Q4 2022 Petco Health and Wellness Company Inc Earnings Call
And follow up with that let me turn it over to Ron.
Thank you Kathy and good morning all.
Before we begin I wanted to take a moment to formally welcome Cathy Yao, who joined <unk> as our new Vice President of Investor Relations. Kathy has an impressive and diverse background spanning both buy and sell side in telecommunications and health care. Many on this call will know her she has already become a great addition to.
The team and as a proud pet parent of two Pomeranians loci in Freya, we're delighted to have her and her pets at petco turning to results I want to start by thanking our incredible Petco partners for their excellent work and delivering record quarterly sales in Q4, we achieved our 17th consecutive quarter.
<unk> of comp growth.
16th consecutive quarter of customer growth and delivered cash flow performance significantly higher than expectations, all through an uncertain macro environment.
Our partners continue to embody the mission or purpose driven performance combining strong operating performance with tangible improvements to the lives of pets pet parents and the partners who work at Petco.
<unk> performance was bolstered by a pet category that once again delivered solid growth proving its resilience regardless of the economic environment pet adoptions in 2022 remained elevated above prior year.
Gen Z and millennials continue to be the largest cohort of adopting new pets in 2022, and the highest spending bringing elevated and accretive spend per pet.
Comp sales growth was 5% for the quarter as well as the full year net revenue growth was 4% for both the quarter and full year momentum that continues into Q1, demonstrating the enduring appeal of our one of a kind ecosystem.
Importantly, our performance for the full year has strengthened our balance sheet and <unk> strong operating cash flow performance. This combined with the benefits from our cash management initiatives meant that earlier. This month, we paid down an additional $35 million of principal on our debt as well as taking further actions to manage our floating rate exposure.
And we're committed to pay down additional debt, while continuing to invest to enable our long term growth strategy.
Brian will elaborate shortly.
At our inaugural Investor Day last year, we laid out three core growth pillars first the rapid scaling of services second furthering the differentiation of our merchandize and last leveraging data and membership to build loyalty and share of wallet.
Let me share our progress and results across those pillars.
Services delivered a strong 14% comp growth in the quarter up 36% on a two year basis in veterinary services. We are now at scale with the veterinary presence in 90% of our pet care centers <unk> hospitals and clinics saw nearly one 9 million pets in 2022.
Positioning us as one of the leading providers of veterinary services in the United States.
Record veterinarian hires improvements and ease of online booking and innovation and medical technology significantly boosted transaction volume.
<unk> industry trends with double digit sales growth for the full year.
We added over 1100 veterinarians to our ecosystem in 2022, representing a 40% increase compared to year ago. We also added 50, new full service vet hospitals. This year in line with expectations. We now have a total of 247 hospitals across the country a significant milestone having come.
And at the beginning of 2018 and cementing our position today in the top 10 from our hospital unit standpoint.
<unk> continued to provide a single trusted ecosystem for pet wellness. There remains unique in the industry pet care centers that hospitals continue to see a mid single digit center store lift are growing faster and have higher profit dollars compared to locations with our hospitals that customers are also demonstrating a $2 three.
Times higher lifetime value than non customers.
Last year, we ran over 58000, vetco clinics across 46 states up strong double digits, providing convenient affordable and critical preventative medicine with great care at a great price our vet clinic business is the right offering at the right time for many of today's <unk>.
Pet parents.
Clearly <unk> has built a unique and profitable services offering with veterinary services at its heart.
But it's more than that under.
Under the exceptional leadership of our Chief veterinarian, Dr. Miller and her team we are redefining what a veterinary network looks like through powerful industry partnerships innovative training programs and technological advances in medicine, including AI radiology diagnostics and multi species ultrasound.
The result, our vet business is an incredible growth driver and our model provides a compelling home for veterinary professionals, while improving and saving lives of even more pets.
Turning to our differentiated merchandize 2022 was another strong year.
The addition of exclusive and formerly independent only store brands such as back country in stone and <unk> have been powerful and driving a premium mix and accessing new customers.
Meanwhile, our mix of popular own brand supplies, and consumables, including ready and wholehearted, which both grew in revenue and penetration over the year continue to meet the core humanization trend, while also catering to a variety of wallet sizes.
Taken as a whole our differentiated assortment is driving retention with our health focused customers offering products unavailable in mass or many online channels and reducing our competitive promotional exposure.
Total merchandise sales were up both in the quarter and for the full year highlights include double digit growth in consumables, driven particularly by our own brand wholehearted continued year over year growth in both revenue and customers in fresh frozen and double digit growth in Rx, making progress in this $12 billion addressable market.
And while our more discretionary supplies and companion animal categories saw a decline year over year, our fourth quarter saw an over 100 basis point improvement in the year over year growth rate versus Q3.
In the high value fresh frozen category, we maintained our structure advantage versus online only players.
With over 90% of <unk> customers choosing same day delivery of both this when available we're able to leverage our pet care centers as micro distribution centers getting product to customers faster and in many instances with lower fulfillment costs.
And today, we announced an absolute breakthrough in the industry first and exclusive partnership with fresh pet the number one brand in fresh frozen pet food. This makes petco, the first national Omnichannel pet retailer to offer a customized fresh pet food subscription delivered direct to customers' doors.
With the fresh frozen pet category is expected to reach $6 billion within the next four years and the direct to consumer pet segment growing faster than traditional pet E. Commerce. These custom meals further enhanced <unk> ability to lead the way in the Mega trends of personalization and Humanization.
The fact that the leader in fresh frozen chose to exclusively partner with Petco is a validation of the power and advantages of our unique omnichannel and micro distribution center capabilities, we're delighted to be bringing this industry first offering to market.
But it is not just a merchandise that differentiates us it's also our omnichannel delivery capabilities.
Our digital channels continue to gain momentum App and website sales delivered double digit growth both in the quarter and for the full year translating to 32% growth on a two year stack and an incredible 138% on a three year stack for the full year and this year, we hit a milestone surpassing 1 billion.
And recurring customer revenue driven by repeat delivery vital care and insurance securing revenues that are both predictable and retentive.
In our pet care centers, we achieved 11 consecutive quarters of brick and mortar comp growth and as promised every non training partner and Petco is now paid a base wage of at least $15 an hour.
<unk> partner application retention rates continue to be strong and are up year over year, as we provide an engaging and rewarding environment to work and flourish strengthening our business in the short and long term.
Internationally, our number one Mexico business continued to go from strength to strength delivering double digit revenue growth year over year. We added 12, new locations. This year furthering our penetration this rapidly growing market and bringing us to a total of 120 locations.
Our rural pilot continued to scale profitably, making progress in capturing the $7 billion addressable market as the organization increases in pet spend continues to grow in rural markets. This natural extension of our core offering provides pet products and services that are unique and highly desired by passionate pet parents as a result in aggregate.
The pilot is performing above model and trending to be cash flow positive within the first year.
In addition, our lowest pilot in Canadian tire partnership continued reform extremely well both with significant runway for growth.
Finally, turning to customer loyalty and share of wallet, our insights driven approach to data marketing and customer experience enhancements added 1 million net new customers for the full year, including over 70000 adds in the quarter. Our total active customer base now stands at over $25 million.
In January unified all memberships under the vital care program members of our <unk> program were transitioned to vital care court.
Members of our existing paid vital care program were transitioned to vital care premier.
Dramatically simplifying loyalty petco, and enabling a clear trade up path is already paying dividends with increased upgrades from free to paid.
In February we hit a major milestone reaching half of million paid active vital care premier plans.
In addition to providing tailored benefits savings and advice pet parents are vital care program drives loyalty and rank them further into our ecosystem Premier members have a $3 six times higher lifetime value than nonmembers, they visit more and we see a lift in spend across all categories translating into higher Petco Maher.
<unk> dollars versus nonmembers with recently acquired members spending more than prior cohorts.
Finally, before I close let me turn to Peck of Love.
In the fourth quarter alone together, we saved over 97000 pet lives and have now reunited over 17000 pets to date through Petco left lost and in partnership with Merck Petco Love delivered 172003 vaccines in the quarter, making great progress against our second million free vaccine commitment.
Saving pets from preventable deadly diseases, all incredible examples of how we deliver against our mission or purpose driven performance and we're grateful to blue Buffalo for their financial support to the Yummy Morial cancer Fund a program Dear to my heart, providing financial assistance to our Petro partners for pet cancer treatment.
Personally I'd also like to thank the teams at <unk> 11, priceless pets rescue in Southern California for helping me find the newest member of the <unk> family, our Sweet New Chocolate lab, EOG, which having a father, who is a lifelong net span required some research to confirm Yogi Berra spent almost 10 years with the Mets a few days of the player.
<unk> and the remainder as a coach.
Yoga is fitting into his new role as Chief Dog officer, well pone as skills with dog trainer Zoe at our del Mar location and keeping up to date on all these vaccinations with Doctor race at our Vetco Hospital.
<unk> two.
To conclude.
Energized about the strength of the pet category and our differentiated strategy to be sure. There is still significant progress to be made but we're executing well in the current environment and our strategy for long term growth is unique and working the pet category remains vibrant and we continue to have one of the best teams in retail whose dedication.
Delivering day in and day out with that let me hand, it over to Brian .
Thanks, Ron and good morning, everyone.
Building on Ron's remarks, we delivered against our strategic objectives throughout a challenging macroeconomic background and I too want to extend my thanks to that.
A petco partners across our pet care centers distribution centers and support centers for their dedication to delivering the very best for pets.
Looking at the quarter net revenue was $1 6 billion, an increase of 4% year over year.
Total revenue of $6 billion for the full year was also up 4% year over year.
And our cash flow came in significantly above our expectations, allowing us to take further actions to reduce principal on our debt, which I'll elaborate on more.
In the fourth quarter comparable sales driven by sustained strength in average basket trends grew 5% year over year and 19% on a two year stack.
For the full year comparable sales also grew 5% and 24% on a two year stack.
For the quarter total services grew 14% year over year translating to 15% for the full year driven by strength in debt and grooming and further enhancements in our booking systems.
In merchandise strength in consumables, which grew 12% in the quarter year over year and 13% for the full year continued to offset the anticipated transitory impact of discretionary purchasing of supplies and companion animals, which were down 9% for the full year and as Ron said, we did see a 100 basis point improvement.
In Q4.
Our digital business also showed strength with double digit sales growth in both the fourth quarter and the full year and expanded gross margin in the fourth quarter buoyed by strength in our digital pharmacy and repeat customers and the continued growth of our rapidly scaling AD network.
Moving down the P&L gross profit was down 1% in the fourth quarter at $627 million and flat for the full year at $2 4 billion.
Q4 gross margin of 39, 8% was down 220 basis points year over year and gross margin for the full year of 42% was down 160 basis points.
The decline for both the fourth quarter and the full year was driven primarily by the mix impact of consumable strength and transitory supply pressure combined with elevated supply chain and associated capitalized freight costs, which as for many brought headwinds on a year over year basis.
Our team has worked tirelessly to improve operating leverage by focusing on strategic cost initiatives and it picked up momentum throughout the year.
As a result, I am pleased to report that in the fourth quarter SG&A as a percentage of revenue improved from 36, 5% to 34, 8% year over year down 170 basis points.
For the full year SG&A as a percentage of revenue was 36, 5% down 70 basis points.
On an absolute basis fourth quarter, SG&A expense was $550 million down $3 million from prior year inclusive of continued investment in our pet care Center partners, demonstrating our cost discipline and a balanced approach to managing the short term, while making strategic long term investments.
For the full year SG&A was $2 2 billion up 2% from 2021.
Q4, adjusted EBITDA was $170 million down 1% from prior year with an adjusted EBITDA margin rate of 10, 8% compared to 11, 4% in the prior year.
Full year adjusted EBITDA of $582 million was down one 5% with an adjusted EBITDA margin rate of nine 6% compared to 10, 2% in the prior year.
Q4, adjusted EPS was <unk> 23, a decrease of <unk> <unk> from the prior year based on 266 million weighted average fully diluted shares and a normalized effective tax rate of 26%.
Full year adjusted EPS was <unk> 75 sets a decrease of <unk> 16 from the prior year.
I now want to take a moment to provide an update on changes to our go forward adjusted EBITDA adjusted net income and adjusted EPS definitions.
Date, we've been reporting these metrics consistent with the approach taken by other newly public companies.
Following a period of evaluation and review over the last few months feedback from investors and to remain in line with evolving best practices. We are updating the treatment of certain adjustments on a prospective basis.
Our fourth quarter adjusted non-GAAP results reflect our prior definitions future results will be based on these updated definitions.
To be clear none of these changes will have an impact on pet goes cash flow or affect the company's operations and strategic priorities.
We will no longer include store pre opening store closing and noncash occupancy expenses and our add backs and will limit nonrecurring cost to restructuring charges, one time material legal reserves and significant onetime transaction related charges.
We believe these updated definitions will create more clarity and insight into pet gross operating results.
To assist investors in this transition we've provided reconciliations between our Pryor and new non-GAAP definitions.
Moving beyond the P&L, our liquidity position remains strong.
We ended the quarter with $646 million inclusive of $202 million in cash and cash equivalents and $444 billion of availability on our revolving credit facility.
We've continued to make meaningful improvements in our cash flow performance with a 96% increase in Q4 operating cash flow over the prior year and free cash flow of $71 million up $76 million over the prior year.
The way the team managed inventory was a key contributor to our strong free cash flow and I'll cover of our investments into strategic supply chain enhancements as well as operational discipline.
In stocks were up tangibly year over year, and we continue to work actively with our vendors to position us well, while we navigate this environment.
Last quarter, we said, we expect it to be free cash flow positive for the year, while still investing in pillars of future growth, including veterinary hospitals and cooling infrastructure to accelerate our fresh frozen business.
With exceptional cash flow performance in the fourth quarter free cash flow for the full year was $68 million.
We continue to see opportunities to further improve our working capital moving forward.
Given our strong cash position as Ron noted last week, we paid down 35 million principal on our debt $31 million more than the required quarterly payments indication of our strengthening balance sheet and commitment to reduce overall debt levels. Additionally.
Additionally to take further actions to manage our interest rate exposure, we implemented collars on a portion of our floating rate debt combined.
Combined with the caps, we implemented last quarter, we have significantly mitigated our interest rate exposure.
Now shifting to 2023 as we plan for the year, we remain confident in the strength of our unique health and wellness ecosystem that continues to set <unk> apart.
And in our ability to deliver against our strategic priorities, including that digital and owned and exclusive brand differentiation.
We fully expect the pet category to remain resilient with growth overall as seen in past economic downturns with notable strength in consumables and services.
While discretionary categories remain pressured and while we anticipate that macro environment to remain fluid, we expect our supplies and companion animal businesses to work their way towards normalization.
In the meantime, we are focused on our programmatic cost initiatives to mitigate against mixed pressure to manage our business in the short term, while reinvesting in the business to improve long term profitability and create additional shareholder value.
We're confident in our ability to continue to improve free cash flow in 2023 and to do so without sacrificing ongoing investment in our strategic long term growth initiatives.
Turning to guidance I'd like to remind you that our outlook reflects our new updated non-GAAP definitions.
Additionally, fiscal 2023 will be a 53 week year for petco, leading to an incremental week of operations relative to fiscal 2022 or.
Our guidance reflects the extra week.
In fiscal 2023, we expect revenue of $6, one 5 billion to $6 $2 75 billion.
Adjusted EBITDA of $520 million to $540 billion to be roughly flat.
Adjusted EPS of 40 to 48, including an incremental 12 to 15 and expected interest expense in fiscal 2023, approximately $273 million of shares outstanding and an effective tax rate of 26%.
And $225 million to $250 million of capital expenditures.
The expected reduction in capital spend in 2023 reflects the completion of onetime investments in high ROI initiatives, such as freezer build outs for fresh frozen and the retirement of some technical debt.
Importantly, we will continue to invest in our long term growth drivers.
Additionally, we are targeting principal debt payments of approximately $100 million as a commitment to further strengthening our balance sheet.
Our guidance is based on the current economic outlook and represents a one times forward looking comment on our debt Paydown in light of this unique environment.
We expect to open 50 to 55 owned vet hospitals in 2023, and 10% to 15 rural locations both of which are reflected in our guidance.
We're thinking about our guidance there are few things to keep in mind in light of our expectations of the macro evolution as a transitory softness in the discretionary categories. We anticipate adjusted EBITDA to be down in the first half with Q1 being a low watermark and flat to up in the second half.
As we start to see normalization of discretionary trends, we expect improvement to the revenue and gross margin trajectory that we are currently anticipating for the year and correspondingly and enhanced EBITDA rate.
We saw modest improvements in freight costs in the back half of 2022, and we expect to see further improvements to our freight costs of 2023 as the overhang on freight alleviates, which will be increasingly realized as we progressed through the year.
Finally, I'd like to reiterate our emphasis on investing for long term growth and our continued execution against our working capital optimization provide us confidence to support our balance sheet, while also making high ROI capital investments.
To conclude we remain committed to delivering against our short medium and long term goals to provide the best and the only full service health and wellness ecosystem for pets and to deliver sustainable profitable growth.
We remain focused on what's in our control and on our structural investments that services differentiated merchandise and data and memberships continue to be the drivers for growth in a resilient category, while making us well positioned for consumers in any economic environment.
Thank you for your time and with that we'd be happy to take your questions.
We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone if youre using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then two in the interest of time, please limit yourself to one question and one follow up at this time, we'll pause.
Momentarily to assemble our roster.
Our first question comes from Kate Mcshane from Goldman Sachs. Please go ahead.
Hi, Thank you good morning.
Wanted to ask.
<unk> consumables and supply thanks for that color you've given so far.
You had noted more normalization in the supply category as we go into the back half should we be assuming that and flex and just what is being incorporated.
Our guidance for this category when it comes to the potential for a tougher macro backdrop our recession.
Hi, Kate I'll start it's Russ.
Ron.
If you look at the segments from a consumable standpoint consumers remains strong.
And we predict they will continue to be strong, particularly with the addition of our fresh pet announcement. This morning services remained strong we continue to see strong growth in grooming and double digit growth in that so we're very pleased with that segment. As we stated we saw a 100 basis point improvement Q4 to Q3.
There were macro dynamics as well as we took some initiatives like our supplies perks program, which we relaunch.
We launched this quarter and we're already seeing 300000 plus customers in that program. So if you look in past recessions. It's actually played out playing out exactly the way. It is now consumables and services stay strong and discretionary spend gets impacted for five to six quarters, you'll recall it started last.
So we would anticipate that normalization along that similar timeline I'll, let Brian add in terms of assumptions in terms of assumptions for the guide Kate.
Back.
On said, we expect consumables to continue to grow we expect services to continue.
Part of our guide implied that if you look at the first half as I mentioned in the prepared remarks, we would expect EBIT to be down in the first half that's primarily due to that mix shift pressure with consumable strength away from the discretionary categories as that normalizes, we would expect that to sort of come.
Back in the second half.
Thank you and then just a quick follow up question on fresh cut is there any margin differential with a fresh set within the consumables category.
We couldn't be more excited about fresh pad first.
If you look at fresh frozen and fresh food.
<unk> delivered to customers. Most of the offers that are customized are coming to the customers' frozen. So it is a game changer from that standpoint, the margin is accretive to our current fresh frozen offering for the most part.
Our next question comes from Oliver <unk> from Evercore. Please go ahead.
Yes, good morning, and first of all thank you for changing the adjusted EBITDA.
EBITDA calculation.
So my questions are.
No doubt the <unk> net adds if you could maybe comment on that what drove it and what do you expect.
In 2023 for net adds.
And then.
My follow up would be to the adjusted debt to EBITDAR ratio. If you have a new goal there for this year going forward and I think last time.
You spoke about maybe buybacks by the end of 2023. When you reached your former adjusted debt to EBITDA ratio, if you could update us on that as well. Thank you.
Hi, Alan Thanks for the question.
We've grown our active customer base for 16 consecutive quarters, we reached 1 million net new this past year. So we now today have over 25 million customers, which is a lot more than.
You and I started talking several years ago.
Importantly over $24 million of those are members of our loyalty programs formally powered now vital care. So our ability to interact with those customers provide enhanced services is very strong we.
We like many of the dynamics within our customer base, we're growing multi category customers with growing recurring revenue actually recurring revenue.
Customer revenue is over $1 billion in 'twenty, two which is a big deal. If you think about predictability and stickiness, we have over a half million vital care members and we're growing penetration with the higher spending millennials and yet all of that is good while.
Q4 adds were below orders was primarily driven by churn amongst lower spending customers.
But we're also not going to sit on that we've enhanced our otp offerings profitable otp offerings, and we'll continue to do that and then get those customers into loyalty programs.
So we're focused on it and continuing to add as I said, we've had 16 consecutive quarters of net ads, Yes, Let me let me take the second one also in terms of that I'm not going to comment on any kind of up.
Today in terms of.
Ratio, we would expect to update other future analyst day, the way, we would expect to do in the coming months.
We did a couple of things this quarter, we put collars in place, which combined with the caps that we did last quarter significantly.
And also allows us to capture.
Kind of an interest rate.
We paid $35 million down on our principal debt last week, and then we have a target for the year of $100 million bucket into a specific.
We're committed to deleveraging.
Again, if you have a question. Please press Star then one.
Our next question comes from Elizabeth Suzuki from Bank of America. Please go ahead.
Great. Thank you could you just elaborate a little bit on what some of the great Bob.
Top drivers for that better than expected free cash flow and then your expectations for 2023.
Yeah, let me start by saying the right way to think about 'twenty three as higher free cash flow in 2022 in terms of the drivers we've been talking a while for a while now about opportunities in working capital I think the team did an exceptional job this quarter in managing inventory. If you look at our overall inventory management in stocks were up Tanja.
<unk> at the same time inventory on balance sheet was down in dollars and more meaningfully down unit. So we managed our in stocks better we managed our balance sheet better theres more opportunity for us in terms of working capital.
That's what translates to expectations of higher free cash flow.
23.
Yes.
Great. Thank you.
Thanks Liz.
Our next question comes from Corey Grady from Jefferies. Please go ahead.
Hey, Thanks for taking my question I was wondering if you can provide a little bit more color on what youre seeing in the vet labor market <unk> been very successful at hiring best this year. So curious how you're seeing that market evolve in Q4 and Q1.
Thanks for the question Corey.
In nutshell, we're very pleased with our performance to date.
The vet market, while it remains tight.
Very pleased with our ability to bring in high quality that's into our network. We brought in a record 1100 facts into our ecosystem, 40% more events in Q4 than the prior year.
And our time to fill in our attention or above industry benchmarks clear that our strategy is working it's clear that our value proposition is working whether you look at we allow that to practice medicine as they see fit we provide vets with stock. There's a lot of unique attributes of our offering that just is ahead of what competitors are.
<unk> <unk>.
Also establish a strategic pipeline with our vet Tech program, which is one of my personal favorites. What that means is if you're a center store partner Petco and you have interest in being a bad Tech. We will send you to vet Tech school and Youll be a feeder into our system and the vet tech market as tight as well and actually our first graduates are going to happen in 2023, and I'm really excited.
About that so net net it's a tight market, but we're outperforming in a tight market.
Thanks, and then just as a follow up on the outlook for 50% to 55 that centers. This year is that reflective of the type market and is that.
The rate, we should think about you, adding best centers going forward or do you expect to get back to the long term seven year model.
Maybe two.
<unk> thousand 24.
Yes, Corey that's more reflective of a balance as we look at our total capex spend for the year as I guided to $225 million to $250 million part of that decrease was the rollover of some onetime high ROI investments, we made last year in freezers, the retirement of some technical debt, but we're taking a balanced approach to capex with $50 to 55 hospitals, we're still <unk>.
And it's that for long term growth at one of our number one priorities in terms of long term strategic growth. We have 10 to 15 of our small town rural build outs on top of the $50 to 55. So in total when you think about units you're still about 70 units roughly if you take the best combined with the Str's and so we feel like the guidance, we put out with Capex the balanced approach.
The short term versus long term investments is the right approach.
Not to mention the debt pay down not to mention the debt paydown.
Our next question comes from Anna <unk> from Needham <unk> Company. Please go ahead.
Great. Thanks, so much and good morning, guys. Thanks for taking our question.
I wanted to ask about gross margins.
There are about 300 basis point below the pre pandemic level for the business can you talk about what's implied in the guide for gross margins for the year.
We expect the declines there can you begin to moderate here in the first half on freight normalizing or is that mostly dependent on the supplies category stabilizing.
And then secondly, and connected to that Ron you had mentioned for a number of quarters now promotional activity in this space being pretty rational but can you talk about what you saw in the fourth quarter and what are you seeing to start 2003, so far thank you so much.
Yes, let me take the first one.
So the vast majority of the margin pressure on the business is driven by that transitory mix shift headwinds.
In prior economic cycles, as Ron mentioned with the discretionary categories of an impacted for about five or six quarters, we'd expect that to follow a somewhat similar pattern. Our guide for the year implied EBIT down in the first half flat to up in the second half primarily due to that transitory mixed shift now underneath the businesses, we continue to make operational.
<unk> if you look at our services business, we grew margin year over year. If you look at our digital business. We grew margin year over year that includes a rapid scaling of our AD network. So taking all of that and we're taking a somewhat cautious view and we're focused on executing as we navigate through that environment and I'll flip it to Ron for the second question, Yes, Hi, Adena, Thanks for the quest.
<unk>.
Overall, the pet market does continue to be fairly rational one of the dynamics in the industry is demand continues to exceed supply that gap is narrowing but at the same time, we're getting cost concessions and some favorability in freight which gives us more leeway from.
From our standpoint, we focus on delivering value that includes great products for great prices. So we're seeing.
Significant growth and wholehearted as an example, which is more of a mid tier price, but great value for a great product, where we promote we focus on being strategic in search surgical's, we've talked in the past about leveraging promotions to drive outcomes like focus where we have favorable profitability and loyalty program adoption like vital.
Care and.
And speaking of vital care customers saved $400 a year in vital care, we're thrilled to get over 5 million customers. So we see the market rational.
And there is a fundamental reason for that and Thats kind of demand continues to exceed supply.
The next question comes from Simeon Gutman from Morgan Stanley . Please go ahead.
Good morning, everyone I wanted to follow up please on the guidance so.
The down $10 million that it sounds like some buffer in case, the first half or second half I guess mix doesn't pan out and Thats just to confirm.
The right interpretation.
Yeah, I'd say, we're taking.
A prudent view Simeon when we look at the year and Thats why we kind of gave a little bit more color on the half versus half.
Do you think about the half guide with EBIT down in the first half flat to up in the second half that is an expectation around sort of the pattern of the supplies and CA categories.
Okay.
The comment around 100 basis points improvement in supplies.
Is that flowed through to the first half and then I guess is that a one year number or is it a stack that's an underlying like how should we interpret that as that would suggest things are getting better sequentially or do you not run rate that into your first half guide.
So the comment on Q4 versus Q3 with the sequential improvement in the growth rate versus year ago. So sequential improvement in the growth rate versus year ago in terms of Q1, we're not going to break down at the segment level. What we said at the macro level is our momentum on the total business has continued.
Into Q1, we see both category strength as well as we're happy with what we're seeing.
I guess not early days anymore, but five or six weeks into our Q1.
Our next question comes from Steven Forbes from Guggenheim Securities. Please go ahead.
Good morning, Ron Brian .
Wanted to follow up or start with ROIC return on invested capital I think Brian you mentioned some high ROI investments like coolers. This year. So open maybe if you could just take a step back given the guidance for 2023 and speak to your ROIC targets and our hurdle rates and just comment on whether the current environment does impact.
And your willingness or ability to spend on strategic initiatives or if youre still sort of achieving those hurdles and targets.
As you would expect.
Yes, I actually love. This question. So thanks for it if I think about our Capex investments if you think about where we're.
We guided on vet hospitals, and small town rural locations. Those are both meaningfully above any hurdle rate that we put out in terms of ROIC.
Small town rural locations are cash flow positive generally in the first year and aggregate those locations are performing above our expectations for the ones that we've actually rolled out so 10% to 15 is a slight further step in to that scale pilot in year two.
That remains a priority for us in that $50 to 55 hospitals continues to track for the 247, we have in place in line or above our historical IPO model for that so those are tangibly above any kind of hurdle rate for ROIC.
We are doing if you look at the step down in Capex from 2022 levels to 2023, we did have some sort of one time ish investments last year Freezers is the big one that we've referenced we have freezers and over 1000 locations now in our <unk>.
That sort of return on investment that that doesn't take a whole lot to compute.
Look at the fresh market as a slightly below $1 billion market growing to $4 billion in the next three years. We think we have a competitive advantage in that market. So the investment was something that we felt really good about making let me build on that that does not imply we won't increase the number of coolers. It was a unique deal with a certain vendor where the financial terms were in.
That in since we put in the coolers there are other instances, where the vendors and the majority of lenses, where the vendors fund the coolers. So we don't anticipate.
Not putting in more coolers because the category is growing it's just where those dollars get paid for in most instances it's vendor funded.
I appreciate the color and then just a quick follow up more of a clarification clarification question around the share count it looks like the guidance implies two 5% growth. So maybe just help help us understand what's driving this on a year over year basis.
What's the right burn rate to think about.
As the business stands today as it pertains to the share count.
Yes, I think.
I have to think about there since we went public two years ago, we started issuing equity as a company two years ago and there is a slight increase in share count associated with that.
Our next question comes from Seth Basham from Wedbush Securities. Please go ahead.
Thanks, a lot and good morning, my question's around inflation can you give us some color on how much inflation driven pricing benefited your comps in the fourth quarter and what your outlook is for 2023 that would be helpful.
Hey, Seth.
I'll talk briefly about 'twenty three and then.
Then Brian can talk about.
Packed into Q4.
The pricing we took in 'twenty, one and 'twenty two as sticky.
<unk> continues to exceed supply, particularly with consumables. We believe the vast majority of vendor pricing has come through.
While there may be pockets, we don't anticipate significant further vending vendor pricing actions in 'twenty three the way I think about 'twenty three is it.
There'll be a balance of some areas, where theres disinflation in some areas, where there is slight inflation. So I'd call. It an even year in terms of how to think about it at the category level and our level I'll, let Brian talk about that for Q4, yes.
Just add that Amy College, and our merch team they really do a tremendous job managing cost inputs and pricing actions and I also add that freight costs have improved modestly in the second half we would expect that to continue into 'twenty three one of the benefits of having a differentiated portfolio is the strength of our relationship with vendors. So we typically have a long lease.
Lead time to evaluate any inflationary inputs analyze the pricing elasticity and then respond in a way that's in the best interest of customers and the company.
That's helpful and just a follow up so flattish in terms of 2023, but there should be some wrap around benefits from the pricing check in 2022 is that a low single digit contribution to your comps in 'twenty three.
Yeah, we're not going to get into specifics what I will tell you is that when you look at our basket. We've been really pleased with our basket performance not just in Q4, but for the balance of the whole year in 'twenty. Two we're excited about that in 'twenty three and that is much more than pricing. It has to do with a lot of the hard work that the team is driving.
As a reminder, if you have a question. Please press Star then one.
Our next question comes from Michael Lasser from UBS. Please go ahead.
Good morning, Thanks, a lot for taking my question.
There's a lot to unpack with the guidance given the extra week. The adjustments you made to the definition of adjusted EBITDA.
On that can you give us more of an explicit sense on how youre thinking the comp is going to unfold.
Of course of the year you expect the <unk>.
Applied business to improve in the back half does that mean, the overall comp is going to improve in the back half and then what is the year over year change in margin.
Assumed in the midpoint of the guidance.
Yes. Thanks for the question, Michael I'm, not going to get into any kind of quarterly guide I would tell you I'll reiterate some of the points. We made in the guidance. We expect consumables to remained strong services to remains strong we've talked about a 5% to six quarter cycle in the discretionary categories were somewhat in the middle of that so we'd expect that to normalize as we can.
Get into the back half with that certainly would come enhanced revenue and enhance margin.
And my follow up question is on the long term margin outlook.
So your operating margin for this year is going to be slightly above where it was in 2019, what's the path to getting to the long term goals that you had outlined at your analyst meeting a year ago is it simply seeing an improvement in the supplies business.
As a way to improve the overall profitability of the enterprise from you.
Yes, a couple of points Michael number one you hit on it.
The impacts of the business from mix shift is sick.
Cyclical this is something that we would expect to normalize over time I would remind you too that in the fourth quarter, we deleveraged on an SG&A rate by 170 basis points in the fourth quarter 70 basis points for the full year. So we have cost actions in place to make sure that we are deleveraging what that does for US is it protects us in any kind of a.
Scenario in 'twenty, three and then an upside scenario provides a significant leverage to enhance that EBITDA rate.
I will also tell you when you look at the long term, we're excited about our positioning in the market. We continue to invest in <unk> as that model matures. We would expect improvements in services gross margin, we talked last year at analyst day about having about 500 basis points of room to go on our digital margin. We continue to make progress against that so theres a lot of room for us underneath the <unk>.
<unk> and as that mix shift normalizes, we would expect that to improve.
Our next question comes from Chris, particularly area from BNP Paribas. Please go ahead.
Guys. Thanks for taking the question asked a similar question on Michael obviously cut it differently.
If I look at the guide seems to imply that two 9% year on year growth on revenue.
So if you back out the extra week, one and a half I mean can I take base effects for Q4 versus Q1 and Q2.
Out of that other point to revenue. So I guess my question is it doesn't sound like there's a lot of comp embedded in for 'twenty. Three is there is there any store closures and things like that that actually hurts revenue next year and I think to think about that could be weighing on the revenue guide for 'twenty three that we should be mindful of.
No Chris I think the way you think about revenue versus comp is relatively similar there's not a whole lot of difference between comp and revenue. So I think the numbers you are quoting are probably at the midpoint of our guide one five and three.
But that should roughly translate to come so there is comp growth implied in the guide.
Okay. That's really helpful. And then just like overall question. It sounds like you are betting that the.
Consumables hardgoods kind of starts growing again back half.
In April this year.
As the consumer like healthy like are you seeing people trade down from discretionary in the store or is it similar across demographics.
What gives you that confidence that as we get easier compares on.
Hard good supplies, if things get better in the back half.
Yeah, Hey, Chris Thanks for the question. So let me let me segmented first to be clear our consumables continues to be strong we're talking about double digit growth. There was just a piece of research that said that pet parents are twice as likely to cut back on their own food as they are their pets' food. So we don't see any change in in fact, we continue to premium is within our.
Portfolio. So in general within our portfolio. We continue to premium is tied to the Humanization trend. That's a decade long trend it continues today.
So we see strength on that we see strength on services from a supply standpoint.
You see the discretionary spend youre seeing it across different categories. We did see a sequential improvement this quarter.
We have gone back and analyzed prior recessionary times and the behavior looks looks pretty similar we saw an improvement when gas prices backed off so there's lots of different dynamics in it but if you look at past recessions, it's about a 5% to six quarter dynamic but overall.
Demand remained strong as I said it remains above supply. So that's the dynamics are positive. It's just the discretionary piece that is cyclical.
This concludes our question and answer session I would like to turn the conference back over to Ron Coughlin for any closing remarks.
Thank you operator to our analysts and our investors as always we're grateful for your time and your support.
Pet category remains resilient and it is a growth category, we remain committed to executing throughout this environment, while simultaneously, making progress against our long term strategic growth priorities.
We look forward to updating you throughout the year on our continued progress.
Fourth quarter 2000, <unk> earnings conference call.
I'll be available after the call. If you have any follow up thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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