Q2 2022 Petco Health and Wellness Company Inc Earnings Call
Whether as a result of new information future events or otherwise.
In addition, today's presentation contains references to non-GAAP financial measures.
Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and presentation as well as in our filings with the Securities and Exchange Commission.
And finally during the question and answer portion of today's call and to allow US time for questions from as many participants as possible we would be grateful if you could keep to one question and one follow up with that let me turn it over to Rob.
Good morning, everyone and welcome as always I'd like to begin my remarks, clearly and simply the pet category continues to grow.
Petco business continues to grow.
Our customer base continues to grow and our unique competitive moats continued to deepen.
Despite the current economic environment. The pet category is once again proving its unique defensive growth characteristics and the focused execution of our 29000 Petco partners both improve the lives of countless pets and pet parents.
We delivered tangible progress against our strategic priorities, including further expansion of that networking capabilities continued mix shift towards premium products. The addition of over 100, experiential fresh frozen pantries, and pet care centers and double digit growth in our recurring and royalty custom.
<unk>.
Importantly, our non discretionary categories as consumables and services continue their strong upward trajectory.
As expected and similar to other consumer categories deflationary pressures have soften the discretionary areas of our business. This transitory response is consistent behavior during previous recessions and past experience indicates a return to growth with economic improvement and the passing of the <unk>.
In the U S over that period.
Additionally, our team has done a nice job managing supply chain challenges and their impacts while maximizing sustainable customer and business growth.
Importantly in aggregate, we feel comfortable with our inventory position both in quantity and makeup.
Having operated in the current economic environment for several months now we have greater clarity in terms of consumer and cost dynamics and have adjusted our assumptions for the full year, Brian will share. These shortly.
Turning to key numbers comparable sales were up 4% equating to 23% and 34% on a two and three year stack net revenues grew by 3%.
Our unique model and powerful marketing continued to win new customers. Our active customer base grew by double digits year over year, and we added 325000 net new customers in the quarter.
This is our 14th consecutive quarter of growth in our customer base.
Recurring customer revenue grew by 54% year over year, driven by repeat delivery insurance top box and vital care members.
Total active vital care customers reached 282000 in the quarter, including customers, we've converted into final care with the acquisition of thrive cut.
Customers, joining vital care have been increasing their visits and spend by double digits with a lift in spending across all categories and delivering a three five times higher LTV and average customers. This is up 10% from last quarter.
The additions we made with <unk> in March have resonated with pet parents, who clearly see the value in this program, especially in the current economic climate.
The average pet parent can save over $300 annually and for Pepco standpoint, recapture far greater share of wallet with around 30% of vital care customers due to food with us and 40% due to services, both up versus vital care one data.
We have a robust roadmap of enhancements to come allowing us to add many more members and capture further share of wallet, we look forward to sharing more details soon.
The value of loyalty and membership is significant, especially when combining vital care with our existing $1 6 million rooming in nutrition perks members, who continue to increase visits and spend by almost 50% and 40% respectively year over year and they have over two times higher LTV and average customer.
Yeah.
Demand for services has proved resilient delivering 13% year over year growth translating to a robust 62% growth on a two year basis, driven by strength in both grooming and our veterinary business.
Services are such a differentiator versus online a mass competitors and pet parents, who see the value in our training veterinary services agreement.
They also act as a feeder for tecogen into a broader health and wellness ecosystem, including OTC solutions, Rx food Rx medicines and insurance.
Specifically, our veterinary services, our strategic long term growth driver and competitive moat for Petco. This has been a quarter with exceptional progress.
We closed the thrive acquisition in May and integration is going ahead of our plans.
We've now added over 600 veterinarians to our network in the last six months alone.
We opened 11, new that hospitals in the quarter, we remain on track for our targeted 50, new hospitals for the full year.
We also made significant enhancements to our online booking system, allowing customers to seamlessly you appointment availability across multiple locations and driving a 30% increase in online hospital bookings.
Every day it becomes more obvious that our vet model positions <unk> to win customers.
Not only does our full service hospital mix of preventative diagnostic and treatment get pets, the best possible care.
But our ecosystem with mobile in store clinics provides the cost the convenience to fit every pet parents needs.
And we are rapidly becoming a disruptive innovator in the vet space evidenced by our collaboration with butterfly IQ plus that technology, bringing their cutting edge handheld ultrasound system to all of our vet hospitals by the end of the third quarter. This not only allows us to provide pet parents peace of mind with onsite diagnostics.
It also removes the need for referrals out of our hospitals and enables us to capture that high margin revenue.
It's also a talent magnet being one of the most sought after technologies veterinary professionals export before choosing which hospital to join.
And merchandize as in Q1 consumables continue to surge demonstrating the recession proof nature.
Sales grew 12% year over year, 37% on a two year stack. This strength is great for the long term health of our business as consumable customers have a higher retention rate and bring a 30% higher LTV and customers, who don't buy consumable streams.
Our over indexed to the pet parents that take the best care of their pets, and who are the highest spending customers continues to power our multiyear shift to healthier premium food even in this hyper inflationary environment. These.
These include high end Kibble brands like origins Royal Canin Hills case of the wildlife kitchen.
Can't be found in the mass or grocery channel.
Pet parents are continuing to migrate to more premium fresh frozen brands like just food for dogs instinct and fresh pad. We opened our second just food product kitchen, where we actually make the food in our sports Arena Petcare Center in San Diego. These.
These kitchens really bring the fresh food experience life, creating unique brand building experience that halos and entire market to drive awareness and trial.
To summarize make no mistake about it we continue to drive a positive mix shift towards more premium and super premium tools.
We're also mix shifting towards owned brand consumables, our wholehearted brand took more share from lower quality more broadly distributed brands with over 30% growth year over year.
When you combine the growing strength of our wholehearted brand with the macro trends of premium innovation and fresh frozen the future is clear to us that.
Is why today, we are delighted to announce the launch of a wholehearted fresh recipes as a bowl of next step in our nutrition leadership.
In collaboration with just with regards we're launching an exclusive new human grade fresh and frozen on brand pet food as part of their wholehearted line available pet care centers and online beginning this month.
I was thrilled to see a brand new wholehearted cooler and our Carmel Valley location near the office two weeks ago.
Overall, our owned and exclusive brands continue to extinguish our business from competitors or supplies remain a cornerstone of <unk> offering, including our owned and exclusive ready brand, which even now offers putting beds and clothing to help execute call in these record setting temperatures.
Structurally our supply, they're highly profitable extremely well positioned and at scale, providing significant financial advantage versus online only competitors the lapping a year ago stimulus and the current inflationary environment does create transitory pressure on the supplies business growth.
But it is a pressure, which history has shown dissipates as lapping dynamics and inflation moderates.
Importantly, our customer insight grounded in innovation engine continues to be a core competence in.
In the quarter, we launched an exclusive partnership with Cliff with plant based jerky smart crossover from human food, if youre grabbing clif bar on a hike why can't that see the border Collie had one too.
We also launched back country recreation on year, beating pet parents' desire to spend more time outdoors with their pets with fund floating stay dry rain gear and even at Darlington. The brand is off to a superstorm start.
Our pet care centers deliver their ninth consecutive quarter of positive comp sales fueled by growth in basket via continued mix shift towards premium merchandise and our ability to pass through pricing as a result of both the uniqueness of our offering and the incredible capabilities of our pickup partners to connect on a highly personalized level.
<unk>.
This past quarter I visited pet care centers in Arizona, Idaho, Washington, State, Texas, California, and New York and.
In each case, our net passionate Peck our partners focus on improving the health and wellness of pets.
Each other safe during a protracted pandemic environment and building a stronger petco business.
In the spirit of pick our partners across our network.
And the labor market remains competitive petco stands out of caring fund purpose driven environment for our partners helping.
Helping pets and pet parents on a daily basis correspondingly in the last quarter, we saw applications to work a pickup increased 16%.
The prior year.
Our Mexico business continued its upward trajectory with sales up double digits year to date.
I am very excited to share that our neighborhood farm and pet supplies strategy is now alive and resonating with local community early indications from our first location in Florida, Texas, which opened in June are exceptional.
Financial performance and customers are exceeding our expectations with particular strength in suppliers opinion animals meeting an unmet need in this market during.
During the Grand opening multiple customers came up to me and said. Thank you. Thank you. Thank you we needed a pet focused retailer here and I no longer need to drive the San Antonio All the time. It was also the first opening we remember having horses and attendance, we're excited and what we're learning now addressable multibillion dollar farming.
Seed market across segments like equine chicks and bovine.
We're looking forward to the multiple planned additional openings for Q3 and Q4.
Our digital business continued to drive powerful profitable growth through innovation, including in App repeat delivering sign ups and multilocation fulfillment for same day delivery in Q2 total digital sales were up 10% or 143% on a three year stack.
We've more than doubled our digital business over the last three years, our digital customer spend is now up over 20% year over year, continuing to outpace our T online competitors recent trends.
We also expanded digital margins year over year through distribution efficiencies, including a renewed jordache contract and rapid acceleration in our AD network revenues.
The role that our digital plus brick and mortar plant our ecosystem that is more significant the deployment of our pet care centers as micro distribution centers creates an unmatched competitive advantage and agility.
We continue to not only fulfill nearly 80% of the digital orders through our pet care centers, but delivered a record number of same day delivery orders in the quarter, a 60% increase year over year.
Needless to say same day delivery provides a competitive moat versus our key online competitor.
Not stopping there we added 75, new brands to our online assortment. So far this year, including much loved brands like Andy Pet a digitally native and science backed multi vitamin supplement and tech focused offerings like ring webcams and Irobot back units.
Finally on digital our advertising network is now firmly a jewel in pet those clouds with over 200% growth year over year, our platform and bespoke data capabilities provide a compelling offering for vendors connect with pet parents and convert them down the marketing funnel.
Were confident our pipeline of in flight enhancements will support projected triple digit growth year over year for full year 2022.
Before I hand, it over to Brian I'd like to take a moment to focus on our North star our purpose and it starts with our partners. We've been focused on improving wages for the last four years and as a result, our average total hourly compensation is currently over $17 per hour.
This month, we announced we're lifting the floor.
Every non training at Pepco, either brand, new or tenured, who make $15 base wage per hour or more by the end of the year.
We believe this is the right thing to do particularly given cost of living increases and it recognizes the extraordinary contributions our Petro partners make every single day.
Enhanced retention and make us an even more attractive destination for talent.
<unk> partners also celebrate our community of pride events across the country, joining virtual events from happy hours panel discussions on LGBTQ IAA plus communities in the veterinary field, joining the annual Pride parade in our hometown of San Diego and even joining a private deep spin class led and DJ by our very own.
Brian the Roes.
In June we published our environmental social and governance report for fiscal year 2021, giving an in depth look at our sustainability progress and it we outlined the proactive steps, we're taking as a leader in our category for finding sustainable solutions that positively impacted wellbeing pets people and the planet we share.
Particular note over the last year, we've engaged with over 350 product vendors as part of our efforts to increase our sustainable product mix to 50% by the year 2025, we eliminated nearly 8 million pounds of cardboard and 66000 pounds of plastic through digital fulfillment and we also published.
Our first EPA scope III carbon footprint.
And together with <unk>, we continue our mission to help and seed pet lives.
Now delivered over 917000 pre vaccine to date to under resource communities, putting us in arm's reach of our 1 million vaccine commitment and partnership with Merck. We also saved over 95000 pet lives in the quarter, Oklahoma and have reunited over 10000 pets with our loving Sam.
At least to date through Petco Love lost.
In closing our.
Our ecosystem and results driven orientation is enabling growth and we continue to make a difference in lives every single day.
With our recently evolved leadership structure, we're laser focused on putting customer centricity and operational excellence at the center.
Meeting the customer needs of a one stop experience for the pet health and wellness.
As always thank you to all our knees and Petco partners and customers. Despite the environment. This is an exciting time for <unk> and we remain grateful to our partners. We're on the journey with us to deliver purpose driven performance every day with that let me hand, it over to Brian .
Thanks Ross.
At the halfway Mark for the year, we remain confident in our position as the leader in pet health and wellness and are proactively managing the macroeconomic environment.
Across the entire business. The teams have done an amazing job at remaining laser focused on driving performance every day and controlling our controls while delivering against our strategic priorities and making investment decisions for the long term perspective.
Looking at the quarter, specifically, we delivered yet another quarter of strong net revenue at 148 billion up 3% year over year with comparable sales up 4% or 23% on a two year stack with continued strength in average basket trends.
Total services grew 13% year over year, and 62% on a two year stack across pet grooming and training.
Momentum in consumables continued up 12% year over year, and 37% on a two year stack and delivering a 30% higher LTV over our other customers.
It is clear our team is executing extremely well and we were able to leverage our structural advantages versus our competitors, including the ability to offer. Both this same day delivery and ship from store by leveraging our pet care centers as micro distribution centers.
Youll remember in our last couple of earnings calls, we outlined that supplies and companion animal will be lapping a stimulus driven elevated prior year comparable.
Like others, we have seen some softening in discretionary spend with supplies in companion animal down 9% year over year.
Finally, before we move down the P&L, we closed on the purchase of the remaining stake in our drive joint venture in May at a cash price of $35 million.
This is a real accelerant in our vet business, bringing approximately 800 veterinary professionals to Tycho combining the hospitals under a single brand and delivering an improved ROI.
In addition, during the second quarter, we incurred approximately $11 million of acquisition related integration costs, bringing total year to date spent $13 million, representing the majority of the $15 million to $20 million total estimate we communicated last quarter.
And although early stages, we're pleased with what we're seeing on integration and return on investment.
Moving down the P&L gross profit decreased $5 million or 1% to $594 million.
Gross margin was 41% down 170 basis points year over year, and 110 basis points on a quarter over quarter basis, driven by the mix impact of consumables onetime thrive integration related cost and elevated freight costs.
Gross margin when adjusted for the drive cost was 46%.
SG&A as a percent of revenue improved from 37, 8% in Q1 to 36, 8% in Q2 down 100 basis points, demonstrating our cost discipline.
Drive transaction and integration related charges included in SG&A accounted for approximately 30 basis points translating to an adjusted SG&A rate of 36, 5%.
On an absolute basis, SG&A expense was $545 million up $19 million or three 5% from prior year.
Excluding thrive SG&A would have been $540 million up $14 million or two 7% from prior year as we remain adept at managing costs, while continuing to invest for sustained future growth through infrastructure and our people.
And while there will always be puts and takes in aggregate our network inventory levels remained well managed and in line with demand.
Q2, adjusted EBITDA was $142 million a decrease of eight 5% from prior year with an adjusted EBITDA margin rate of nine 6% compared to 10, 8% in the prior year a decline of 120 basis points.
Quarter over quarter, adjusted EBITDA was up 60 basis points.
Q2, adjusted EPS was <unk> 19, a decrease of <unk> <unk> from the prior year and up <unk> <unk> quarter over quarter based on 266 million weighted average fully diluted shares as well as a normalized effective tax rate of 26%.
We continue to have strong liquidity, ending the quarter with $569 million inclusive of $125 million cash and cash equivalents and $444 million of availability on our revolving credit facility.
Looking at cash flow for the first half of the year, we generated strong cash from operations of $100 million and had $136 million in capital expenditures, which increased 36% year over year as we continue to reinvest in future sustainable growth across that fresh frozen and digital infrastructure.
To Echo Ron's remarks, the halfway point of our fiscal year provides a distinct opportunity to both reflect and examine the balance of the year ahead.
Today, we have greater clarity of the extent of the incremental headwinds likely to impact our business and our customers, which means we also have greater clarity on how to stay ahead of them.
Looking ahead, the current economic environment necessitates that wed be pragmatic while also ensuring we can still make long term investments are essential to our future success.
Specifically, while momentum has continued into Q3, we believe it is prudent to adopt an appropriately cautious outlook for the full year.
We therefore are making the following adjustments to align with our current expectations as follows.
Revenue of $5 97, 5 billion to $6 5 billion.
Adjusted EBITDA between $580 million and $595 million.
$250 million to $275 million of capital expenditures.
Adjusted EPS between <unk>, 77, and <unk> 81, assuming $90 million of interest expense, 26% tax rate and a 267 million weighted average diluted share count.
When thinking about our guidance there are few things to keep in mind.
Our ongoing ability to proactively manage the dual vectors of inflation, both in terms of impacts to shipping and to the customer through efficiencies in our pet care centers same day delivery and membership offerings.
Our consumables and services businesses continue to be non discretionary, but strong growth expected to continue.
We believe the current pressures on supplies in companion animals are transitory in nature, and anticipate an improving trajectory as inflation and other economic pressures dissipate.
While in stocks continue to improve as vendors are scaling to meet the demand or in stock position is currently slightly better than where we started the year.
And we fully anticipate a typical seasonal uplift at the holidays from Q3 to Q4.
Above all hetzel remains a strong profitable growth company with a unique and innovative ecosystem and a resilient category that remains highly relevant for consumers over the long term.
In short we remain focused on our goals and we will never stop pushing ourselves to succeed.
This continued drive for operational excellence and sustained profitable growth wouldn't be possible without our petco partners their unwavering optimism and attention to detail and their ability to help pet parents maximize the health and wellness of their pets.
Thank you for your time and with that we'll move to questions.
Okay.
Thank you.
We will now begin the question and answer session.
You ask a question you May press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset.
Keith.
Thanks, Jonathan the question queue. Please press Star then two.
At this time, we will pause momentarily to assemble our box.
Okay.
Our first question comes from Kate Mcshane with Goldman Sachs. Please go ahead.
Hi, good morning, Thanks for taking our question I.
I Wonder if I could just focus on traffic versus ticket during the quarter and the cadence of same store sales throughout the quarter. I know you mentioned you have momentum going into Q3, but I'm wondering if you could give a little bit more context around that.
Thanks Kate.
So this marks the ninth consecutive quarter growth was in brick and mortar. So we've.
Can you just show momentum in brick and mortar.
And that's due to our unique portfolio, our partners and the IR ecommerce assets and the pricing leverage our basket has continued to increase ticket size has increased we also have a healthy and growing services business, which creates a unique ecosystem as you know and.
And we have differentiation versus masking growth Street, we continue to see great engagement in the pet care centers. There is trip consolidation margins driven by gas prices, but all in all between the basket.
Ticket size, we continue to drive positive revenue growth and increase efficiency, because we are getting.
Core sales.
Lower trips, so thats an efficiency driver for us.
Okay.
Thank you.
Question, We just wondering if you could talk about.
Some of your strategies around pricing.
The inflation that we've seen.
<unk> consumables.
Great.
Does that change for you maybe quarter on quarter and if there are meaningful.
The promotional environment.
Some of the discretionary.
Yes, no. Thanks for the question.
So we took a pretty holistic pricing actions in the second half of last year, which we've talked about since then it's been more moderated.
We have taken some pricing actions whenever we do that we do deep analytics on a SKU by SKU basis test the elasticity of that pricing model to make sure that we're actually not handle foreseeable so.
We have taken.
<unk> pricing actions in the first half of the year not like begin in the second half of last year consumables remains strong. So we have not seen a trade down impact we've not seen any sort of the elasticity impact from pricing actions. We've taken are consumables. So we feel really good about where we're positioned from a pricing standpoint in terms of promotional activity with <unk>.
<unk> seen a dramatic change there the market remains strong consumables remains strong and the market overall, including our competitors remains very balanced.
I would just add you still have more demand than supply so.
From a fundamental standpoint that drives price rationality and then the other piece of your question was around Q3 and as Brian said.
Pleased with the momentum that has continued into Q3 on both total revenue as well as traffic trends.
Our next question comes from Scott <unk> with.
Jeffrey Please go ahead.
Thank you Hello, everyone I wanted to follow up on Keith's question. In your response, just with respect to in stock levels any sense of when you might be back at grade in terms of matching supply and demand.
So it's a dynamic we've been talking about there is not one of our vendors that planned 4 million you've had to happen in 2000, 2021, and there continues to be more adoptions versus pre pandemic into this year. So that's the bad news.
Since its ask Alan I was at a brand new plant fries kitchen.
In Dallas several months ago I.
I met with a host team they just announced big investments. So capacity is coming on in real time, and correspondingly, we're seeing improvements in our in stocks and enhancements to our ability to match supply to demand.
Three weeks, so it's all getting better a lot of that capacity got approved in 'twenty early 'twenty, one and that's now starting to come on so it will get better and better as we progress through.
Half of the year and into 'twenty three.
Okay. That's helpful and Brian one for you I'm, just trying to square up the guidance in terms of the <unk>.
Revision to earnings versus the revision to sales it doesn't look like a significant revision to revenues. So just trying to kind of back into what youre, assuming in the middle of the P&L for the back half.
London to a more significant profitability.
Yeah no. Thanks for the question look let me start with.
As <unk> stated on revenue we grew in the quarter.
We are setting ourselves up for sustained growth in the future. So what we're taking in terms of guidance as a balanced approach for managing the short term, we're continuing to reinvest for the long term. So we have a $40 billion incremental Tam opportunity in front of us. So we continue to lean into that investment.
Are you seeing in terms of the guidance is there a couple of factors in play we do have a very strong consumables business, which continues to grow double digits and we expect that to continue we have a resilient services business, where we have not seen a demand impact in terms of elasticity. We expect that to continue we're seeing some softening in that.
Discretionary space in terms of supplies in companion animal and so we're taking a more balanced approach to that now the good news with that category is that category has proven through prior turbulent economic cycles that they return to profitable growth as the economy improves. So we're not sitting still Stephanie we're taking a pro.
Active programs in place to rolling out to accelerate those discretionary categories, whether it be vital care, whether it be nutrition parks and so we are setting guidance in terms of what we currently see in the economic environment. We are in a different space than we were 90 days ago, and we believe that our guidance reflects what we currently see in the market.
Okay, Brian just to clarify would you like us.
More heavily impact the gross margins based on mix just given that you saw some nice SG&A progress in the quarter you wanted to continue to carry that forward into the back half.
I think thats right.
The team did a great job on SG&A, if you look quarter on quarter, we improved 100 basis points quarter on quarter in terms of SG&A leverage if you look at gross margin. There are kind of three factors. There. Stephanie first yes, you know there was a onetime thrive impact of 50 basis points.
And as I, just talked about Theres, a transitory mixed pressure in terms of consumables growth.
Impacting gross margin there are also some elements of supply chain.
In particular freight and impacted gross margin, but we have made structural improvements in our gross margin profile.
In terms of improvements and consumables mix.
Shifting to premium we've improved our digital gross margin that profile of business in terms of distribution savings had ad networks.
And look when we look mid to long term, we expect some of those things to abate, but we are taking a more cautious and conservative outlook in terms of our guidance on the bottom line.
Very helpful. Thank you so much.
Our next question comes from Anna <unk>.
<unk> with Needham <unk> Company. Please go ahead.
Great. Thank you so much and good morning, guys.
Two quick follow ups.
Can you talk about the gross margin.
Watson takes as we go through the year.
Holdouts rates as one of the pressure points during the quarter are you seeing freight costs moderate.
Oil prices have been coming down here and then secondly on supply.
You mentioned.
With strong trends quarter to date has that category move at all and what are your lines of supply for the year.
Yes, let me let me take the first one.
So in terms of some of the inflationary pressures.
Really important to remember that in areas like freight we don't get a real time adjustment on some of those charges. So for example, the cost inputs that we received in Q2, a lot of those are capitalized into inventory and I guess flushed through the P&L as we roll that inventory and sell it trips so over the midterm as inflationary pressures abate.
Tori turns over and we would anticipate some relief in those areas. It's just not an immediate so to be clear, we will see more favorable cost, but theyre not reflected in Q3, I would expect that gross margin and EBITDA from a seasonal standpoint would be improved in Q4 relative to Q.
Three is we have that seasonal uplift in the fourth quarter.
In terms of your second part of your question was related to I'm, sorry can you repeat that.
Yes, I'll take that one.
So first I just want to reiterate a strong tourist business is fantastic for our business.
It's sticky and the LTV is 30% higher than a non consumables customer.
Three year basis supplies as up almost 30%. So we have been scaling supplies strongly it's highly profitable and it gives us financial advantage versus our key competitor.
Because of the strength of our supplies business inflation is pressuring that business.
It's a combination of inflation and the year over year on stimulus as those abate, we expect those to come back and Thats.
Reinforced by consumer research that says that of the folks that arent buying these types of products, 40% are actually postponed purchases not canceled purchases. So we anticipate that coming back and more.
We're excited about coming into holiday, we do great business on Halloween, we do create business on Christmas and Hanukkah and.
And our team is fired up and we have great merchandise against that.
We are as Brian said, we're not passengers on the bus we're launching initiatives to catalyze purchase in these categories, but as you said, we're taking a cautious projections for the time being given the economic uncertainties.
Okay. That's helpful. I appreciate it can I squeeze another one in what are you guys seeing in terms of the overall growth in the past there's been some chatter about higher relinquishment coming in just curious what's your view and thank you again.
Yes. This is something that we both tracked closely and quite Frank managed care a lot about the.
Fantastic News has relinquished rents are below pre pandemic levels.
No.
The episodic new story on this but through petco.
In touch with the majority of rescue scale rescues around the country and.
Relinquishment or below 19 novels, which is which is great news.
Okay.
Alright, thank you so much.
Thanks Anna.
Our next question comes from Seth <unk> with <unk>.
Can you. Please go ahead.
Thanks, a lot and good morning. My first question is just a little bit more clarity on the outlook from a margin pressure standpoint, the biggest factors pressuring your margin outlook for the balance of the year are those from mix or supply chain or investments in loyalty programs or otherwise.
Yes, I think you I think you nailed the orders.
The first the biggest impact is the transitory mixed pressure, which we would expect to reverse in the mid to long term as the economy improves the second biggest impact would be the freight and distribution costs, which as I said, a little bit earlier, we capitalize some of those costs inventory ask those term we would expect those to improve.
But you hit your third point's valid we are balancing our approach here. So we are managing the short term, but we continue to invest we have a massive opportunity in front of us a $40 billion incremental Tam we continue to invest in that opportunity to make sure that we come out of this economic cycle stronger and set up for the long term.
That's helpful. And then my follow up question is just looking at the hard goods category, where do you see inventory levels being right now for the industry and do you think that area of the industry gets more promotional in the back half of the year and could impact margin rate for you guys.
No I look.
Still really good about our inventory levels, there's a lot of noise in the market in terms of this sector and inventory levels. We do not have those same challenges. We felt really good that team has done a great job managing inventory levels. If you look at the year over year increase that was driven a lot by cost from a unit standpoint, our units are up.
Slightly ahead of revenue from a year over year basis, and relatively flat quarter on quarter. So I feel really good about our inventory position.
Going back to the promotional environment <unk> seen rationality in the promotional environment across consumables across by some do not.
Yes.
That's helpful and if I could just throw in one more follow up for Ron just thinking about vital care and how the sign up they are trending now.
Relative to your expectations and the spend per customer are those on track and you think that creates more opportunity in this higher inflationary environment for your customers.
Yes. Thanks for the question Scott So I'll take the latter part first absolutely vital care provides opportunity in this economic environment.
<unk> can save over $300 annually. So it is the right program at the right time and its differentiated nobody has anything like it.
In terms of sign ups. We are ahead of our internal plan.
And there will be news.
The coming months months months Scott.
In terms of.
We're going to capitalize even further sign ups and accelerated sign ups. So we're very excited about vital characterize where we are.
<unk> is outperforming one danone and there will be more news shortly that will further accelerate viral cure and it's right on trend right now in terms of customers for that mid to lower end customer. It is absolutely the right program can help them save money.
And for the high end customer it really helps us gain more of their share of wallet.
Got it thank you.
Thanks Scott.
Our next question comes from Zach.
Adam with Wells Fargo. Please go ahead.
Hey, guys. This is David Lance on for Zach Thanks for taking our questions. I guess first one from me would be how your expectations for the category have changed in the second half of the year with the lowered top line outlook.
Yes look.
David.
Our expectations for the category haven't changed we still believe this category is a great opportunity for US 7% long term expected growth and if you look at our long term algorithm, we still expect to gain share in that category over the long term. So what we're seeing in terms of the second half outlook is transitory those discretionary categories are.
Pressure to what we've seen in prior economic cycles as those categories are temporarily impacted they do respond well as the economy improves and we would have no different expectations. This time around.
Great and then just one follow up can you talk about what youre seeing with some of the recent initiatives with a shop in shop flows and Rover.
Yes, we're really happy with the shop in shop with Lowe's.
It's going well and actually just to give proof of our ecosystem coming to us we're actually now running petco clinics.
In the parking lots of those locations as well so we're excited about that.
And it's a great complement to actually to our small town rural and assurance as well so.
It's going well.
Great. Thanks.
Okay.
Our next question comes from Steven <unk> with Citi. Please go ahead.
Great. Thanks, very much for taking my question. Good morning, guys. So maybe to follow up on the revision to EBITDA guidance. So the new guidance calls for an EBITDA down 2% to up 1% on revenue growth of up three to four.
Analyst day earlier this year, you talked about EBITDA growth tracking faster than revenue as a framework. So as you take a look at the year do you see the primary drag to EBITDA. This year, it's onetime in nature I guess, if consumable strength continues into next year would this be an ongoing drag to EBITDA margins.
No. Thanks for the question, Steve We do believe that onetime in nature. So we are still really confident in the long term algorithm that we laid out at Investor day, where as you said, we expect even though the grow faster than sales growth. What you are seeing this year is transitory in nature and that mix shift from suppliers in companion animal into consumables.
But the good news about that is consumables customers. If you look on a long term basis have 30% higher LTV than the typical customers. So thats good news.
So if you look at back back at past economic cycles the.
The impact to supplies in companion animal are transitory they are temporary and we expect that to rebound so.
And then if you look at cost what were seeing in terms of input costs from Dcs as well as freight is also transitory we would expect that to abate and start to normalize in the second half. So as we look to 'twenty three and beyond we would expect EBITDA to return to our long term algorithm.
And we're already seeing improvements in freight costs.
Great. Thanks for that follow up I had was on you mentioned that you haven't seen any sort of trade down in the business and I guess I'm curious Pat.
Pat has seen Thats premium innovation, that's been a secular trend.
What gives you confidence that won't be at risk to a trade down of just people scaling up to buy more premium food.
Well first thing is this is as you stated a long term trend right. This is a decade long trend and underneath it isn't a power is a powerful consumer insight and powerful segmentation, which is humanization has been a trend for the last decade.
Utilization trend.
Is it across all segments, particularly so with Gen Z and millennials and is Gen Z and millennials.
Become a greater proportion of pet.
Parents that that creates upward pressure on premium amortization, our upward trend on compensation. So.
It only continues.
The microcosm of that is fresh frozen fresh.
Fresh frozen is predicted to go from $1 billion.
Right now to $4 billion to $5 billion over the next three years is surging and that is to me the appear to be.
Transition towards more premium and Humanization. So we're not seeing anything slow down and in fact actually it's not just on so as you look at ready are ready business continues to grow double digits.
And so premium amortization, even in supplies continues concurrently.
Thanks for the detail best of luck in the second half.
Thanks.
Our next question comes from Simeon Gutman with Morgan Stanley . Please go ahead.
Hey, good morning, everyone I wanted to talk about services for a minute you mentioned that consumer discretionary there was some weakness is there any overlap or line of sight into either the vet spending or the grooming side have you seen anything change in frequency and then how are you thinking about it for the second half.
Yes, both businesses are strong trips are up revenues up double digits and our.
That business continues to have a positive impact on the center store sales so.
Yes.
Similar to my commentary on prioritization and people arent cutting back on on grooming our vet visits.
And thats, providing us with strength and buttressing our trips.
There is a demand part of that equation in there as part of that equation and I'm one of the things that makes us really excited as we added 600 that professionals to our network in the first half of the year 800 veterinary professionals.
Thrive. When you include that tax so our capacity has seen a significant increase which will only continue the momentum that we're seeing.
Thanks.
Follow up is on the supplies in companion animal.
I guess can you take us through the sequential change of the last couple of quarters in this and what I'm trying to zero in on is the impact either of gas prices that it had on this versus general normalization against Covid trends versus the industry trends is there.
Any light you can shed or the way you assess it because we've seen some gas price led up did the business improve a little from that or it's not that we're normalizing against COVID-19 and it's not about the near term fluctuation in let's say gas prices.
Yes, let me let me take a couple of steps that's come in.
So first we look at it on a couple of different ways. One of the things we've taken a look at it is on a three year trend because you have to normalize some of the dynamics over the last couple of years on a three year trend of supplies and companion animal businesses very strong up over 20% on a three year stack. If you look Q1 to Q2.
We saw consistency in the business, but I would say if you look at the what we published and the presentation on the site minus nine in Q1 minus nine in Q2 on a year over year basis again, three year strong over 20% in terms of gas prices as I said, a little bit earlier, while some of those are starting to come down in terms of RP.
And how that impacts consumers, our P&L will see some of that flush through it later in the back half of the year as inventory turns we have seen some trip consolidation in terms of our consumer behaviour as gas prices have sort of stayed elevated despite some little bit of decrease and again going back to where this category is resilient we have.
<unk> time and time again through prior economic cycles that this category responds and as Ron said earlier, 40% of some of these.
Purchases and supplies in companion animal.
<unk> got canceled so we would expect that to come back.
Thanks helpful. Thanks, and good luck.
Thank you.
Our next question comes from Chris <unk> with B P.
Paradise Exane. Please go ahead.
Hey, Thanks for taking the question.
Just wanted to follow up on your last comments when it looks like the Hartford's mix was flat quarter on quarter.
What drove the gross margin decline ex of that acquisition. It looks like it was down 60 basis points is that all.
Transportation or was like the mix within hard goods or mixed the consumables weaker this quarter.
Yes, both.
You hit it right on the head Chris So as both that was it was.
Mix within that hard goods and it was transportation cost. So again, if you look at the market I think there is some market noise about transportation costs, starting to abate that is true you do not get a real time adjustment from that as some of those costs get capitalized and transfer inventory so on a quarter on quarter basis, those transportation costs were a headwind.
And then if you look at the mix impact as you said it was relatively flat year over year, but there is mix within the mix as well.
Got you that's helpful and then on SG&A it looks like you're looking to raise the kind of base wage to $15 an hour.
How far are you off that level today in Q2, and then what does that mean for spend in the back half and just broader question.
Can you speak more of the labor and what Youre seeing and Thats flat consolidated like it sounds like youre material applications roughly.
Enormously.
Just want to hear your perspective on each of those.
Yeah. Thanks, Chris.
So first our total wage is up about $17. So we've been working on this for multi year journey to get this to a good space.
It's been a personal objective in mind to get every single.
Partner Petco about $15, which is why we feel great about making the move that was already baked into our long term model.
Get over $15 as kind of the base and in light of inflation and the impact that's having on people we felt like now straight time.
In terms of the labor environment.
HEICO is a great place to work you got to.
You get to leverage your passion for pets.
Mission based company, we take good care of our people and as a result, our applications.
Said are up double digits, and actually up 30% on a quarter over quarter basis. So we're able to attract talent and these moves we're making on our compensation will only make it more so.
Okay. Thank you for the time.
Thank you.
Yes.
Okay.
Our next question comes from Glenn <unk> with Bank of America. Please go ahead.
Just wondering if you could go through capital allocation priorities given that you took down the capex guidance, a little bit but you also took up your interest expense assumption for the year. So presumably as rates are rising in that that cost is going up. So how are you thinking about.
Where you wanted to deploy cash going forward and thinking about your leverage.
Yes.
It's a great question. So let me start with we have not come off of our long term.
Leverage guidance that we laid out at analyst day in terms of prioritization cap, we still have a lot of investments with high ROI that we feel excited about in the first half of the year, we leaned in heavily into that we also leaned in heavily to fresh frozen. So we expect to be in over a thousand locations for <unk> by the end of the year.
We as we launch as we announced today, we have a whole hard into fresh frozen launch that we are really excited about in the second half those are high priorities that remains a high priority the balance in terms of the takedown for Capex for the year, It's just being pragmatic about how we balance that cash as you said.
<unk> increased our interest expense guidance $76 million for the year to $90 million as we looked at our overall cash envelope, we felt it prudent to bring down that capital expenditure to $2 50 to $2 75 range that said, we are not trading off our long term investments, we will continue to lean into that.
When you to lean into fresh frozen, we will continue to lean into digital assets to improve our capabilities.
Great. Thank you.
Our next question comes from Michael Lasser with UBS. Please go ahead.
Good morning, Thanks, a lot for taking my question, Brian It looks like you're embedding pretty consistent comp into your outlook in the back half of the year, both on a one and a three year geometric basis.
This is despite.
What's probably been the vast majority if not more than the majority of the comp being driven by inflation and you will lap some of the price increases that you took in the back half of the last year starting this year.
Do you expect that your units starting to accelerate as these.
Is the inflation.
Start to be.
If thats. The case would you also expect a corresponding improvement in the supply business over the next couple of quarters.
Yeah no. Thanks for the question Michael look.
You hit it if you look at our three year stack, we actually see on a three year basis, a slight acceleration in the second half so mid <unk> on a three year stack, but a little bit better in that second half, we do expect more of that builds in the second half. So if you look at what we said, we said 50 to 60 bps for the year, we did 15 in the first half.
We'd expect the vast majority of those to be in the second half.
We have about 15 net PCC store ads in the second half of mix of small town rural amps traditional Pcs from a supplier.
NCI basis, but we're being pragmatic about our approach to guidance in the second half. We do expect this category to return, but I think we're in a different spot than we were 90 days ago and as we look at the second half of the year. We felt it was appropriate to guide as we get to be pragmatic about how that category of insurance.
Okay.
Please go ahead, Ron Chris Sorry, Mike I was going to add we also have enhanced improving inventory situation. So that that helps us in the second half as well.
That's helpful. And then my follow up question is on.
The thing that you're running the business for the long term how would you expect free cash flow to unfold over the next couple of quarters given that.
It was under pressure year over year in the first half of the year.
Yes, I would expect it to get better in Q4, Michael Q.
Q4 is a seasonally strong quarter as we look at free cash flow, we look at it obviously on a couple of factors I was really pleased with the operating cash flow in the quarter that the team generated particularly around the way they managed inventory levels.
We will continue to lean into Capex, although we've brought the guidance down and there's still a significant investment in capex for the year, which we felt really good about that long term ROI.
We cadence through the balance of the year I would expect free cash flow to improve in Q4.
Thank you very much and good luck.
Thank you.
Okay.
Our next question comes from Peter Benedict with Baird. Please go ahead.
Okay.
Okay, maybe we don't have Peter.
Maybe let's go to the next one operator, who can come back.
Pardon the interruption please hold.
Great.
That will be the next questionnaire.
Okay.
Okay.
Our next question will come from.
Oliver Winter mantle with Evercore ISI. Please go ahead.
Yes, good morning, guys.
Question regarding your net adds can you maybe tell us a little bit more about which areas were.
The most important too to add to them that it was it more consumable customer or services.
It would be helpful.
Yes, there was strength.
Across both and I should say are this is 14 consecutive quarters that we have added customers speaks to the strengths of our marketing piece this strength.
Our partners in.
In the aisle speaks to the strength of our digital offering so 14 consecutive quarters of net adds so we're really pleased with it.
There was strength across consumable strengths across.
Services. If you think about we're now up to two hundreds at hospitals, and that's bringing new people into our location and you think about our perks programs are quite unique in terms of.
Getting discounts on food getting discounts on grounds that are differentiated and DNA.
Tough inflation environment goes really appealing to customers. So the ads are across both 14 consecutive quarters.
Ads.
Got it thank you and maybe this one is for Brian going back to the question about leverage and I think you said.
If it gets too.
Leverage targets that you set out by the end of 'twenty three.
Some some buybacks.
Anything of that thinking has changed.
No nothing's changed there all of our so we remain committed to what we laid out at analyst day.
Although the current year guidance. This change we have levers to actually improve that so whether it be working capital improvement in earnings as I said, a little bit earlier, we still believe long term algorithm and that return to EBITDA growing faster than revenue.
We are focused to getting to that destination.
Yeah.
Got it thanks, very much and good luck.
Thank you.
Our next question comes from Peter Benedict with Baird. Please go ahead.
Hey, guys can you hear me now.
We thought we lost you Peter.
Oh, what happened I don't know what happened there I apologize.
Just.
Hi, guys. A quick question on you guys mentioned momentum.
Continuing into <unk> I'm, just trying to understand what you mean by that can you expand on that is that the comps were better in July than they were for the quarter and that's continued or.
What's kind of behind that comment that's my first question.
Yes, what we'd say is our growth has continued into the third quarter I think we're going to expand beyond that.
We see.
See transactions heading and be in a better direction.
So overall we are.
Seeing continued growth momentum, we're seeing transactions heading in the right direction.
B.
From a mixed standpoint, we're not seeing a dramatic change at this point.
Okay. That's helpful. Ron. Thank you and then just with respect to the wholehearted frozen fresh offering that you guys have Kevin can you maybe talk a little bit about.
Don't know how many skus you guys are planning to have what's the pricing.
Structure relative to the other kind of frozen and fresh product. That's in your store, how you price it relative to premium cable kind of where does it fit.
And then lastly, just the timing of the refrigerated offering.
That.
That was mentioned in this morning's press release. Thank you.
Thank you. So there is synonymous refrigerant offering and the new wholehearted offer is synonymous so the human grade fresh frozen is synonymous with refrigerated offering.
Really excited about it.
Even before before I get to fresh frozen.
<unk> brand was up 30% it is a great product at a great value. The way, we think about it in Kimball is similar to how we're thinking about it in fresh frozen if you have the classic good better best we have the best with just food for dogs and this is the better and it is actually manufactured by just food for dogs.
Obviously, they see it as complementary as well.
And fresh frozen one of the impediments to fresh frozen is.
Is access great from a cost standpoint, so having a more affordable, but still fantastic fresh frozen offerings, we think as Tam expanding to fresh frozen and is unique in the marketplace. So we're really excited about it we wanted to have another growth leg.
Got it.
While respecting kind of Super premium premium cable vendors space and this gives us that growth factor for <unk>.
So hard at and it makes us even more competitive in the fresh frozen space, but the pricing piece. It's a classic good better best this is a better play complementing the best play Im just food for dogs or it needs thinks of the world.
Got you makes sense. Thanks, so much.
Thank you.
Our next question comes from Steven Forbes with Guggenheim. Please go ahead.
Good morning, and thanks for taking my question.
Brian Brian I wanted to start with the active customer engagement trends. So curious if we look at the 2021 and 2020 customer cohorts are they behaving any differently than the pre cover cohorts inclusive of spend by category as we think about this consumables versus supply.
Dynamic and then how are you thinking about retention trends within the active customer base as we look out to 2023, just given given the growth that you're seeing in the business.
Yes.
Thank you Steve.
Really happy with the fact that we continue to add customers may 14th consecutive quarter speaks to the strength of our model our strategic thesis.
Our marketing.
The customers that have been with us one year or longer have solid retention.
And look like prior customers, which speaks to the strength of our model.
The low level of turnover that we see tends to be low value customers that were acquired during the pandemic.
Really exciting to US is the programs would actually move the needle on this front so programs like vital care, where I said, 30% new to fluid, 40% new services with us higher retention perks programs for pizza delivery.
Following up significantly 54% growth in recurring growth from recurring revenue customers. So we feel like we have leavers.
We know we're adding customers the customers that are leaking tend to be more valued customers.
And then maybe as a quick follow up on that.
You mentioned vital care membership exceeding internal expectations and just the commentary there.
I mean do you is there enough evidence here that perks and vital care is sort of.
Our new acquisition vehicle for you guys and are you seeing greater conversion.
New customers immediately into those programs.
Absolutely.
There is a significant portion of <unk> customers that are new.
So it's not just the conversion.
But the real real magic of Bioterrorists Cheryl.
And it really is a manifestation of our core strategy of being the only player in the market, perhaps into an ecosystem idle cares manifestation of that but it is bringing in new customers, perhaps are bringing in new customers, but the primary focus of <unk> is around share of wallet, which is doing fantastic.
Sure.
So we can't move fast enough and getting more people into final care and as I said.
There'll be some news in the coming months or so on further accelerating but I don't care.
With some good news there.
Okay.
Thank you Ron best of luck.
Thank you Steve.
That concludes our question and answer session of today's call I would now like to pass it over to you Mr. Ron Coughlin for closing remarks.
Thank you operator to our analysts we appreciate your time and your questions to our investors. Thank you for showing faith in US every single day Echo continues to grow in a category that remains strong and resilient even in times of economic headwinds above all else our teams remain committed to driving.
Operational excellence are putting the customer at the heart of everything we do and delivering against our long term strategic priorities with purpose driven performance. Thank you for your time.
That concludes the <unk> second quarter 2022 earnings conference call. The team will be available after the call. If you have follow up questions. Thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.