PetSmart, Inc. (PETM)
Q2 2008 Earnings Call Transcript
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

Analysts

Matt Nemer - Thomas Weisel Partners
Matthew Fassler - Goldman Sachs.
Alan Rifken – Merrill Lynch
Peter Benedict – Wachovia Capital Markets
Michael Baker – Deutsche Bank
David Mann – Johnson Rice & Co
Christopher Horvers – JP Morgan
David Schick – Stifel Nicolaus
Dan Wewer – Raymond James & Associates
David Cumberland – Robert W. Baird & Co

Presentation

Operator

Good day ladies and gentlemen and welcome the PetSmart second quarter 2008 investor conference call. (Operator Instructions) At this time all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session and instructions will be given at that time. If anyone should require assistance, please press *, then 0 on your touchtone telephone, and as a reminder this conference call is being recorded. I would now like to turn the conference over to your host Ms Tawni Adams, Director of Investor Relations. Ms Adams, you may begin.

Tawni Adams – Director Investor Relations

Good afternoon and 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. Thanks and I’ll now turn the call over to Phil.

Philip L. Francis

Thank you Tawni and hello everyone. 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 a 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

Thanks Phil, good afternoon everyone. 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 and 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 same 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.