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PetSmart, Inc. (NASDAQ:PETM)

F2Q08 Earnings Call

August 28, 2008 4:30 pm ET

Executives

Tawni Adams – Director Investor Relations

Philip L. Francis - Chairman of the Board & Chief Executive Officer

Robert F. Moran – President & Chief Operating Officer

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

Analysts

Matt Nemer - Thomas Weisel Partners

Matthew Fassler - Goldman Sachs & Co.

Alan Rifken – Merrill Lynch

Peter Benedict – Wachovia Capital Markets, LLC

Michael Baker – Deutsche Bank North America

David Mann – Johnson Rice & Company

Christopher Horvers – JP Morgan

David Schick – Stifel Nicolaus & Company, Inc.

Dan Wewer – Raymond James & Associates

David Cumberland – Robert W. Baird & Co., Inc.

Operator

Welcome the PetSmart second quarter 2008 investor conference call. (Operator Instructions) I would now like to turn the conference over to Tawni Adams, Director of Investor Relations.

Tawni Adams

Welcome to PetSmart’s conference call to announce our results for the second quarter of fiscal 2008. With me on the call today are Chairman and Chief Executive Officer, Phil Francis; our President and Chief Operating Officer, Bob Moran; as well as Chip Molloy, Senior Vice President and Chief Financial Officer. Phil will kick off the call today with an overview of our second quarter results, then Chip will take you through the financial review of the quarter as well as our earnings guidance and 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. I’ll now turn the call over to Phil.

Philip L. Francis

I’m happy to report that we are executing well in this tough environment and we expect to achieve our targets for the year. Our long-term focus continues to be on building a solid business model that can deliver sustainable returns to our shareholders. For the quarter we delivered on our guidance with earnings per share of $0.30 and comparable store sales or sales of stores open at least a year grew at 4%. We continue to see top line strength coming from our ability to pass inflation through to the customer. Our average ticket was up 5.6% in the quarter including the 450 basis point inflation benefit to comp sales. That compares with a 220 basis point inflation benefit in the same period last year.

While traffic is still negative trends are improving. Comp transactions decreased 1.6% which is slightly better than the 2.3% decline we saw in the first quarter of this year. You may remember that we first saw comp transactions fall off last year in the third quarter with the worst performance in the fourth quarter at negative 2.6%. We’re encouraged by the modest rebound from that low in the first quarter of this year and by the continued trend upward in the second quarter. So we continue to work on driving transactions and the same time delivering consistent execution throughout the business. We opened 32 net new stores and 14 new PetsHotels during the quarter. We are on track to build between 100 and 104 net new stores and 45 PetsHotels for the year.

We brought our replacement full line Reno distribution center online with great success and expect to complete the implementation of a better labor management system in our US stores this year. Our work list in 2008 is neither short nor easy so we’re intently focused on execution and financial discipline. With that focus we’re pursuing a plan to deliver on our targets for the back half of the year and to invest future capital at rate that allows us to profitably grow and take market share over the long term.

At the beginning of this year we indicated that we’re going to reduce our capital spend in 2009 and beyond by slowing our growth by about 20% in our new stores and building approximately 45 PetsHotels a year. Since that first look at slowing our spending we’ve had the opportunity to better assess the changes in the market landscape and refine what we believe will be an appropriate level of capital investment. We are now targeting our capital investment to be in the range of $180 million to $200 million a year. Within that framework we expect to build between 60 and 65 net new stores in 2009 and between 50 and 60 stores in 2010 and beyond. We also expect to build approximately 35 PetsHotels a year. The reduction in investment spending will give us the ability to balance the focus of our capital and human resources between improving the productivity of our current assets and building new assets that create long term shareholder value. We’ll keep looking for ways to drive top line growth and maximize the performance of our stores.

In this difficult environment we’re focused on driving sales and on taking great care of the customer. Our total lifetime care strategy of providing solutions to every pet parent that enters our store remains the touchstone of our business. We have an excellent business model with a number of competitive advantages, we’re the leading player in pet specialty, we have a winning offering of services and merchandise under one roof and our stores are in great shape to delight our customers.

With that I’ll turn the call over to Chip to give you more detail on our financial performance for the quarter.

Lawrence P. Molloy

As Phil mentioned we delivered earnings of $0.30 per share which was in line with our guidance for the quarter. Revenue for the first quarter totaled $1.2 billion up 11.2% from last year’s second quarter. Our comparable store sales grew 4% for the quarter on top of 4% comp growth for the same period last year. Operating income for the quarter was 6.1% of sales down 150 basis points from the second quarter of last year driven entirely by the pressure on gross margin. Gross margin declined approximately 150 basis points to 29.5% of sales. During the second quarter of last year we had some benefit on the gross margin line due to favorable timing of rent reimbursement from Banfield. We didn’t have that benefit resulting in 50 basis points of decline this year. Our remaining rent and occupancy costs were unfavorable to gross margins by an additional 50 basis points.

Warehouse distribution costs were unfavorable by 35 basis points as a result of opening our full line replacement Reno distribution center and pressure from rising fuel prices. Merchandise margins were unfavorable by 10 basis points and services margins were flat to the second quarter of last year. Operating, general and administrative expenses were 23.4% for the quarter or flat when compared to the same period of last year. In the second quarter of 2007 we had a combined benefit of approximately $7 million from the impact of reductions in insurance and stock option expenses. Those two items were one time in nature and combine for an 80 basis point benefit for the second quarter of last year.

Various cost savings including reduced store expenses and fewer professional fees provided a net benefit of approximately 80 basis points this year. Our second net interest expense as a percentage of sales compared to the sale period last year increased 45 basis points. The increase was primarily the result of the funds required to execute the accelerated stock repurchase during second half of last year that both reduced investments in short term securities that provide interest income and increased our debt interest. During the quarter we generated $90 million in operating cash flow, spent $66 million for capital projects and purchased approximately 850,000 shares for $20 million. We ended the quarter with $58 million of total cash and cash equivalents, $32 million of debt on the balance sheet and 126.6 million shares outstanding. We are on track to spend no more than our target of $285 million on capital projects for all of 2008 and have $25 million remaining of our current $300 million share purchase authorization.

Looking forward we expect to deliver third quarter earnings per share between $0.25 and $0.29 and comparable store sales of mid-single digits. This is on top of a 1.4% comp last year. For the full year we now expect comp sales of mid-single digits and our earnings outlook is in line with our previous projection of $1.51 to $1.59 per share. The current trends of the business and the operational activities in place today set us up to take advantage of a weaker back half comparison. We expect an increase in comparable store sales in the back half as we continue to see a benefit from inflation and we anniversary weakness form the pet food recall and the exit of a state line tack business.

On the gross margin side we expect more pressure due to sales mix shift than previously anticipated. That will be offset in part during the back half as we begin to leverage our warehouse and distribution system and services start to become accretive from a year-over-year comparison perspective. On the expense side we will continue to focus on controlling costs and running the business efficiently. However it will be difficult to totally offset the gross margin pressure with OG&A leverage and we are now expecting operating margin to be flat to down 20 basis points for the full year.

As we look forward to our future we believe we have a solid business model that can deliver profitability in a tough environment. As Phil mentioned we plan to slow our capital spending and take a more balanced approach between investing for the future and making our current asset more productive. This will be a major step towards our goal of producing a flat to expanding operating margin at a 2 to 3 comp. We believe this approach can help us deliver ongoing earnings growth and has potential to drive sustainable shareholder returns.

Now I’ll turn it over to Bob who will provide more details on how we plan to deliver on our commitments.

Robert F. Moran

Our performance in this challenging economic environment is a good indication of the strength of our business model and our ability to focus on the things that will make a difference and generate returns. A significant piece of our business is in the less discretionary consumables category. That makes a bit more resilient and a bit more able to turn in consistent results. We are building on that strong basic model with the addition of financial discipline and operational consistency. We think it’s a powerful combination that positions us to deliver returns through good times and bad.

So let’s talk about what we’re focusing on to deliver this year. As Phil mentioned our ability to pass through inflation is helping the top line but we’re also seeing weakness in traffic continue to offset some of that benefit. We know that our loyal customers by channel exclusive foods and use our services so there is continued strength in the consumables category. Consumables made up about 50% of our business in the second quarter up from 48% during Q2 of last year. At the same time we saw healthy growth of 20.4% from our services business during the second quarter. Services now make up 11.4% of our business. We continue to be encouraged by the ongoing strength of this highly differentiating part of our business but we all are very well aware of the ongoing consumer weakness and we are cautious about our ability to continue to deliver services growth of 20% in the back half of the year.

We also continue to see weakness in our hard goods business as consumers pull back on more discretionary products like toys and apparel. For the quarter our hard goods penetration was 36% down from 39% last year. So we continue to work to understand and get better at retaining our most profitable customers. We think our more promotional marketing mix can drive a value message to our customers in this tight tough environment. Our PetPerks database allows us to track promotional offers and focus only on those that are most profitable and our merchants have continued their work on the good, better, best strategy in an effort to give pet parents what they want at a price point they can afford.

On the gross margin line as Chip mentioned we expect to see pressure all year from the mix shift, occupancy costs and higher fuel prices. We have been able to pass through inflation on consumables but it has become more difficult to pass it through on hard goods. We will continue to try to mitigate the margin pressure through forward buys on products, streamlining processes and making our distribution network more efficient. We should get some benefit from the anniversary of the opening of our distribution center in Noonan, Georgia in the back half of the year as we see a reduction in the amount of miles we drive and an increase in productivity. On the expense side we continue work through opportunities to find efficiencies and save costs.

We are on target to complete the implementation of our new labor management system in our US stores by the end of 2008. We are not waiting for the system to be completed to move forward on managing labor. We’re giving our stores tools and processes that standardize non-customer facing tasks and make it easier and more cost efficient to run the store. Our work to move product efficiently through the store continues to pay out in savings on labor hours.

In summary we are seeing both more strength on the top line from inflation and more pressure on margin from the mix shift than we anticipated coming into the year. We expect a benefit on the top line to help mitigate the margin pressure and with continued work to leverage expenses we believe we can deliver on our guidance for the back half so we are committed to achieving our targets for this year and shifting our focus to efficiently managing our assets to continue to grow this business and drive shareholder returns.

With that I will turn the call back over to Phil.

Philip L. Francis

Now we’ll be happy to take your questions.

Question-And-Answer Session

Operator

(Operator Instructions) Our first question comes from Matt Nemer - Thomas Weisel Partners.

Matt Nemer - Thomas Weisel Partners

My first question is can you comment on the reaction from consumers to inflation in the consumables category? Are you seeing people trade down in brand or buy smaller bags? What sort of consumer behavior have you noticed?

Philip L. Francis

We are not seeing that sort of behavior. We have dog food divided up a lot of ways including Rx at the very, very top and we are seeing the best growth still at the high end of the spectrum. Our grocery standard is growing but it is our weakest category and I’d say we see the trading up continuing. It has not been damaged to date by the rising prices.

Matt Nemer - Thomas Weisel Partners

My next question is given the inflation in hard goods categories, have you thought about making a deeper push into store brands or private label in some of those categories? Can you give us an update on the percentage of your mix that is private label right now?

Robert F. Moran

About 20% of our products, mostly in hard goods, are private label. Obviously there’s always more work you can do to improve on that and obviously the focus on price value is even more important today and it will probably be more important tomorrow. I think we have strategy initiatives to address that and we also have initiatives to improve on that in the future.

Matt Nemer - Thomas Weisel Partners

Lastly, can you comment on the change in CapEx guidance? I’m really looking at 09 CapEx guidance versus 08. What are the major components there? Can you give us any detail on detail on what you’re assuming in dollars per store and per hotel? Are there any other one time items in there?

Lawrence P. Molloy

$180 million to $200 million is what we said for next year. We are not assuming a change in the actual cost per unit. There is fewer units that are driving that. In addition to that we don’t have a new DC coming on line next year so that’s part of the come down in cap and then the third piece of that is we were renting some space here in Phoenix. We’ve relocated that space to new buildings here at our corporate headquarters and we won’t have that cost next year either.

Matt Nemer - Thomas Weisel Partners

Are there opportunities, I know you were looking at taking some expense out of the hotel build out. Could there actually be an additional opportunity on top of these numbers to take out some per unit expense either on stores or hotels or both?

Lawrence P. Molloy

We’re looking at both and we’ll continue to look at that but right now we’re not assuming that those costs will be coming down.

Operator

Our next question is from Matthew Fassler - Goldman Sachs & Co.

Matthew Fassler - Goldman Sachs & Co.

I’d like to start out with a question on the retail store and CapEx cuts which are terrific moves, I’m just curious what in your mind changed from your initial assessment at the end of 2007 through today that led you to make those further cuts particularly on the store side?

Philip L. Francis

Others may want to chime in here. I think that reason for us is that the world has changed and when the world changes it makes us think probably we should change as well. Given that there’s less new real estate being built and we think that with the aging stage of our company that whatever the mix was between growth and earnings growth and predictability we think this is shifting the weighting more in favor of earnings growth and predictability as compared to just top line moves. The simple answer we’re after growth and operating profits. Because the world has changed, that’s more important to us and this cut in CapEx makes earnings growth more predictable and more consistent.

Matthew Fassler - Goldman Sachs & Co.

Second question relates to inventory which was up substantially. Can you comment on the mix of inventory, food versus hard goods and also to what degree the commodity inflation is contributing to that inventory increase?

Lawrence P. Molloy

It’s a couple things that are giving us the increased inventory. One of course is just the number of new stores on the total inventory line but from an inventory per store perspective. Inflation is a piece of that and we have done some full revise in Q2 as we’ve taken some advantage and gone after some gross margin dollars so we’ve done some forward buys. That will start to smooth its way out as we roll into Q3 and beyond and we’re expecting to still hit our target for the year of total inventory growth of around 12%.

Matthew Fassler - Goldman Sachs & Co.

When you think about the forward buys, were you being opportunistic vis-à-vis market opportunities or are those opportunities that were always there, you just decided that margin was more important at the moment?

Lawrence P. Molloy

Matt, they were opportunistic. Obviously with the pressure on commodity pricing a number of our large vendors, mostly consumable vendors, were offering opportunities to us that we felt that we could take advantage of and the fact that our strongest side of the business is consumables we felt that we could sell through it and it wasn’t going to put any pressure on markdowns of inventory or anything, we could most likely sell through that and we are selling through that.

Matthew Fassler - Goldman Sachs & Co.

Finally on a couple of financial details from some of the one time items, what was the ESO number this quarter?

Lawrence P. Molloy

I think it was, hold on a second. $4 million I believe.

Matthew Fassler - Goldman Sachs & Co.

And that was up from how much?

Lawrence P. Molloy

[Inaudible] occupancy expense was $3.95 million this quarter and last quarter it was $4.1 million.

Matthew Fassler - Goldman Sachs & Co.

So it was about the same as last year?

Lawrence P. Molloy

About the same, yes.

Matthew Fassler - Goldman Sachs & Co.

And the MMI benefit last year, that showed through on gross margin, all of it, or was it on both line items?

Lawrence P. Molloy

All of it on gross margin.

Operator

Our next question is from Alan Rifken – Merrill Lynch.

Alan Rifken – Merrill Lynch

Just a couple of questions, Chip what do you believe the impact on EBITDA will be in 2009 of the implementation of the labor management system?

Lawrence P. Molloy

Alan, first off the labor management system, it’s not just the system, it’s the process around the system. When I think about labor we’ve done a lot of different things to try and control labor. For instance we’re now controlling it centrally where before there was more of an opportunity for the stores to control it locally. It’s wrapping up those processes which is what we’re working towards today and the labor management system is going to roll into place. We’re going to see leverage. We’re actually seeing leverage today from store labor from a comp perspective and we’re going to continue to see it in the next year but we haven’t given specifics as to how it’s going to do for the overall company.

Alan Rifken – Merrill Lynch

Just to follow up on Matt’s question earlier, Phil can you confirm that your decision to cut back on the new store openings is really just prudence on your part and making an incremental investment into the existing store base and not a function of a saturation number that is potentially not as high as what you once thought it was?

Philip L. Francis

This is strictly recognizing age and stage, desire to improve operating margin and the belief that when the world has changed it’s appropriate for us to change. Whatever the number is for how many stores we can build this differentiated growth rate moves out by years running up against the most conservative target we ever gave and frankly whatever you worried about that, the worry has been delayed by three our four years by this change in growth rates. But the main driver for us is we want to have a reputation as consistently growing our earnings at the age and stage of our company in this macro environment so we thought the world changed, we changed and that’s why we did it.

Alan Rifken – Merrill Lynch

One last question if I may, I believe that you mentioned that your merchandise margins were down 10 basis points, can you maybe just expand a little bit on that? Are you in fact able to pass on not only the higher wholesale prices that are put to you in terms of dollar terms but have you been able to maintain the percent as well?

Lawrence P. Molloy

We have been able to maintain the percent. The reason the gross margins are down is because of the weakness in the hard goods which are higher margin goods. But from a rate perspective we’re actually in the green and we’re positive and from a mix perspective we’re negative and when it all flushes through we’re about 10 basis points down.

Alan Rifken – Merrill Lynch

One last question if I may, as you guys continue to slow down the stores and as you maintain the 45 hotels and we believe they’ll be accretive collectively in 09, certainly the services are going to become great and greater proportion of not only your revenues but certainly of your profits. Can you maybe compare the incremental returns on invested capital from the hotels versus a new store if that’s possible?

Lawrence P. Molloy

One just to clarify, we’ve now said that we’re going to do 35 hotels a year, we had said 45 now it’s 35. From a relativity perspective right now the way we’ve modeled it out the stores are slightly higher from a returns perspective but very close and the reason that we don’t build more stores and stopped building hotels is that not only does the hotel, one it’s a new kind of concept, but we believe that it’s a differentiator for us and we’re willing to accept slightly less returns for hotels than we are on stores because the differentiation and the access to new customers and the fact that it’s essentially a pillar for us from a strategic perspective.

Operator

Our next question is from Peter Benedict – Wachovia Capital Markets, LLC.

Peter Benedict – Wachovia Capital Markets, LLC

Can you talk a little bit about how much leverage you’re expecting to get in the back half of the year here from the warehouse and distribution efficiencies that you’re going to see?

Lawrence P. Molloy

As you remember I think we pointed out in Q1 it was dilutive about 65 basis points and we’re starting to see it become less dilutive as we get further down away from the opening of Reno. It was 35 basis points this quarter. As we start to go into the back half of the year, we’re predicting it to be essentially flat from a year-over-year comparison in Q3 and in Q4 our expectation is it will actually be accretive to the tune of probably 10 to 20 basis points.

Peter Benedict – Wachovia Capital Markets, LLC

Just on the CapEx coming down in 09, big boost in free cash flow coming there, could you update us on your thoughts on the use of cash going forward and remind us, you might have said this, how much you have left on the buy back authorization right now?

Lawrence P. Molloy

We have $25 million left on the buy back so we still have that available to us. Obviously there will be more free cash flow. Right now we have a history of giving that back typically to the shareholders in the form of dividends and share repurchases and I don’t suspect that that will change in the future.

Operator

Our next question is from Michael Baker – Deutsche Bank North America.

Michael Baker – Deutsche Bank North America

First question is are you seeing anything in the food part of the business on units? We know that price is driving the comp but is there any slow down in units?

Lawrence P. Molloy

On the unit side of the house, on the consumable side, we have seen essentially [inaudible] units, comp units, essentially flat and that’s an improvement from last quarter where comp units were down mid-single digits.

Michael Baker – Deutsche Bank North America

I think in the gross margin comments you said that you expect to continue to see deleverage on the occupancy even outside of the distribution center, I guess store occupancy, even on a mid single digit comp, did I hear that right? And if that’s so, why is that?

Robert F. Moran

There will continue to be some deleverage on the store occupancy side on rent, we’ll see that for the third quarter and in the fourth quarter we’ll actually start to leverage just because it’s a bigger quarter for us. It’s been there, it’s been running 50 some basis points a quarter, it’s really always been there for several quarters in a row. We just started giving you guys visibility of that for the last couple quarters and it’s really because of the fact that we were ramping up the number of stores along the years and the net of that was cannibalization, it’s been de-levering.

Michael Baker – Deutsche Bank North America

So right now I guess you need more than a 4% comp apparently or even more than a mid-single digit comp to leverage that so that leverage point comes down in the future as you have fewer immature stores? Is that the right way to look at it?

Robert F. Moran

We said early at the beginning of this year it would take a 3 to 4 comp for us to have operating margin leverage. Because of the mix shift it’s a little bit bigger than we thought it was coming into the year and it’s put a little bit more pressure on gross margin. It’s North of four to have operating margin expansion. Yes, the answer to your second part is as we go into next year and beyond, lowering the CapEx and lowering the number of units growth will help us get to a lower leverage point, if you will, and that’s what we’re striving to is to get that to 2 to 3 comp place where we can leverage the operating margin at a 2 to 3 comp.

Operator

Our next question is from David Mann – Johnson Rice & Company.

David Mann – Johnson Rice & Company

Bob, you mentioned that you expect services growth or you were cautious about services growth in the second half, can you talk about whether that caution is across all the different services and how much slower might you expect the growth to be?

Robert F. Moran

We’re pretty happy with what has happened in the first half especially in the second quarter having growth over 20.4%. We’re being cautious not because we’re cautious about the business. We’re being cautious because of the macro event. So we’re doing everything that we have a control over to maintain this type of level of growth. We’re just being cautious because of the macro events. In fact this is a discretionary spend so we’re being prudent by saying we’re being cautious.

David Mann – Johnson Rice & Company

Over the summer at a time where hotels might be used more because of vacations, did you see any change in consumer behavior given all the noise that was out there, gas prices, macro, etc.?

Robert F. Moran

We saw obviously the movement towards stay vacations and obviously less plane trips. We saw fewer nights but we also saw more people trialing the PetsHotels than they ever did before because we didn’t have the capacity because we were basically all sold out. Obviously the hotel is dependent on, a lot of it, the travel industry and we know that’s changing and it’s forecasted to continue to change especially with the number of reductions of flights coming up at a number of airlines. We move with that but we’re seeing is day trips still take place, vacation needs are still there and hotel needs are still there.

David Mann – Johnson Rice & Company

Can you just update us on what you’ve seen with your pricing efforts in the hotels?

Robert F. Moran

We have shifted our pricing in a number of areas, both grooming and hoteling and we have not seen any resistance to that at all. Obviously the customers that are using services are our best customers and obviously how they feel about their pets are different than other segments, customer segments. We’re continuing to look at that, we’re continuing to see what the market will bear and we’ll just keep that as part of our everyday work.

Operator

Our next question is from Christopher Horvers – JP Morgan.

Christopher Horvers – JP Morgan

As you look at your little bit of raise to the comp store sales growth for the year going to mid-singles from low to mid-singles, is that largely because you’ve seen a bit of upside here in the first half of the year? In other words is there any change from your original outlook for back half comps?

Lawrence P. Molloy

I would say the answer to that is yes. What we’re seeing for the year versus when we came into the beginning of the year is we are seeing slightly stronger top line growth, some of that is driven by more inflation than we thought coming into the year. We’re seeing a little bit more margin pressure than we anticipated at the beginning of the year, driven primarily by the mix shift and we’re seeing our costs come in line where we’ve been managing to, so we’re creating more leverage at the OG&A line, a little more pressure on the margin line but net we feel comfortable about our guidance for the year and it hasn’t changed since we started the year.

Christopher Horvers – JP Morgan

As we think about comps in the back half you’re getting a little bit more inflation, it sounds like traffic is actually a little bit improved from the trend where you gave guidance for the year, so as you look at 3Q and 4Q are you thinking about comps that are now higher than you were thinking one or two quarters ago?

Lawrence P. Molloy

Yes, we are and it’s driven primarily by the higher inflation primarily but we also, if you remember when you think about it, I like to think about it from a two year stack perspective, if you think about last year in the quarters we had a 4, a 4, a 14 and a .8. So far this year on a two year stack we have a 6.9, in this quarter we have an 8. So just do the math against a 14 and a .8, that would suggest that we do believe the comps in the back half of the year are going to be higher than they were in the first half.

Christopher Horvers – JP Morgan

On the state line tax side of the business, it was 150 basis point drag in 1Q and 90 in 2Q, do you expect any lift now that that’s behind us?

Lawrence P. Molloy

Yes, we do.

Christopher Horvers – JP Morgan

Just one follow up on the SG&A side thinking holistically is there a target that you’re saying well SG&A per store should be this or we think SG&A per foot this is the goal and as we get those store openings down, bring the CapEx down, we’re targeting that number and that’s where we’re headed long term?

Lawrence P. Molloy

I would say, Chris, you’re probably one step ahead of us in that area.

Operator

Our next question is from David Schick – Stifel Nicolaus & Company, Inc.

David Schick – Stifel Nicolaus & Company, Inc.

The question is as you think about taking that store, or as you are taking that store growth down, if you could give some details on the nature of where those stores were going to be? What I’m trying to get at is will there be an appreciable removal of cannibalization, will this help your comp or were these all new markets? Is there anything about the stores that you’re not going to open that will impact comp over the next few years?

Philip L. Francis

I don’t think there’s big news here. Remember I think we’re in the top 80 markets in America with at least one store. So there’s no brand new ones to do and by and large we’re adding stores to markets here. We’re very aware of cannibalization when we do stores. As you look at the class of 09 since we dialed back in original expectation I think you’d expect us and we did take from the top of the deck and neither defer or delete things that were going to be in the bottom of next year’s decks. We feel strongly about next year’s portfolio but as for big changes in cannibalization I think we’re still doing primarily fill in stores in an odd single store market when we can find it but we’re going to have help from less cannibalization just because of fewer stores, but there’s not much difference from where the stores are going to be.

David Schick – Stifel Nicolaus & Company, Inc.

But the pure math will still help you comp next year?

Philip L. Francis

The pure math, just in how many are there that are going to be woodwork, yes.

Operator

Our next question is from Dan Wewer – Raymond James & Associates.

Dan Wewer – Raymond James & Associates

Phil, I just wanted to make sure I understand on the reduction in the store openings next year, this should be viewed as a secular change for PetSmart and not a cyclical change with respect to what you’re seeing in the economy to this year or next?

Philip L. Francis

That’s correct. We think at our age and stage and what’s important to our shareholders, we can now spend more time relatively on the existing asset base which is large, be very selective about new stores that add shareholder return and if the economy were to turn up significantly in 2010 or 11 I think we’d stay at about the guidance that we have given you here. It’s a recognition on our part that the world has changed and our age and stage has changed and we think is the best behavior for shareholders going forward irrespective of a cycle.

Dan Wewer – Raymond James & Associates

Last October at the Analyst Day you had broadened the secular growth target of the company to a range of 15% to 20%. With the reduction in the long term store expansion rate, where would you peg that long term growth rate the company is now targeting?

Lawrence P. Molloy

We haven’t given long term guidance this year. We probably won’t do that until the end of this year as we roll into next year and we start to give guidance for next year and beyond. Obviously the world has changed a lot since October and I think it’s prudent on our part to wait until we get to a little later in this year.

Dan Wewer – Raymond James & Associates

If you could just remind then on the prior target of 15% to 20%, do you recall what that was assuming for annual store growth rate? As I recall it was around 10% but correct me if I’m wrong.

Lawrence P. Molloy

It was about 100 stores a year and the hotels were ramping up pretty materially. I think they were up to 70 by next year.

Dan Wewer – Raymond James & Associates

So it might make sense to think about maybe take 4 points off that secular growth estimate?

Lawrence P. Molloy

Well I would think about, once again we’re not into the long term guidance yet, but I would clearly think about coming back on the top line and then over time, part of the reason we’re doing this is to drive earnings up.

Dan Wewer – Raymond James & Associates

Increase the operating margin, right?

Lawrence P. Molloy

That’s correct.

Operator

Our next question is from David Cumberland – Robert W. Baird & Co., Inc.

David Cumberland – Robert W. Baird & Co., Inc.

On the last call you talked about shifting your advertising to more broadcast with emphasis on value and promotion. How did that perform for you and do you plan a similar approach in the second half?

Robert F. Moran

Obviously looking at 4% comps you feel pretty good that some of that movement has helped the current focus in our macro world right now as price and value and we feel that we can use a lot of our capabilities, really do target it, promotions. We can use our database to really focus on the profitable promotions. We can also work with our vendors to get the right TPRs to drive the traffic in. We believe we’re going to continue doing that. We believe the 4% comps, that is a signal that it’s working and we’re going to continue that into the second half.

David Cumberland – Robert W. Baird & Co., Inc.

Chip, for the last couple of quarters you’ve cited lower professional fees as providing some savings, what is the remaining opportunity there?

Lawrence P. Molloy

Obviously it’s a year-over-year so for this year it’s in our guidance. That’s low hanging fruit, if you will, so it’s not going to be something we’re going to be able to bring down much further next year but it doesn’t mean that there’s not other things that we’re looking at from an efficiency perspective.

David Cumberland – Robert W. Baird & Co., Inc.

And then also for you Chip, you talk about the operating margin guidance flat to down 20 basis points, what is the base that you’re using for 07 so we’re all clear on that since 07 had an extra week and had some charges?

Lawrence P. Molloy

That was just in GAAP, GAAP to GAAP.

Operator

This concludes our Q&A.

Philip L. Francis

Thanks very much for your attention and support. We’ll talk to you again in about 13 weeks from today. Have a great holiday weekend.

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