandising -- instilling discipline in the organization over the last few years as a management team. Are there other -- are there big buckets left to tap into on the cost side, whether you can implement new systems, new processes to generate some further savings?

Chris Molloy

The answer to that is there’s nothing, you know, just [laying] there. But we do have a culture here that is constantly looking for ways to improve our processes and become more productive. And we’re going to continue find ways to be more productive both in the boxes, in our DCs and here at SSG. And we like to do that so we can invest in areas like marketing or drive business and drive top line and drive margins. So there’s no silver bullet or a set of silver bullets, it’s just ongoing cultural work.

Michael Lasser -- UBS

Understood. Thanks. Good luck.

Chris Molloy

Thank you.

Operator

Your next question comes from Peter Benedict from Robert Baird.

Peter Benedict -- Robert Baird

Hey, guys, thanks for taking the questions. Just a couple. First, I guess, Bob, on the premium food business, did I hear you correctly in saying that that accelerated in the third quarter in terms of growth? And as we think about the natural food reset you have for next year, remind us kind of the timing of that. Any P&L impact, Chip, that we should be thinking about there? And what brands are getting extra space there, or are there any new brands that are coming in? Just something on that would be helpful. Thanks.

Chris Molloy

Hey, Peter, I’ll take the first part, I’ll let -- Bob will do the part around the reset, if that makes sense.

I used the word accelerating as probably is the velocity of the higher-end foods is much higher than the velocity on the lower-end foods, and that’s been consistent. It didn’t actually accelerate, it’s been very consistent.

Peter Benedict -- Robert Baird

Got it. Thank you.

Chris Molloy

Now, on the reset side, Bob will speak to that.

Bob Moran

Yeah, Peter. Peter, hi, how are you doing?

Peter Benedict -- Robert Baird

Hi, Bob.

Bob Moran

Let’s talk about the reset. We have it scheduled for February. We did it two years ago and we opened up the space and focused on really the optimization of the assortment and also the space and also brands. That will continue into February. We’re not going to disclose at this point in time which brands that we’re going to add space or assortment into at this moment in time. But we shouldn’t see any blip from an expense point of view. It will be fairly rapid turnaround and we’re getting vendor funding to pull this off. So, and probably because of the efficiency and experience that we picked up two years ago, we’ll probably even be able to do it faster.

So, again, this is going to be normal every other year, about understanding how the flow of -- especially when the consumable sides, what’s selling, what’s not selling, and making the space and also the assortment match up to it.

Peter Benedict -- Robert Baird

Okay, that’s helpful. Thanks. And then just on kind of your online experience, I guess. Have you guys noticed any change in your consumers’ behavior online? I mean, obviously in the store things are going well. Has there been any change in terms of maybe shopping habits or patterns online, what they’re buying, that type of thing?

Chris Molloy

And again, as we talked about our online business, we really look at our online business as two-faceted. One is the e-commerce on the online but also driving customers inside the store. And we really haven’t seen that much of a change on the online customer, but what we’re seeing is an acceleration of the number of customers that were actually driving into the store.

Now, behind the scenes, we’re also looking at how we can expand our assortment. We’ve added 3,000 SKUs that are only available online, which drives this up and the total offering online to 14,000 SKUs. And what we’re, you know, and as I say, driving the traffic to the stores, we’re finding that we’re approaching about 5x of our e-commerce sales were driving into the stores.

We’re constantly looking at cost and we’re also investing in our website, not only with talent but also the site experience. That will continue. And more to come there.

Peter Benedict -- Robert Baird

Okay, great. And then one final question, just on the new stores that you’re thinking for next year and then even slightly beyond that, how are you thinking about kind of a smaller store footprint? Can you just update us on what your thoughts are there? Thanks.

Chris Molloy

Yeah, it’s, you know, 45 stores. That would be sort of the target. And this year, about 60%, 60% to 65% of the smaller, we call them 12 to 13’s. I don’t know the exact percentage next year, but it kind of looks similar. And my guess is that it’ll probably look very similar from now ongoing.

Peter Benedict -- Robert Baird

Okay, great. Thanks so much, guys.

Chris Molloy

All right.

Operator

We have time for one final question. Our final question comes from Dan Binder from Jefferies & Co.

Dan Binder -- Jefferies & Co.

Hi, good afternoon. My question is regarding some of the comments that came out of Wal-Mart yesterday. They had indicated that based on better in-stocks, they saw about a 300-basis-point improvement in their rate of comp in their dog food category. And I realize they’re probably more focused on the value side. I was curious if there was anything on the value side of your business that you thought may have changed during the quarter?

Bob Moran

Dan, this is Bob. Actually, from a consumable side, what we saw, as Chip pointed out, an acceleration on the natural organic side. However, on the value side, we did not see any changes on the contribution or balance of sale.

Dan Binder -- Jefferies & Co.

Great. And then the final question, you mentioned strength in adoptions, I’m just curious how the rate of improvement in adoptions is trending. Is that similar to the last couple of quarters when it turned positive, or is it actually the rate of improvement getting better?

Bob Moran

The rate is flat, and the good news in the previous quarters was that it was going to flat or slightly above flat, but it’s basically in the flat area, which is we consider to be positive because of the stabilization of pet acquisition. We’re also seeing our training business, for example, to go positive. And then we had roughly around 4% comps last quarter. So again, proxies, maybe early indicators of some stabilizations in the pet acquisition.

We had a national event last week where we saved over 16,000 pets. We’re becoming better learners on how to transfer that to the commercial side and then conversion rates we’re getting better at, but more to come on that. So we consider that to be decent news. And as long as it doesn’t go negative.

Dan Binder -- Jefferies & Co.

Great. Thanks.

Chris Molloy

Thank you.

Bob Moran

Well, I think we have come to an end, and I just wanted to thank everybody for joining us today. And we will speak with you again in March. And before that, I would like to wish everybody a happy holiday.

Operator

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

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