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PetSmart, Inc. (NASDAQ:PETM)

Q2 2012 Earnings Call

August 15, 2012; 04:30 pm ET

Executives

Bob Moran - Chairman & Chief Executive Officer

David Lenhardt - President & Chief Operating Officer

Chip Molloy - Executive Vice President & Chief Financial Officer

April Lenhard - Head of Investor Relation

Analysts

Matthew Fassler - Goldman Sachs

Alan Rifkin - Barclays Capital

Chris Horvers - JP Morgan

David Mann - Johnson Rice

Aram Rubinson - Nomura

Michael Baker - Deutsche Bank Securities

Michael Lasser - UBS

Peter Benedict - Robert Baird

Brian Nagel - Oppenheimer & Co.

David Goldberg - Morgan Stanley

Kate Went - Wells Fargo

Daniel Binder - Jefferies & Co.

David Strasser - Janney Montgomery

Operator

Good afternoon ladies and gentlemen and welcome to PetSmart’s second quarter 2012 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, Head of Investor Relation.

April Lenhard

Good afternoon and welcome to PetSmart’s conference call to announce our results for the second quarter of fiscal 2012. With me on the call today are Chairman and Chief Executive Officer Bob Moran; President and Chief Operating Officer, David Lenhardt, as well as Chip Molloy, Executive Vice President and Chief Financial Officer.

Bob will kick off the call with an overview of our results and then Chip will take you through the financial review as well as our earnings guidance. David will review the operations of the business and provide insights into the remainder of the year and finally, we’ll take your questions.

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

Robert Moran

Thanks April and hello everyone. We are pleased to report another quarter of solid earnings growth. For the second quarter earnings per share was $0.71 up 31% when compared to $0.54 for the same period last year. Comparable store sales or sales in stores open at least a year grew 7% and comp transactions, which we use as a proxy for traffic were up 2.9%.

Our performance in the second quarter was due to the strengths across all three merchandising categories: consumables; hard goods and live goods, as well as across services. Our comparative everyday low price strategy, coupled with our commitment to our uniquely engaged in-store experience that is not easily duplicated, has led to continued success in growth, even in today’s challenging economic environment. But its our differentiation that makes us the leading pet specialty retailer, by providing solution for our pet partners to help them help their pets live long, healthy and happy lives.

We build a culture of innovation and diffraction showing our customers how we are different from the competition and how we are best choice and our commitment extends to saving the lives of homeless pets through our partnership with PetSmart Charities, the largest founder of animal welfare efforts in all of North American. During the second quarter we were proud to be able to celebrate a milestone event, the 5 millionth adoption in our stores since 1994.

Our commitment to saving lives and ensuring that pets stay in happy homes has made a real difference is the lives of more than 5 million pets and their pet parents and we remain committed to strengthening this partnership in our stores with associate support for new pet parents, in offerings like the adoption kit and puppy starter kits with valuable coupons for products and services.

All these things define PetSmart brand really strong and it resonates with our customers. I am proud of the success 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 as we continue to strengthen our position as the leading pet specialty retailer.

And now I would like to turn the call over to Chip.

Lawrence Molloy

Thanks Bob and good afternoon everyone. Today, I will be reviewing our second quarter performance, as well as providing guidance to the third quarter and full year. As Bob mentioned, earnings for the quarter was $0.71 per share, which represents 31% growth when compared to $0.54 for the same period last year. Comparable store sales growth was 7% and comp transactions were positive for the ninth consecutive quarter at 2.9%.

Total sales for the quarter were $1.6 billion, up 9%. The increase in total sales included an unfavorable impact from foreign currency fluctuations of $4 million. Services sales, which are included in total sales increased 7% to $191 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.

Their sales mix for the quarter included consumables at 52.7%; hard goods at 33.2%; services at 11.8%; live pets at 1.7%; and other revenue at 0.6%. Gross margins for the second quarter were up 80 basis points to 30.2%. Within the gross margin line, merchandise margins increased five basis points, while the services contribution to the overall gross margin rate was unfavorable 10 basis points.

Store occupancy and supply chain were favorable 70 and 15 basis points respectively. Operating, general and administrative expenses were 21.8% representing 20 basis points of leverage compared to the same period last year. Net interest expense for the quarter totaled $13.6 million. Overall, earnings before tax increased to $122.5 million or 7.6% of sales. This represents 28% growth and 110 basis point improvement. The tax rate for the quarter was 39.5%.

During the quarter we opened 11 new stores and closed three, bringing out total to 1249 stores. So did not open any new PetsHotels during the quarter. We ended the quarter with average inventory per store of $554,000, up 4% compared to the second quarter last year.

During the quarter we generated $104 million in operating cash flow, spent $35 million on capital expenditures, distributed $15 million in dividends and repurchased $47 million of PetSmart stock.

Depreciation and amortization expense for the quarter was $60 million. In June we announced the board of directors approval of a new $525 million share repurchase program that begins this quarter and expires in January of 2014. In addition we also have $57 million remaining as of the end of the second quarter on the June 11 share repurchase program that expires in January 2013, for a total of $582 million of share repurchase authorization outstanding.

In June the board also approved an 18% increase in our dividend, bringing the total quarterly payout from $0.14 to $0.165 per share per quarter. We ended the quarter with $354 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 healthy balance sheet. Although the macro economic environment still holds some uncertainty, we remain cautiously optimistic about the reminder of 2012 and are confident in our ability to influence those things within our control to deliver on our commitment of driving strong results.

As a reminder, 2012 contains a 53rd week. The annual guidance is for 53 weeks, however I will again summarize at the end the impact of the extra week on several key measures.

For the year we anticipate comp store sales growth in the mid-single digit range and total sales growth between 10% and 11%. We are raising our earnings per share guidance from our previous range of $3.19 to $3.31 to our current expectations of $3.30 to $3.40.

We now expect our gross margin to improve 90 to 100 basis points. OG&A to grow in dollars approximate 10%, interest expense to be down slightly and EBT margin to expand 110 to 130 basis points. We anticipate an annual tax rate of approximately 38%.

The impact of the extra week is estimated to be $120 million in sales, almost 20 basis points of the gross margin expansion, $19 million of the incremental OG&A expense, 30 basis points of the EBT expansion, and $0.16 of EPS.

For the third quarter of 2012 we are expecting comparable store sales growth of mid single digits and earnings per share of $0.59 to $0.63. EBT margin is expected to improve 700 to 80 basis points when compared to the third quarter of last year. All of the EBT margin expansion is expected to come from gross margin.

OG&A expenses are expected to grow approximate 9% and could produce some slight deleverage. The higher increase in cost year-over-year is driven primarily by increased advertising and professional fees associated with a few IT products. The tax rate for the third quarter is expected to be close to 40%. We remain committed to our long-term guidance and believe we have an operating plan that can deliver on those goals.

And with that, I’d like to turn it over to David Lenhardt, who will highlight our second quarter activities and provide insights into the remainder of 2012.

David Lenhardt

Thanks Chip and good afternoon everyone. As Bob mentioned, our second quarter performance was due to strength across all of our merchandising categories: consumables, hard goods and live goods, as well as across services.

In consumables, super premium channel exclusive foods continue to be our fastest growing category. We expanded the space in this category with the consumables reset during the first quarter, adding innovative new formulations and expanded grain free and limited ingredient assortments in dog and cat. We are pleased with the early results of the rest and believe we are well positioned to maintain our competitive advantage of carrying the best assortment across the isles.

In hard goods we refreshed and re-branded the dog toy isle in the second quarter, with a new PetSmart toy chest, look and feel and we are pleased with the early customer response. As the pet specialty retailer with the largest selection of dog toys, this rest brought some exciting new changes focused on newness and innovation, including the exclusive ToysRUs Pet’s and Brett Michael’s Pets Rock collections.

Through our exclusive partnership with ToysRUs, the ToysRUs Pet’s collection adds engaging and entertaining toys for your dog from puppy hood to adulthood, helping to simulate a pet’s intellectual growth. Made of mixed materials, these bright fun toys provide a range of options for playtime and healthy development. We are excited about our partnership with Brett Michael’s, the legendry rocker and dedicated pet parent.

In the second quarter we launched the Brett Michael’s Pet’s Rock collection, including toys, beds, apparel, collars, leashes and bowls. Designed with Brett’s own pets in mind and a signature rock start style, this exclusive line offers pet parents unique products that are cool and edgy and reflective of their pets personalities.

Brett’s in-store appearances across the country to meet his fan and bring this line to life, coupled with the national media attention and marking buzz has generated a positive response from both customers and associates alike. The rocker vibe of the Brett Michael’s Pet’s Rock collection extends our assortment of exclusive products, adding yet another one of a kind option for pet parents.

Also in the second quarter we reset the aquatics and small animal categories to support the growing trends by adding hundreds of new items and in improving the category adjacencies and flow with solutions based signage, designed to inspire and educate in order to drive continued, sustained momentum in these categories.

Underpinning the successful execution of our resets this year has been an integration and alignment across the merchandizing, marketing, supply chain and store operations teams. In order to maintain their leadership position, we must continue to evolve with our customer’s desires and by planning and executing these resets with minimal store disruption, it allows us to stay on the forefront of innovation, so that we can continue to differentiate our brand with the best possible selection for our pet parents.

We have worked hard to establish a culture and pipeline of innovation in merchandizing throughout the store through the year. As we gear up for the holiday season with Halloween in the third quarter, we have planned for even more innovation and compelling offerings across expanded categories to help pet parents celebrate the season with their pets and we’ll continue to tell our story of differentiation, by investing in integrated marketing campaigns that message the exclusivity of our key brands and highlight our value proposition.

Our unique in store experience would not be the same without our highly differentiated services offerings. Services had another strong quarter with positive comps across the board. Our quality of care and grooming continues to drive sales and we are seeing strength in the PetsHotel and pet training businesses as well.

We are excited to be able to better serve our customer and improve our operational efficiencies through our PetsHotel call center, which is in the process of being rolled out nationally to all of our hotels by the end of the third quarter, just in time for our peak holiday season.

The in-store experience for our customers is also unique and highly differentiated. Thanks to our passionate and knowledgeable associates who engage with our pet parents to offer solutions. Delivering authentic customer connections is at the core of our customer experience and I am excited to tell you about ways we are continuing to evolve the customer experience in our stores, by investing in our associates with training and development, so that they can continue to engage with our pet parents in a genuine and authentic way.

A few weeks ago we made a significant investment in our associates with the newly refreshed behavioral training program, focused on customer engagement strategies. With role-playing and real life scenarios, this training was designed to inspire and empower our associates to take the next steps forward on the customer experience journey.

Over 44,000 of our store associates participated in this two-hour training session held in all of our stores across North America. And to further facilitate engagement, we’ve redesigned our name badges with a place to insert a photo of the associates pet, right on the front of their name badge next to their name, which helps to open a dialogue with their pet parent customers in an authentic way.

We are excited to be able to roll out these new name badges after the positive customer response we received when we tested them. These are both, examples of the work that we are doing to continue to evolve the customer experience that will differentiate us from the competition. When pet parents leave our stores, we want them to feel like they’ve had an experience they just can’t find in any other retail store.

While we expect the macro economy will continue to hold challenges for the remainder of the year, 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 2012 we believe we have the opportunity to continue to do all the right things to drive future sustainable growth and long-term shareholder value.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll take our first question coming from Matthew Fassler from Goldman Sachs. Please go ahead Matthew.

Matthew Fassler - Goldman Sachs

Thanks a lot. Good afternoon and congratulations on a strong performance. I’ve got two quick questions. First of all, it looks like the occupancy and distribution leverage got a bit bigger for you in the second quarter relative to the first on a comp that’s not only softer. I know there can be some movement in the drivers from quarter-to-quarter, but there’s a pretty significant step out there in leverage for you on those line items. So any color you could give on what drove that would be really helpful.

Chip Molloy

Hey Matt, it’s Chip. There’s really not anything special in there. Obviously the comp was a pretty good comp, so therefore your going to get leverage as it relates to the first quarter. Its more just timing of the openings, it’s a little bit on the utility side, but there’s nothing of any significance in there.

Matthew Fassler - Goldman Sachs

With that mind, is there any step up in the rate or pace of leverage that you expect to get per comp point going forward. Is there some structural change in that metric?

Bob Moran

As we go forward, sort of mid single digits in the back half, your looking at some pretty good leverage in Q3, but in Q4 we are going to anniversary a relatively low utility cost year in Q4 of last year. So it really depends on weather, so right now in Q4 you won’t get as much leverage.

Matthew Fassler - Goldman Sachs

Got it. And them my follow-up question, going into the second quarter, the one cautionary note that you had made in anticipation of some of your activities was the reset activity and was the cost of that activity and potential disruption – obviously it sounds like the efforts are paying off. How does that play out relative to your expectation in terms of cost disruption and any other side effects?

Bob Moran

Yes, those resets. In the first quarter we got out of the old inventory, so there was some margin piece there and in the second quarter we were expecting on the cost side, because of the activity in the store and it came in generally in line. So if you look at our overall cost on the OG&A side we did have some leverage, but that was on a pretty good comp and from a cost perspective the increases year-over-year in pure dollars, a chunk of that was associated with those resets.

Matthew Fassler - Goldman Sachs

I got it. Thank you so much.

Bob Moran

Sure.

Operator

Okay, thank you. And we’ll take our next question coming from Alan Rifkin from Barclays Capital.

Alan Rifkin – Barclays Capital

Thank you. I would certainly like to add my congratulations as well on another outstanding quarter from you folks.

I was just curious if there were any inflationary benefits at all in the quarter with corn and soy up so significantly in the last few months and maybe if you can give us any color on whether or not flea or tick contributed to the comp or whether or not that was actually maybe a slightly headwind in the quarter because of the weather dynamics that was going on.

Chip Molloy

Hey Alan, it’s Chip. On the inflationary front, just going back a little bit in history, as you remember we had several cost increases last year. During the second quarter it started to really impact the latter part of the second quarter. So as it relates to year-over-year, we probably had a very similar inflationary impact this quarter over the last, around 200 basis points.

As we look forward in the back half of the year, our expectations as we sit here right now was that we were not going to have any impact, so that was going to trail off. However just literally in the last week or two, we are starting to get some hints at some cost increases. We don’t know where that will ultimately go. My expectation is we probably won’t see any impact until late in the year and the beginning of next year.

Alan Rifkin – Barclays Capital

Okay. And for the third quarter Chip…

Chip Molloy

I’m sorry Alan, flea and tick. Flea and tick, it was actually still a really good quarter for us within Q2.

Alan Rifkin – Barclays Capital

Okay. One follow- up if I may Chip, you said in the third quarter with the mid single digit comp your actually looking for a slight deleverage on the OG&A line. Is there anything one time in nature going on in the third quarter or do you think that a higher threshold than what we’ve seen in the past is actually necessary for leverage on that line item.

Chip Molloy

It’s a little higher. Part of that is some incremental investment on advertising, which is planned and then a piece of that is professional fees associated with the timing of some of our projects. Last year in the third quarter that was actually our lowest quarter of the year on the proceeds line and this year it’s actually the highest quarter of the year.

Alan Rifkin – Barclays Capital

Okay. And one follow-up if I may, intending with you folks resetting some of the categories, has there been any material change at all in square footage allocation to some departments versus other in tandem with the resets.

Chip Molloy

No, all the food has been done with in the space within consumables and then even on the specialty and the hard goods we’ve really not shifted the overall space for those key divisions.

Alan Rifkin – Barclays Capital

Thank you again.

Chip Molloy

Thanks Alan.

Operator

Okay, thank you. And we’ll take our next question from Chris Horvers from JP Morgan.

Chris Horvers – JP Morgan

Thanks and good evening guys. Can you talk about within the food category, what the relative growth rates have been across the different price points and maybe how that’s changed in 2Q versus what you’ve seen in prior quarters?

Bob Moran

Yes Chris, the high-end food for natural super premium isle for us has done really well. It’s been doing very well for a long time. The last two quarters has not only done well in dog, but it’s started to accelerate in cat, which has been a very nice outcome for us.

The rest of the food isles I would say are slow. The bridge and the premium isles are slow-ish and the grocery isle by design is down and that’s part of the food rest, was to take space away from that area and add it to the naturals.

Chris Horvers – JP Morgan

And then maybe how was that contributed on a year-to-year basis in terms of the growth in ticket.

Bob Moran

It has. Our AUR has been up higher than the inflationary impact and I would say this last quarter on AUR we had almost as much impact on peer. I would call it quality of goods going in the basket as we did for inflation. So it is having an impact overall and most of that is on the consumable side.

Chris Horvers – JP Morgan

Got you, understood. And last question, as you think about what you know most retailers have talked a lot about, a lot of volatility in their same store sales trend and your has been impressively consistent. Within the quarter, did you see any of that June swoon that a lot of retailers have talked about?

Bob Moran

Yes, we don’t talk much about the quarter within the quarter, so it was pretty consistent. The Olympics were kind of weird that first week, but that, we got beyond that and everything was fine.

Chris Horvers – JP Morgan

Thanks very much.

Operator

Okay, thank you. And we’ll take our next question coming from David Mann from Johnson Rice. Please go ahead.

David Mann – Johnson Rice

Yes, thank you. Great job guys. I’m curious on the gross margin guidance that you’re giving. How should we be thinking about the components of the margin in the third quarter and back half?

Bob Moran

Yes, we are not going to break it out too much, other than we are going to see some pretty decent gross margin in Q3 and as well in Q4, probably similar as we did in Q2. The components within there are going to be slightly different. We’ll get a little bit more on them merge side in the back half. We are anniversarying some of the activity we did last year that reduced that, so some of the aggressive pricing we had on the food last year we are not repeating, so we’ll pick up some there and you’ll get a little less on the occupancy line, especially in the fourth quarter.

David Mann – Johnson Rice

Great, that’s very helpful. And then in terms of adoptions, can you give us an update? Elaborate on what trends your seeing in terms of adoptions, adoption rates.

Bob Moran

Hey David, Bob Moran, how are you doing?

David Mann – Johnson Rice

Good afternoon.

Bob Moran

Actually the improvement that we saw was in Q4 of 2011. That’s continued into the first half for 2012 and we believe that this improvement has really – that we’ve seen in the adoptions in our stores has been really through our partnership with PetSmart Charities and by the way, all those trends are encouraging. But we still at the same time remain focused on supporting these adoption efforts in our stores, so that we can actually see if we can turn this into a trend. I think it’s too early to say it’s a trend yet, but its very encouraging.

David Mann – Johnson Rice

Are you seeing in terms of pet perks, an acceleration in terms of new membership player, in terms of new customers?

Bob Moran

I think what we are seeing is really a stable percenting to the new customers coming in. If you think about our comp transactions last quarter are 2.9%. We get around 75% to 78% in reductions into pet perks, so that’s really helpful.

What also has been helpful for us too is our focus on the adoption kits and also the focus that we’ve been doing on our puppy kits too. So again, as we see some of these trends with pet acquisitions we’ve been trying to really put some actions behind it to really help the store associates to be able to tell stories and actually have handouts to go along with it.

David Mann – Johnson Rice

Great, thank you. Good luck.

Bob Moran

Thanks.

Operator

Thank you. And we’ll take our next question coming from Aram Rubinson from Nomura. Please go ahead sir.

Aram Rubinson - Nomura

Hey, thanks for taking my questions. It looks like your kind of crushing your fishbone that you put out at your analyst day. I wondering just to think about where operating margins might go. At some point down the road if you can do kind of a north of 10% margin company and how your thinking about that and then I have follow-ups if you don’t mind.

Chip Molloy

Hey Aram, its Chip. You guys know that we don’t typically or we don’t ever give out sort of targets on the operating margin side. I can tell you that we look at EBT margin, because interest expense is mostly capital leases, so that’s really where we think about operating margin.

What’s really important for us that it aligns and make sure that its stable to expanding. We tried to set up as you know our fishbone. We set it up in a way that over time we can continue to increase that in a relatively low comp environments. But we don’t want to pitch any sort of target. We’d rather tell that you that we are myopically focused on it and we know its important and we want to make it stable to expanding.

Aram Rubinson - Nomura

Would you say it to the extent that you are beating at fishbone and its almost all comps and the leverage that’s driving it, because you had planned it two to four or is kind of throughout the skeleton so to speak.

Bob Moran

I would say its primary driven with PowerPoint, so we are out performing on the top line and that’s getting a lot of leverage, but on the merger side we are getting some slight accretion on the merger side year-over-year, which is the stable to expanding piece. Our cost buck has grown 4% to 5% on a high end of that. Mostly because as we continue to earn our way, we are making investments along the way sometime on a discretionary basis, in a variable cost like advertising, so we can pull that back if necessary. But generally it’s driven by higher top line.

Aram Rubinson - Nomura

Can I also ask you for your comps, how they are driven between smart with hard math and kind of others if you can give us just a range there that would be great, thank you.

Bob Moran

Yes, we don’t actually break that out within those groups. Thanks Aram.

Aram Rubinson - Nomura

Good luck

Operator

Okay, thank you and we’ll take our next question coming from Michael Baker from Deutsche Bank. Please go ahead Michael.

Michael Baker - Deutsche Bank Securities

Hi, can you hear me okay?

Bob Moran

Yes Michael, we have you.

Michael Baker - Deutsche Bank Securities

Good, hi. A couple of questions here on some of the merchandising. Just first, some of those new introductions on ToysRUs Pets and Brett Michael’s, are those too early to be having a comp impact in the second quarter and I guess what’s expected or what’s in your comp guidance for the back half of the year.

And then I got another sort of merchandising question, what are PetMed side, a couple of competitor type back quarters. I wondering how you’re Banfield faired this quarter and just generally speaking, how does that sort of impact your traffic and your total company cost. Have you every talked about, is that customer spend ex-times in the stores, those types of things. Thanks.

David Lenhardt

I think Michael – its David. A couple of things; from a merchandising perspective, as you mentioned we just finished a couple of resets this past quarter and specifically ToysRUs Pet’s, Brett Michael’s as well as the aquatics and small animal reset. It’s too early to tell specifically what those are driving. But what I can tell you is we are very pleased with what we are seeing, in terms of the early results and you see that baked into our guidance for the rest of the year.

I think in all three of the cases we are excited about what they are doing in terms of being able to provide us with new, unique and innovative new products and give customers a reason to come in exclusively to our stores. So we are very excited about those.

In terms of Banfield, more specifically and as you know we are not the owner in Banfield so we don’t disclose their overall results. But as we think about Banfield as part of our differentiation, we absolutely do know that it is the key component of providing solutions to our pet parents. We know that that is the most trusted person in our store from a customer perspective and you will see their continuing contribution go through our income line.

Michael Baker - Deutsche Bank Securities

Okay thanks. If I could ask one more follow up, just real quick to Chip, what are your expectations for depreciation going forward. I though that its changed a little bit, I think at your analyst day it was down $5 million or $6 million year. Then it was down $3 million or $4 million a year. Just wondering what we should expect annually in deprecation.

Chip Molloy

Yes, I would say as we look at all of our assets and part of the change is just trying to ongoing as we add assets and look at the timing of the deprecation of that; its quite complicated. But that being said, we are at our peak number now. So we are kind of running around, call it $16 million a quarter. It’s not going to go up; it’s going to start to decline as we get in the next year, immaterially. It starts to decline a little bit more in ‘14 and much more material in ‘15.

Michael Baker - Deutsche Bank Securities

Okay. I know it’s hard, that’s why I asked you rather than do it myself.

Chip Molloy

Yes.

Operator

Thank you, and we’ll take our next question coming from Michael Lasser from UBS.

Michael Lasser - UBS

Good afternoon and thanks a lot for taking my question. Do you have a sense for how your market share trended over the quarter? Are you taking share from other players or are you actually growing the market by virtue of your merchandising and marketing activities?

Bob Moran

Hey Michael, it’s Bob. I definitely believe we are picking up market share. We are still looking at the market growth in the 4% to 5% range and when you look at our top line growth its empirically looking at the data and we are defiantly picking up share.

At the same time, I think the culture of the work that we’ve done on the innovation and differentiation, does have some effect on the expansion of the market place and then at the same time, we kind of use adoptions as a proxy for some of the pet acquisition. We fell that there is not only a stabilization here, but a slight improvement there. So all these things are kind of adding up to a healthy sector, a healthy industry. So I would say definitely market share growth.

Michael Lasser - UBS

And then if you plot adoptions versus your comp trends, is there a pretty clear relationship that you’re seeing historically.

Bob Moran

Not really, and again as I said before, their correlation to pet acquisition is really housing and we are seeing a little bit of stabilization in the housing front. So we need that macro event to really help us there. So we are doing it without the pet acquisition side, but we are structurally set up. If that even comes back we are going to be well positioned.

Michael Lasser - UBS

And a final question from me; Wal-Mart’s recently made some noise about being more aggressive on the premium specialty consumables side. What are your thoughts about that?

Bob Moran

Michael, when you look at it, we just talked about how healthy the industry is and our sector is and so pet category has always been desirable. So we are always constantly seeing competitors trying new things, be it the introduction of new products or changes in space allocation or products. But we are mindful; we are respective of it, these changes, but at this point in time we have not seen any impact in our business.

But you now our track record if you really look at it over multiple quarters is that we’ll take appropriate action if necessary to counteract that. So at this point in time we are watching.

Michael Lasser - UBS

All right, that’s very helpful. Thank you so much.

Operator

Thank you, and we’ll take our next question coming from Peter Benedict from Robert Baird. Please go ahead Peter.

Peter Benedict - Robert Baird

Hey guys, good afternoon. A couple of – Chip, first some clarifications; first on your inflection comment; are you trying to say that you think inflation will remain at about a 3% tail end for the back half of the year and then you potentially get more as some of these price increases that you may be getting it start to flow through later this year and end of ’12 or do you not think there’s going to be any inflation tail end at the back half of the year. That’s my first question.

Chip Molloy

Well, the answer Peter is our expectation is there won’t be any for the back half of the year. It will drop pretty precipitously beyond this quarter, this past quarter, because we haven’t had any cost increases since last year at this time. That being said, we are just now getting hints of some cost increase that may impact us in the late part of this year and into ’13, but its too early to tell.

Peter Benedict - Robert Baird

All right, that’s helpfully, thank you. And then, I don’t know, may be for Bob, but you guys talk about channel exclusivity; it’s important with some of these premium brands. Recently you saw Buffalo just get on Wag (ph). How do you think about those brands. They are really big brands for you guys. How are the conversations going there when they do something like that? Is that a potential stress in the relationship or is that just kind of business as usual for you.

Chip Molloy

Well, we are not going to ever be in a boardroom those types of decision are made. Simultaneously the best we can do is performance. I’m suppressed that with Buffalo being on Wag (ph) by the way, because I don’t think that has been any of our potential conversations that have been out there. But obviously we had conversations, our relationship with our vendors, those are important in our performance within our model is very important, because the best way of counteracting that is continuing having productivity within our core business.

Peter Benedict - Robert Baird

Okay, that’s fair enough. And then lastly, just can you update us on the kind of the smaller footprint stores, kind of your thoughts there, performance, opportunities and then we’ve noticed that at Pet Store they’ve been a bit sharper on some items. I don’t know if that was best indicative of a competitor that’s kind of stressed here in this market. But maybe you can talk about what you are seeing from them thanks.

Chip Molloy

Peter on the smaller store front, which would be essentially our 12, 13 K box, we are very pleased with those stores, because that store allows us to keep the same customer proposition with the same selection services, the same number of skews, plus a fewer facings and well, it allows us to go into some markets we wouldn’t have been able to go it into a bigger box, just because it will be a too costly and the returns on those stores are pretty nice, especially given the last several years of vintages. They are significantly higher. It’s low rent per square foot, higher sales per square and more productive stores.

As it relates to some of the other competitors out there, we monitor them, we watch them closely, but we really don’t speak about them publicly.

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

Okay, thanks Chip

Operator

Thank you. And we’ll take our next question coming from Brian Nagel from Oppenheimer. Please go ahead Brian.

Brian Nagel - Oppenheimer & Co.

Hi, good afternoon. Congratulations on another great quarter. My question I had just on the buyback Chip. Clearly you guys have had or shown a pretty consistent appetite for your stock and you put out the new authorization. But if you look at what you bought back this quarter, I mean it was less, less than the last quarter. I mean less than the quarter before that. So I guess the question is, how do you manage sort of cadence of the buyback. Is it opportunistic? I think should we read intently the variability quarter-to-quarter.

Chip Molloy

I would say don’t read into it, it is opportunistic. We did say at the beginning of the year that we were targeting towards roughly 110 million shares weighted average for the full year. By the time we got to the end of the year I think we are on target to deliver that, and beyond that I wouldn’t look into any specific quarter as to what it implies.

Brian Nagel - Oppenheimer & Co.

The second question I had, kind of the bigger picture, but you mentioned, I think in response to one of the prior questions about the benefit of improving housing environment on your business. As you look across your chain, across United States and markets where housings has -- kind of pick up a little bit more, you know stabilize. Are you seeing better trends at your stores there than on your company average.

David Lenhardt

Yes Brian, it’s David. We are actually seeing pretty consistent performance across the country, across regions, across districts, so its very broad based.

Brian Nagel - Oppenheimer & Co.

So you are not seeing any out…

David Lenhardt

Not at all, not in particular. We are seeing strength across the country.

Brian Nagel - Oppenheimer & Co.

Got it. Okay, thank you.

Bob Moran

Thanks Brian.

Operator

Thank you sir. And we’ll take our next question from David Goldberg from Morgan Stanley.

David Goldberg - Morgan Stanley

Good afternoon, thanks for taking the question. Just wanted to touch on the online business flow. I know last quarter you guys talked a little bit about trialing some new things on the website and trying to figure out what the go forward strategy is going to be there and just curious if you have any early take-aways or any kind of sense of the direction your going to go.

David Lenhardt

Yes David, it’s David. We continue to be excited about the path we are headed down. We are on the new channel strategy and as we talked about before, we are really focused on a coupe of key areas as we think about building a seamless customer experience, whether they are in the store, whether they are online, whether on a mobile device, desktop, and as we are thinking about that, a couple of key areas we have been focused on.

First is really focusing on our website experience and making sure that we’ve got the best website experience we can and we continue to make a number of different enhancements. Since we last talked, probably about a dozen enhancements we’ve made to the site today.

And as some examples of that, from a recommendation perspective, we are getting to more personalized recommendations on the website, better filtering around the product reviews that our customers that make, better navigation, and just the overall layout of the website and I think if you go look at it today, I think you if you have been following it, you will notice those chances. So we continue to focus on that, we will continue to focus on it going forward.

We also continue to focus on extending the isle online and adding new skews that we don’t offer in our store. Today we have about 8,000 skews we offer online in addition to everything that we offer in our store and so far this year of those 8,000, we’ve added 3,500 more this year and we will continue to do that and we think that’s a key piece of this.

And then finally we continue to focus on different ways of driving our fulfillment cost and you’ve seen us out there with free shipping. More recently we just finished a $4.99 shipping offer and we are continuing to experiment and test with those things. I think when you put that all together, we continue to be as I said, excited about where we are headed and we think this a big opportunity area for us.

David Goldberg - Morgan Stanley

Great, I just had a quick follow up for Chip. Hopefully this isn’t getting too much into the new share, because the dollar I guess are relatively small. But just in your accounts payable, it seems like this is a second quarter in row where you’ve had a fairly sizable pick-up year-over-year. I’m just curious if there is anything going on there, and if so is that at a sustainable trend.

Chip Molloy

Yes David, I would say that it wasn’t an area of focus for us historically and beginning about a year ago we started to make it a higher priority for us to think about our terms with all of our vendors as more focused on our goods not for resale vendors and we are starting to see some of the benefits materialize. This started last quarter, again this quarter and I expect to see in another couple of quarters some improvement.

David Goldberg - Morgan Stanley

Do you have any sort of targets there in terms of accounts payable with inventory or anything?

Chip Molloy

No, we haven’t been public with that and we are learning as we go.

David Goldberg - Morgan Stanley

Okay great, thank you and congratulations.

Lawrence Molloy

Thank you.

Operator

Thank you, sir. And we’ll take our next question from Matt Nemer from Wells Fargo. Please go ahead sir.

Kate Went – Wells Fargo

Hi, it’s actually Kate Went in for Matt Nemer. Congrats on a great quarter. I just had a question about new guidance for the year. It seems to imply perhaps a more positive view, specifically of the fourth quarter and I was just wondering if there’s anything in terms of certain initiatives or any other areas that you think will be particularly beneficial that quarter.

Bob Moran

No, I would say that we’ve got one half in the bank and we are taking trends and we forecast our business periodically and where we thinking going in the back half of the year looks pretty solid for us.

Kate Went – Wells Fargo

Okay, great. And just a quick follow up for you Chip. You mentioned a few IT projects as it pertains to guidance. And I was just wondering if they might be related to e-commerce or CRM or other areas. If you could provide some color?

Chip Molloy

Well, not specifically. We have projects that we are always working on, every year, whether some of those are just infrastructure improvements. Some of them are things like our services management system that we are working on and some other items that we are working on and they always have timing. A lot of that work gets outsourced and some of that hits the professional fees line and so there’s just a timing of when those events hit and where the bulk of the work gets accomplished.

Kate Went – Wells Fargo

Okay, great and then just one last one. If I heard correctly, services where actually a margin head wind this quarter versus the benefit in prior quarters. I’m just wondering if you could explain what was driving this when I think services was up as a whole and in each of your businesses.

Chip Molloy

Yes, a little bit of that is associated with the mix within grooming. So grooming is by far the largest business where we’re seeing a little bit of shift from bathing to grooms, which is, grooms there is less margin, it’s a commission base, where bathing its on an hourly base, so that’s primary it, but it was small, but yes it was a little bit of headwind.

Kate Went – Wells Fargo

Okay great, but I guess grooming would problem be higher in ticket than bathing.

Chip Molloy

It is, yes it is.

Kate Went – Wells Fargo

All right, great. Thanks so much you guys.

Bob Moran

Thank you.

Operator

Thank you and we’ll take our next question coming from Daniel Binder from Jefferies. Please go ahead.

Daniel Binder - Jefferies & Co.

Hi, good afternoon. You did a lot of work in different areas of the sore and I’m just curious, one, if you have any up coming resets in this quarter and then two, as you look at the progress you’ve made in each area of the stores, is there anything that’s really kind of left where you see a hole or an opportunity that you really want to address in the next few quarters.

Chip Molloy

For the big ones this year they are all behind us, and then as it relates to percentage, some folks ask us about percentage of the stores and how much is finished and how is to go and resets are just activity that keeps the store fresh and innovative and you are going to see reset activity pretty much every year as we continue to evolve, as we bring in new assortments, as we take out old assortments and that’s really being a good merchandising company and that’s what we are really trying to be and you are seeing that happen year-over-year. There will be some more activity next and I suspect there will be again in the year following that.

Daniel Binder - Jefferies & Co.

I guess what I was driving at, in terms of the move to more premium foods or the move towards more proprietary toys, move towards GMC and when you look at other areas of the store, are there any other obviously sort of opportunities besides just sort of the natural evolution in merchandising.

David Lenhardt

Yes Dan, its David, just to build on Chip’s point I think that is something that our merchandising team in constantly focused on and as we think about how to continue to build innovation and diffraction in terms of the offerings to our customers, that is something that our merchants are looking at all of the time and I think with the continued trend of humanization of pets and with people continuing to treat their pets more and more like children, that gives us a lot of opportunity to continue to drive that innovation is our box. So that’s something we continue to work on.

Daniel Binder - Jefferies & Co.

Okay and then just a follow up. Anything you can show us on PetsHotel and with regard to the web, what do you think that sort of goes to the share. I know it’s off a small base.

Bob Moran

Yes, in the hotel, the hotel continues to be a good growth story within our services portfolio. As we talked about in the past, the overnight business is closely correlated to the human travel business and that has been continuing to do well for us and that’s now a trend that’s been going on for several quarters and we continue to be excited about what we see there.

We think with the reservation center, the call center that we are now rolling out to all of our hotels and we’ll have that in for all of our hotels by the end of Q3, that’s also giving us an opportunity to improve the customer in terms of check in and check out, as well as having more consistent dialog with the customer around things like add-ons and we think that is also helping our performance right now.

Daniel Binder - Jefferies & Co.

And the web?

Bob Moran

In terms of the web today, we do not do online reservations for the hotel or any of our services. That is a project that we are working on right now. We do believe it’s an opportunity for us, because from a human perspective people are used to booking services online. That’s something that we are actively working on, but at this point that has not been rolled out.

Daniel Binder - Jefferies & Co.

Thanks.

Operator

Okay, thank you. And we have time for one final question. Our final question comes from David Strasser from Janney Montgomery. Please go ahead sir.

David Strasser - Janney Montgomery

Thank you very much. I wanted to follow-up on a question on the web. First of all, I do agree, I think it actually much, much better than it looked in the past. When you look at traffic on the web there, there was one website compete showing about 18% increase in traffic on your website. Are you seeing that type of increase in our closed rates as well. is a lot of that traffic really on the information or are you seeing that transform into sales online and how are you tracking sort of what that customer is doing?

David Lenhardt

Yes David, it’s David. We are seeing a little bit of both in terms of the traffic, whether it would be converting or just as importantly are we taking that traffic, are they learning something, educating themselves and/or are they are moving them through the store and that’s a big piece of our strategy, is driving that online traffic to our store. But overall, we do continue to see nice traffic. We are the number one traffic website in the category and we are continuing to grow at very attractive rates.

David Strasser - Janney Montgomery

I don’t know if you can track, but do you think your also the number one selling product on the website or do you even care that much or are you just content to have people coming on…

David Lenhardt

Its very much a balanced approached, and again, we are focused on what we would call the influence driving customers to the store, as well as if they want to transact with us online, we absolute want to be there for them and we want to make it as simple for them as possible and that’s really part of our broader online channel strategy that we are beginning to invest heavily in.

David Strasser - Janney Montgomery

And I just guess one last follow-up of a different note. I guess Wall-Mart they are launching that product, their ultra premium, I think it within this week or very recently. I mean from a strategic standpoint, is Wall-Mart any different than anyone else. Does it worry you more or less? I mean they are so big, but obviously they’ll overlap probably using that strong with the customer base. I just have to kind of be looking into a little bit ahead of Wall-Mart’s earnings. I’m just sort of curious if strategically that one worries you more than even the web or just another competitor.

Bob Moran

Yes again, as you mentioned, I think there is I think a customer base question and a difference there. I think more broadly, obviously this has been, the natural food category has been a fast growing category within the industry and I think lots of different competitors are starting to or trying to play in that space. As we think about it, our role here is to continue to innovate, differentiate it, bring in brands and formulations that you can’t find any place else and that continues to be our broader goal.

David Strasser - Janney Montgomery

All right, thank you very much. Congratulations.

Bob Moran

Thank you.

Chip Molloy

Thank you.

Bob Moran

Well, I believe we have come to an end of another call. So I just want to thank everybody for joining us today and we look forward to speaking with you again in November. Take care.

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 great day.

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