Petco Health and Wellness Company, Inc. (NASDAQ:WOOF) Q3 2023 Earnings Call Transcript

Petco Health and Wellness Company, Inc. (NASDAQ:WOOF) Q3 2023 Earnings Call Transcript November 29, 2023

Petco Health and Wellness Company, Inc. misses on earnings expectations. Reported EPS is $-0.05 EPS, expectations were $0.02.

Operator: Good morning, and welcome to the Petco Third Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. And now, I’d like to turn the conference over to Benjamin Thiele-Long, Vice President of Corporate Communications. Benjamin, you may begin.

Benjamin Thiele-Long: Good morning, and thank you for joining Petco’s third quarter 2023 earnings conference call. In addition to the earnings release, there is a presentation and infographic available to download on our website at ir.petco.com, summarizing our results. On the call with me today are Ron Coughlin, Petco’s Chief Executive Officer; and Brian LaRose, Petco’s Chief Financial Officer. Before they begin, I would like to remind everyone that on this call we will be making 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. 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&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 Ron.

Ron Coughlin: Thanks, Benjamin, and thank you, everyone, for taking the time to join us today. To start, I’d like to express my utmost appreciation to all our Petco partners across the country. Their dedication makes Petco the special place that it is, and this quarter the team worked especially hard to deliver the very best for pets. In Q3, results were below our expectations, and we’re taking swift and decisive action to improve the performance of our business by broadening our appeal with customers and tightly managing costs and capital. This work is already underway and is the top priority for the entire Petco team. This includes progress against the targeted $150 million in run rate savings by the end of fiscal 2025, which we outlined last quarter.

We remain on track to deliver $40 million in year one. Over the past years, we’ve seen significant changes that have impacted consumer spending. While we saw a surge in pet adoption during the pandemic period, coupled with stimulus that facilitated discretionary spending, the current economic environment means many consumers are increasingly discerning in their spending and actively seeking out more value. As a result, it’s clear we must adapt our business to meet the needs of consumers in this environment. Consequently, we’ve launched an operational reset to improve the performance of our business, which is well underway and consists of four key pillars. The first and most significant is our focus on delivering value. We brought in the category’s largest nationally available value brands in food and treats for both dog and cat.

These brands include Friskies, Pedigree, Purina 1, Beneful, Temptations, and Milkbone among others. These will complement our best-in-class premium in fresh frozen food, treats, and toppers, allowing us to cycle out slower-moving brands and skews and focus on the highest-velocity skews. Food is a primary driver of where and how pet parents shop, with over 70% of households buying at least one of the food brands that we’re now bringing into our portfolio, and equating to approximately $12 billion in category sales for dog and cat annually. Supported by powerful and targeted marketing, we expect these brands will bring more customers through our doors, increasing traffic, and delivering incremental sales through services and supplies attached.

While we remain committed to being a leader in the still rapidly growing premium, super premium, and fresh frozen categories, this is about choice. Bringing as many pets as possible into our health and wellness ecosystem. Whether chosen because of price sensitivity, brand preference, a picky eater, or a combination of these, we believe in the current environment it’s important that no pet is excluded. Simply put, we can’t improve the health of a pet whose pet parent doesn’t walk through our doors or shop with us digitally. Our team has acted fast. These brands are already on shelves, having been set in the first few weeks of November. This is in addition to Fancy Feast, where we began expanding our assortment in Q2. I’m grateful to our vendor partners for their collaboration, and I’m exceptionally proud of the speed and agility with which our merchandising, supply chain, and pet care center teams were able to get these products in distribution centers and on shelf.

This move has already proved acquisitive to our customer base. In the first month since introduction, a significant number of Fancy Fees customers were new or lapsed food customers with Petco. Moreover, they demonstrated significantly higher attach rates when compared to other cat food customers, including litter and supplies purchases, vet visits, and vital care premier signups. I personally worked in multiple stores over the last month, helping our teams put these valued products on shelves, and meeting many customers who are now purchasing products like Fancy Feast, Friskies, or Purina 1 at Petco instead of a grocer or mass outlet. Importantly, while the upfront costs and investment in labor and logistics to get these products on shelves has impacted near-term profitability, we fully expect to realize profitability gains in 2024 as we build loyalty and basket with these incremental customers.

The second pillar is about honing our pricing. We have seen progress with targeted pricing actions to address competitive gaps in key traffic driving brands. In Q3, we adjusted pricing on several hundred SKUs with a tangible uplift in sales. We will continue to use both pricing and promotional cadence surgically at key moments, including through the holidays, with a focus on driving traffic, customers, units, and revenue growth. In aggregate, these actions contributed to Petco returning to customer growth in Q3, with approximately 60,000 net adds in the quarter, and year-over-year Nest Pac growth. These changes will enable even greater top-of-funnel acquisition, loyalty, basket, and share of wallet, as we bring customers deeper into our ecosystem through memberships, services, data-driven personalization, and the attentive expertise of our partners in the aisle.

Third, we’re focused on driving efficiency in our supply chain. While we expect the bulk of our supply chain savings to take effect in fiscal 2024 and 2025, some of the early actions we have taken are already showing favorable results, including year-over-year improvements in distribution costs per unit. And in labor, the fourth and final pillar of operational reset, we’ve completed the previously announced adjustment to our corporate and field leadership headcount by 25% and are working hard to ensure we leverage synergies between teams and optimize our labor model. Inside the PCCs, we made target investments in our people and further enhanced processes. These actions positively impacted store retention, improving over 800 basis points year-over-year, and allowing us to up-level our overall talent and deliver better engagement with our customers.

As we reposition our business to better serve pet parents, we remain focused on executing our core long-term strategy: expansion of services, merchandise differentiation, and seamless omnichannel delivery. In services, we deliver double-digit growth. Our veterinary services teams are driving both revenue and customer growth. We now have a total of 282 full-service veterinary hospitals and are averaging 1,481 veterinary clinics a week. Without a doubt, our veterinary offerings strengthen our hands-on pet capabilities in a way none of our competitors can match. Stores with hospitals continue to drive mid-single-digit center store uplift and our outgrowing rest of chain. In merchandise, In addition to strong continued demand in premium, fresh frozen supplements, pest, farm and feed, and Rx all showed sustained growth as they continue to resonate with pet parents who gravitate to our health and wellness offerings.

In Omnichannel, we saw revenue growth across our digital channels, including growth in BOPUS, while also leveraging reduced shipping costs in same-day delivery. And our membership offerings continue to be both a value driver for pet parents and an indispensable tool to drive loyalty and share a wallet. Vital Care Premier members, now totaling 672,000 remain our most engaged and valuable customers. They continue to visit more and spend triple what non-members spend and are fully immersed in the full benefits that our unique ecosystem offers in a way no other pet care membership program does. As I close, I’d like to reiterate my thanks to our Petco partners. Over the last few weeks, they’ve worked extra hard to prepare our business for the holidays and have dedicated additional effort to delivering against the operational changes that I’ve outlined today.

Above all, we continue to believe that our unique ecosystem means no one can take better care of pets than we can. And we are absolutely focused on executing our operational reset with urgency. Thank you for your time. And with that, let me pass it over to Brian.

Brian LaRose: Thanks, Ron. I too would like to extend my thanks to our Petco partners for their enduring commitment to doing the best for pets. Over the last few weeks, I’ve seen, firsthand, their dedication come to life by executing against our strategic objectives, and I’m humbled by their approach to doing everything they can to ensure every pet is fed, loved, and cared for. Turning to numbers, for the quarter net revenue was $1.49 billion, a slight decrease of 50 basis points year-over-year. Comparable sales were flat, primarily a result of the ongoing pressure on discretionary spending and the increase in value seeking seen in the quarter. Within the business, the hard work of our services team delivered 14% growth, driven by ongoing strength in our vet hospitals, mobile clinics, and grooming services.

In merchandise, consumables were up 2% year-over-year, while our discretionary supplies and companion animal businesses experienced continued softness, down 9% year-over-year. Moving down the P&L, gross profit was $550 million, down from $597 million in the prior year. Gross margin for the quarter was 36.8%. To reiterate what Ron said in his remarks, the impact of gross profit and gross margin in the quarter was primarily due to the continued softness in discretionary spending, coupled with the investment we made in bringing additional brands into our consumables assortment. These upfront costs were necessary to act with the agility needed to get these products on shelves in a timely manner. And while they cause a lag on profitability in the short term, we expect this expanded assortment to be margin dollar accretive in 2024.

In Q3, SG&A as a percentage of revenue increase from 36.6% to 37.5% year-over-year as a result of investments made in store labor, as well as depreciation and stock-based compensation. Q3 adjusted EBITDA was $72.2 million, down 40%, with an adjusted EBITDA margin rate of 4.8%, down 318 basis points year-over-year. Q3 adjusted EPS was negative $0.05 compared to $0.11 per share in the prior year. As we look at the balance sheet, our liquidity remains strong, with $586 million, inclusive of $140 million in cash and cash equivalents and $446 million of availability on our revolving credit facility. Additionally, we continue to make progress on our plan of accelerated debt paydown. This quarter we paid down $15 million in principal, bringing our total year-to-date debt pay down to $75 million.

As a reminder, we also maintain callers on roughly two-thirds of our debt, which has protected and will continue to protect meaningful portions of our debt from potential interest rate [raising] (ph). Our year-to-date CapEx of $177 million was down 17% year-over-year as a result of our continued optimization of cash flow, balancing short-term cash flow management with long-term investment. Before turning to outlook and guidance, it’s important to note that we recorded a goodwill impairment of $1.2 billion in Q3 associated with goodwill recorded in 2015, well before our IPO in 2021. The charge is non-cash and made in accordance with the accounting rules governing the evaluation of goodwill. Looking ahead, as Ron outlined, while we remain focused on the long-term drivers of growth and differentiation, the balance of this year and early 2024 will focus on making operational changes necessary to align our business to the current consumer dynamics.

In terms of guidance for the balance of 2023, given the results of our fiscal third quarter and the current consumer dynamics, we are updating our full-year guidance to the following. Revenue of $6.15 billion to $6.275 billion, which is unchanged. Adjusted EBITDA of approximately $400 million and adjusted EPS of approximately $0.08, each reflective of the year-to-date results and expectations for the fourth quarter. And $215 million to $225 million of capital expenditures, which is unchanged. Assumptions in the guidance include interest expense of $145 million to $155 million, which is unchanged, and $268 million weighted average fully diluted shares, down from $269 million. Also, as a reminder, fiscal 2023 is a 53 week year with an incremental week of operations.

When thinking about our 2023 guidance and laying the foundations for next year, the actions we are taking now and will continue to take in the coming months are focused on generating further operating leverage and earnings growth going forward. Specifically, while we did see upfront costs associated with the addition of value brands, we fully expect to see a healthy return associated with those brands in 2024. We will continue to seek out opportunities to enhance our supply chain and labor models to generate additional compound savings. We are on track to deliver against our projections of $40 million in cost benefits in the first year from the planned $150 million in run rate savings outlined in our Q2 call. We will continue to be prudent and surgical with capital allocation.

Specifically, while we remain focused on evolving our business as needed, we have planned for reduced capital expenditure in fiscal 2024, while optimizing our existing infrastructure. To close, I want to reinforce Ron’s remarks that we’re fully focused on navigating the current economic environment and controlling our controllables as a top priority for the entire Petco team, so that we quickly return to sustained growth and profitability. Thank you for your time. And with that, we’ll be happy to take your questions.

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Q&A Session

Operator: Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Oliver Wintermantel with Evercore ISI.

Oliver Wintermantel: Yes, thanks. I had a question regarding the merchandise strategy. It sounds to us that this is a big shift in focus. During the IPO you always mentioned that the premiumization and premium food, is this — do you consider that a long-term shift in merchandise strategy or is that just adjusting for the current environment? And then second, what are the impacts on revenues and especially on margins? I think Brian, you said you expect gross profit dollars accretive in 2024, but if you could maybe talk a little about the margin impact. Thank you.

Ron Coughlin: Thanks for the question, Oli. So you’re right. We have talked a lot about premium and super premium. And if you look at the past decade plus, and if you look at the future decade plus, the dominant macro trend is about premiumization and humanization, which is why we believe we have the best portfolio in the industry against those trends, whether that be fresh frozen offerings, whether that be limited distribution offerings like Orijen, Acana, Taste of the Wild, we continue to drive against that. That has been the largest deliverer of revenue growth and profit growth in the category. That said, in this economic environment, we’re supplementing that strategy with value offerings. And we’re bringing in some of the largest brands in the entire pet food and pet treat industry.

And the whole idea is to meet customer demand. I was in a store in Charleston, South Carolina and I met a customer who was buying Friskies and what I found out was, she was buying wholeheartedly from us, our own brand, but she was going someplace else for Friskies. So we have customers that are looking for these products and when we provide them, they are pleased that we’re meeting that customer need. This is about incremental footsteps into our stores. We’re seeing a similar basket from these customers. We brought in an expanded assortment of Fancy Feast in Q3, and we’re seeing a similar basket to our overall food customer. That means they’re buying more supplies, they’re signing up for Vital Care Premier, and they’re also actually signing up for vet visits.

So it’s good for our ecosystem. And from our mission standpoint, we can’t make a pet healthier if that pet parent doesn’t walk through our door, if that pet parent doesn’t visit our digital assets. But to sum it all up, this is about supplementing our strategy and it will drive gross margin dollars. I’ll let Brian elaborate.

Brian LaRose: Yes. Thanks, Oliver. The margin rates on these products are lower than the average food margin of the rest of our chain. However, as Ron said, they will drive incremental dollars to the company. It’s about getting more [bats] (ph), it’s about getting more customers into the ecosystem, it’s about driving incremental profit dollars to the company across both food, supplies and services.

Operator: Thank you. And the next question comes from Peter Benedict with Baird.

Peter Benedict: Hey, guys. Thanks for taking question. First one, just around the CapEx view on next year coming down a bit, can you give us a sense for maybe the maintenance CapEx of the business, and then also what the plan is for the hospitals and the rollouts there? What kind of assumptions are you embedding for that next year? That’s my first question.

Brian LaRose: Thanks for the question, Peter. We’re being prudent with the level of investment that we’re making just in light of the current environment. We continue to prioritize cash generation, debt reduction, and continued investment in long-term strategic growth initiatives. In terms of the specifics around whether it be maintenance CapEx or other strategic initiatives, you can expect to hear more of those details at our year end results. But I’ll turn it over to Ron to talk a little bit more about vet.

Ron Coughlin: Yes, on vet, it’s a key differentiator for us. We continue to see the mid-single digit lift in this center store. The stores with vets are outgrowing the stores without. We have 282 now, we’ll be adding more hospitals in Q4. In terms of 2024, as we navigate the current environment, it’s all about balance. So all about balance of driving throughput from existing, investing in more clinics, because the clinic business is doing very well, and then overall cash flow management. So we’ll have more details on that at the — in our Q4 earnings.

Peter Benedict: Okay, that’s fair enough. And then I guess the next would just be around any way you may size the upfront cost. You guys have occurred here to load the new value brands into the store in 3Q and 4Q. Just curious kind of how material that has been? And then the supply chain efficiency actions that you alluded to, maybe a little more color as to what exactly you’re doing there to take those distribution costs down and just kind of the timing of all that? Thank you so much.

Brian LaRose: Thanks, Peter. Let me break it down actually into three different components in terms of the overall profit change in the guidance. The largest driver of the change has been the shift of customers to more value-seeking process — products and the associated promotional and pricing environment related to those products. That’s happened a bit faster than we anticipated and that represents a little over a third of sort of the impact. Second is the continued softness in discretionary spend. That’s about a third of the impact. The balance of that are increased costs, which includes the increased investments associated with getting these products onto shelves. And there are three tiers of that. There’s logistics, there’s store labor, which was the primary driver of the SG&A year-over-year, and the third piece was advertising.

So this is about making the right investments to get the products on shelves. It happened faster than we anticipated, at a larger scale than we expected. And then the advertising is an awareness building campaign to make sure that we get the right customers through the door.