Petco Health and Wellness Q1 2025 Earnings Call Transcript

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Provided by Quartr
May 22, 2024

There are 12 speakers on the call.

Operator

Good morning, and welcome to the Petco First Quarter 2024 Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Benjamin Teal Long, Chief ESG and Chief Communications Officer. Please go ahead.

Speaker 1

Good morning. Thank you for joining PECO's Q1 2024 earnings conference call. In addition to the earnings release, there is a presentation available to download on our website at ir.peco.com summarizing our results. On the call with me today are Mike Mohan, PECO's Interim Chief Executive Officer and Brian LaRose, PECO's Chief Financial Officer. Before they begin, I'd like to remind everyone that on this call, we will make certain forward looking statements, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from such statements.

Speaker 1

These risks and uncertainties include those set out in our earnings materials and SEC filings. In addition, on today's call, we will refer to certain non GAAP financial measures. Reconciliations of these measures can be found in our earnings release, presentation and SEC filings. And finally, during the Q and A portion of today's call, we ask that you please keep to one question and one follow-up. With that, let me turn it over to Mike.

Speaker 2

Good morning, everyone, and thank you for joining us today. I'd also like to take this opportunity to welcome Glyn Murphy as our Executive Chairman. With over 30 years of retail experience, we're delighted to have him join our Board. The entire leadership team will be working closely with him on the next stage of Petco's transformation. In Q1, we made meaningful progress against our strategy to reposition the business for sustainable and profitable growth.

Speaker 2

Although I've been a pet parent for many years and a member of Petco's Board for over 3 years, the last 60 days have provided me with even greater insight into what makes Petco a special place to both work and shop. We operate in an attractive category with a track record for consistent growth and Petco remains an iconic and trusted brand for millions of pet parents. Our store partners bring in a palpable energy for change and I'm grateful for the incredible work they do. It's their enthusiasm that shapes how our leadership team focus on both our mission and our potential as we look ahead. We need to address some big challenges by capitalizing on our strengths.

Speaker 2

Specifically, we must return to profitable growth and generate improved free cash flow, keeping an eye on the long term opportunity to capture further market share and what remains a highly fragmented industry. In support of this, we have restructured Petco's executive leadership team. Consequently, we've simplified decision making, aligned our focus on fewer and clearer priorities and empowered the organization to move with greater speed and agility. The leadership team's priorities to improve profitability are clear. Return to retail fundamentals while executing on cost transformation and takeout.

Speaker 2

Retail fundamentals falls into the following distinct components. The first is store productivity. In our pet care centers, we've begun to roll out the new store operating model. This builds on the work started last year and it reinforces an owner's mindset. The model not only promotes prioritization and increases customer facing time, but also educates and empowers store partners to create a world class customer experience and drive share of wallet.

Speaker 2

The second area is merchandising excellence. We are conducting an end to end review and rationalization of our pricing and assortment strategy across our merchandise mix. Designed to improve traffic, basket and overall quality of sales, this review is focused on better aligning our in store and online merchandising to meet the need of all pet parents while driving long term profitable growth. This will be supported by the 3rd component, which is increasing marketing effectiveness. As we plan now for the balance of the year, we are recalibrating our marketing efforts to deliver more effective lower funnel marketing and engaging actively with pet parents to drive traffic to our stores and online channels.

Speaker 2

We are partnering with vendors to increase top of funnel marketing, reinforcing our unique ability to cater to every pet and pet parents' need. And finally, disciplined inventory management. We see ample opportunity to realign our omnichannel delivery model that balances both cost and capacity to better service our stores and direct to customer fulfillment centers, managing overall distribution costs. We see meaningful opportunities across the entire supply chain to deliver further efficiencies. While there is much more work ahead, I'm pleased with the actions we've taken in just 60 days and we anticipate a fuller update on progress as plans finalize.

Speaker 2

Now turning to cost transformation. We remain on track to unlock a target of $150,000,000 in cost savings and productivity enhancements by the end of fiscal 2025 with $40,000,000 to be achieved in year 1. As we look more deeply into the business, we're working diligently to expedite and augment these savings, including through the disposition or sunsetting of non core assets. Specifically, we are being hypercritical on all areas of spend in reducing or pausing projects that are G and A intensive, but have lower confidence in ROI, sequencing the highest priority drivers that have minimal or no impact on our relationship with customers. For example, in Q1, we completed the sale of our Pupbox business and we recently decided to pause non critical updates to internal systems, thus allowing us to redirect investments in technology towards customer focused enhancements.

Speaker 2

We also deferred this year's Store Leader Summit and are working with our vendors to support this event to focus instead on additional customer and revenue generating activities. Deferring this event not only keeps our partners in stores to interact with customers, but also delivers tangible cost savings. We expect a fuller update on the magnitude and timing of cost opportunities as we finalize our plans.

Speaker 3

As I close,

Speaker 2

I want to reinforce that despite the immense change we are driving throughout the organization, we remain committed to our long term strategy. Our ecosystem comprised of a fully integrated services offering, one of the most comprehensive nutrition and merchandising assortments in the market and a powerful omni channel delivery model remains a competitive differentiator from online only and mass players. This ecosystem powers our customer acquisition flywheel and reinforces our unique position as a retailer of choice within the pet category. The underlying value proposition of Petco remains strong and I'm confident we have clear lines of sight and the right plans in place to return to sustainable profitable growth. Thank you.

Speaker 2

And I'll now turn the call over to Brian. Thanks, Mike, and good morning, everyone. Building on Mike's comments about the quarter, the last 60 days have given us even greater clarity on the full potential of our business and are committed to restoring profitability and balancing our assortment to reflect the needs of pet parents. And we're being forensic and disciplined with cost to ensure future revenue growth translates meaningfully to the bottom line. Ultimately, we expect these actions to return value to all shareholders.

Speaker 2

For the quarter, net revenue was $1,500,000,000 a decrease of 2% year over year. Comparable sales were down 1%. In merchandise, consumables was flat year over year reflecting the impact of lapping prior year inflation coupled with the pricing actions we took in the Q3. Our discretionary supplies and companion animal businesses experienced continued softness down 7% year over year. Services and other, which includes services, wholesale and recently disposed non core businesses delivered 4% revenue growth with services up 10% driven by ongoing strength in our vet hospitals, mobile clinics and grooming services.

Speaker 2

Moving down the P and L, gross profit was $579,000,000 down $26,000,000 from prior year. Gross margin for the quarter was 37.8 percent, a decline of 101 basis points, primarily driven by mix. SG and A as a percentage of revenue increased from 37.1 percent to 38.9% year over year, driven by severance expenses related to the management changes during the Q1, increased depreciation, investments in store labor and a one time expense related the disposition of Pupbox. Excluding severance related charges and the one time disposition expense, SG and A as a percentage of revenue was 38.2%. Q1 adjusted EBITDA was $75,600,000 down 32% with an adjusted EBITDA margin rate of 4.9 $4 compared to $0.06 per share in the prior year.

Speaker 2

Turning to the balance sheet, our liquidity remains strong at $617,000,000 inclusive of $90,000,000 in cash and cash equivalents and $528,000,000 of availability on our revolving credit facility, which was upsized and extended in March of 2024 for an additional 5 years. Free cash flow was negative $41,000,000 down from negative $24,000,000 in the prior year. Q1 CapEx of $33,000,000 is down 47% year over year reflecting the Q1 component of the year over year reductions included in our CapEx guidance for the year. Given our Q1 execution against our CapEx guidance and the ramping benefits of our cost savings initiatives and working capital management, we expect to be free cash flow positive for fiscal 2024. As a reminder, we also maintain callers on roughly 2 thirds of our debt, which have helped mitigate the impact of elevated interest rates.

Speaker 2

I'll now turn to our Q2 outlook. For the Q2, we are guiding to the following revenue, adjusted EBITDA and adjusted EPS. For the quarter, we expect revenue of approximately $1,525,000,000 adjusted EBITDA of approximately $80,000,000 and adjusted EPS of approximately negative 0 point 0 $2 Q2 guidance reflects our expectations for sequential improvement in revenue and profitability trends from the Q1. Additionally, for the full year, we expect net interest expense of approximately $145,000,000 inclusive of the estimated impacts of our hedges against the forward rate curve and $272,000,000 weighted average fully diluted shares, which are unchanged $140,000,000 of capital expenditures for the full year, which is unchanged, and we remain on track to achieve $40,000,000 in cost benefits in year 1 $150,000,000 in run rate savings by year end 2025 with a view to accelerating and augmenting those savings where we can. To echo Mike's remarks as I close, our focus on retail excellence includes shoring up the underlying financials of our business, both for the immediate and long term.

Speaker 2

Like him, share the enthusiasm and energy of our partners in our stores, distribution centers and support centers and have confidence in the way the management team is leading the company at important juncture of our transformation. Thank you for your time. And with that, we'll be happy to take your questions.

Operator

We will now begin the question and answer session. The first question comes from Seth Basham with Wedbush Securities. Please go ahead.

Speaker 4

Thanks a lot and good morning. Congrats on the improving results. I would love to get some color first on the supplies business, which remains under pressure. As you look forward and project revenue into the Q2, how do you think that business is going to perform? Do you see changes to demand levels?

Speaker 4

Do you see any changes to competitive environment?

Speaker 2

Hey, Seth. Thanks for the question. We did see some slight improvement in the year over year decline in our supplies and container elbows business, but we know we have more work to do. The team is taking some decisive action to deliver on this. Overall, we remain confident in our assortment strategy and plans, our breadth of offerings and how we're serving our millions of pet parents.

Speaker 2

And I think I want to be really, really clear for you is that we're acting every day to improve profitability in the near term. My focus is to sequence the highest priority drivers that we have on our compromising on our value proposition or relationship with our customers.

Speaker 4

As it relates to the gross margins, which were stronger than expected, could you provide some more color on the drivers there? As you look forward, how should we think about gross margins relative to SG and A in the second quarter?

Speaker 2

Thanks for the question, Seth. I'll just say we're focused on driving bottom line improvement and we expect sequential dollar improvement on bottom line profitability as the year progresses, steady progress throughout the year. We're looking at initiatives to drive both gross profit improvement and SG and A efficiency. And as I laid out in the prepared remarks, we're on track with our cost transformation and believe there's opportunity to both augment and accelerate progress there. I will tell you specific to Q1, you did see some modest improvement in the discretionary categories and the team also did a good job across supply chain driving efficiencies.

Operator

The next question comes from Kaumil Gajrawala with Jefferies. Please go ahead.

Speaker 3

Hey, guys. Good morning. A lot going on, and it all makes kind of good logical sense. But can you maybe just help us out with prioritization or how you balance each of these items? For example, effectiveness of marketing, when does that come around versus the assortment versus the productivity?

Speaker 3

If you could just kind of maybe just work us out through what the timeline looks like, because obviously doing all at once is difficult. So maybe just if we can get a better sense of prioritization that would be helpful.

Speaker 2

Great. Thank you for the question. I would start with that we are focused on fewer and clearer priorities and we're taking decisive action to improve our profitability while we enhance our customer experience. And everyone in the organization, both at the store and leadership level has rallied around our reset plan. From an overall standpoint, our number one focus is improving our profitability.

Speaker 2

The biggest area to improve our profitability is in merchandising and that's why we have our focus in that area as followed by improvement in our services profitability and our renewed focus on reviewing our SG and A spending. That's how I would line up our priorities. Brian, would you add anything? Yes. I'd just say, Seth, I mean, excuse me, Kamal.

Speaker 2

We gave a couple of examples of things we're doing to prioritize the disposition of Pupbox, the pausing of some of the internal upgrades to systems as well as at the firmament of the summit. Those are just a couple of examples of things where the team is united and working towards the same objectives, which is making sure we have fewer priorities, clearer priorities and those that add the most value to the enterprise.

Speaker 3

Okay, great. And then, in the context of all the things you're doing, it doesn't sound like optimizing the network or closing stores is part of the plan. Is that just my maybe just misreading that or is that something you're also evaluating?

Speaker 2

I would tell you, Kamal, that we are dynamic in the way that we look at our real estate portfolio. We have a very comprehensive process to make sure that we understand the demographics of any market that we enter and the competitive dynamics as well as our own position in the markets that we may exit. So it's a rolling portfolio. I would say that there are not any large scale changes planned at this time.

Operator

The next question comes from Steven Zaccone with Citi. Please go ahead.

Speaker 5

Hey, good morning. Thanks very much for taking my question. I wanted to understand the category performance outlook for the Q2. How should we think about consumables versus some of the more discretionary categories? And then along those same lines, you mentioned returning to sustainable growth.

Speaker 5

The macro is a challenging thing to predict. But from a company specific aspect, what do you think really needs to happen here to drive that sustainable growth going forward?

Speaker 2

Thanks, Steve. I'll start here on the category outlook. Embedded in our guide of the 1.525 $1,000,000,000 revenue, we know we have work to do in our assortment and that's why merchandising excellence and the work we're doing there is at the top of our list. We have an opportunity to improve the quality of our sales to better support our pet parents' needs. And our focus is on improving profitability both within the mix that we sell and then every part of the mix.

Speaker 2

Troy? I would just add, Steve, we haven't baked in any significant recovery in the discretionary category into our guide consistent with the way we came into the year. Services remained strong in the Q1, up 10%. Consumables was roughly flat, which is partly due to the overlapping dynamics relative to inflation. So everything that we think about from those categories going forward is baked into the 1.525 guide for the 2nd quarter.

Operator

The next question comes from Onna Andreeva with Needham and Company. Please go ahead.

Speaker 6

Great. Thanks so much. Good morning and good to see you guys making progress. A couple of questions from us. With Glenn's appointment as the Chairman of the Board, just any of the initiatives that he's looking at that you can share?

Speaker 6

And would he be considered Anum. I've spent a lot of time with Glenn over the last few weeks

Speaker 2

and he'll be a great Anam. I've spent a lot of time with Glenn over the last few weeks and you'll be of great value to me and the team given the experience in retail turnarounds. We remain committed to our strategy and executing on it and our top focus is improving our profitability. The search for the permit CDO is ongoing and we'll provide any updates as soon as we have additional information for you.

Speaker 6

Okay. Fair enough. And just as a follow-up, on vet, can you update us on some of the economics there? Should we think that most of the base is now EBITDA profitable? And are you still seeing that mid single digit lift to the center of the store from that that you used to talk about?

Speaker 2

Thanks, Ana. There's been no change in our long term economics in terms of the vet model. And our plans for the year have not changed since we guided coming into the year, 5 to 10 bets for the year, which are baked into our CapEx guide. I will tell you what we're focused on in that we've just brought in some additional expertise into the vet business. We're the new leader of that business with significant experience in that space, and we're focused on improving both the vet experience within our hospitals as well as the improved customer value proposition.

Speaker 2

We're also looking for ways to improve the profitability through greater utilization.

Operator

The next question comes from Oliver Wintermantel with Evercore ISI. Please go ahead.

Speaker 7

Yes, thanks. I had a question regarding, first of all, the transactions versus ticket or AUR. If you could give us some updates how that trended through the quarter and how you think about it for the rest of the year?

Speaker 2

Thanks, Oliver. I'd say we're not going to break that out for you specifically. I would tell you though that basket was stronger than traffic and that's been consistent with what we've been seeing.

Speaker 7

Got it. And the other one, I think, Brian, you said you're expecting free cash flow to be positive this year. If you could maybe talk about how you get there, what the moving parts are? Thank you.

Speaker 2

Thanks, Oliver. I'll start with Q1. Although Q1 was negative $41,000,000 it was down negative $24,000,000 last year and Q1 is typically and and historically a negative free cash flow quarter for us, given some of the seasonality of the rolling balance sheet items. The knobs for us, Oliver, are quite frankly to continue to focus on profitability of the company, improving the profitability trajectory of the company and we expect steady progress on that as the year progresses. The second variable I would say is continued execution against our CapEx guide.

Speaker 2

We were down 47% in spend in year 1 from last year and that's on track with the $140,000,000 we guided for the year. And the third thing is we have opportunities in inventory. Although the team has done a good job at managing inventory, we do have additional opportunity to continue to rationalize our inventory management and focus on higher velocity skews.

Operator

The next question comes from Stephen Forbes with Guggenheim. Please go ahead.

Speaker 8

Good morning. This is Rene Maron on for Steve Forbes. Given relatively stability within the product gross margin profile quarter over quarter, you help us better understand where we are in terms of bottoming and what drivers the business is working through to improve overall profitability within product sales?

Speaker 2

Thanks for the question. I would just tell you we're focused on driving bottom line profitability. What you saw in the first quarter, as I mentioned earlier, was some modest improvement in the discretionary category coupled with the team's execution against some of the supply chain efficiencies that we saw in the Q1. Looking forward though, we have opportunity across our merchandising strategy to continue to look for opportunities within cost of sales. Got it.

Speaker 2

And then as

Speaker 8

a follow-up, can you help us further break down the 4% growth in services and other revenue between vet training and grooming? I know you mentioned the 10% in the prepared remarks between vet and services, just so that we can get a better understanding of the underlying trends.

Speaker 2

Yes, I'm not going to get into that level of detail for you. Services was strong at 10% and that was driven by grooming, that was driven by our VEKO mobile business and continued maturation of our vet hospitals underneath. So all three of those reported strong results.

Operator

The next question comes from Justin Klabber with Baird. Please go ahead.

Speaker 9

Hey, good morning, everyone. Thanks for taking the question. My first one is just on the consumables business. I understand the disinflation trend, but any color on how units are trending? Are you seeing any improvement just based on the assortment efforts?

Speaker 9

And then how are you thinking about like for like pricing on consumables across the balance of the year? Do you see any risk of deflation or is pricing simply flattening out here?

Speaker 2

Yes. Thanks, Justin. I'll start here. I think I would just go with that our comprehensive assortment and breadth of offerings makes Petco the preferred destination for millions of pet parents. And we've introduced different products over the course of time to make sure we can have a solution for every pet parent and their needs.

Speaker 2

I think on a pricing standpoint, thinking about this inflation, the customer continues to be choiceful. But again, back to our whole offering that gives them great products and solution at the right price points, it gives us the ability to solve all of their needs. We're committed to meeting the customer wherever they are with whatever they need. And we continue to over index in premium, super premium and our fresh and frozen assortments.

Speaker 9

Okay. So you don't see any risk that vendors will take prices lower to stimulate volume?

Speaker 2

The question is a good one. We're always working with our vendors to drive profitable outcomes for both of us on assortments, promotions and demand generation marketing campaigns. With our comprehensive assortment, we have the ability to meet all customers with whatever product solutions they're looking for.

Operator

The next question comes from Greg Badishkanian with Wolfe Research. Please go ahead.

Speaker 10

Hi, guys. This is Scott Stringer on for Greg. I wanted to just ask some more macro questions. The topic of discussion last quarter was market share. Can you provide an update on how market share trended in 1Q?

Speaker 10

And if you could break that out by value versus premium merchandise, that would be helpful.

Speaker 2

Thanks, Scott. I'm not going to give you the level of detail you're looking for, but I'm just going to start with. Our number one priority is to improve our profitability and we have the entire organization rallied around these objectives. Focusing on offering our customers, our pet parents, the products they need and giving them an exceptional shopping experience, while also adjusting our cost structure is our number one focus and these actions will strengthen our competitive positioning.

Speaker 10

Got it. That's fair enough. Maybe just one follow-up on inflation. How is that trending? How is that impacting gross margins today?

Speaker 2

I think the biggest thing to call out there would be relative to the growth in consumables. You saw consumables roughly flat for the quarter. The primary driver of that was the year over year lapping dynamics of inflation. That said, I think the team did a good job managing overall gross margin for the quarter.

Operator

The next question comes from Michael Lasser with UBS. Please go ahead.

Speaker 11

Good morning. Thank you so much for taking my question. Mike Mohan, I hope you are great. And your response to the last question suggested that right now Petco is prioritizing profitability over market share. So A, is that right?

Speaker 11

And B, when is it realistic for outsiders to expect that Petco's market share stabilizes, especially with stepped up efforts from mass merchants and predominantly online only retailers to aggressively target the category?

Speaker 2

Thanks, Michael. Our top priority is improving our profitability And that gives us the basis for us to be more than competitive in a very fragmented marketplace. Our unique end to end offering and our millions of pet parents love our brand, get a chance to experience things that we can do that other online only or mass players cannot do, and we're going to remain focused on that.

Speaker 1

Thank you for your time and for your questions. That concludes today's earnings call. Thank you.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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